Mercosur: Evolution and Implications for U.S. Trade Policy

Congressional research reportMar 26, 2008

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Prepared for Members and Committees of Congress

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Mercosur is the Common Market of the South established by Brazil, Argentina, Uruguay, and

Paraguay in 1991 to promote economic integration and political cooperation among the four

countries. Since then, Mercosur has struggled to achieve deep economic integration, but has

maintained a cooperative economic and political framework, which has also become an

influential voice in determining the fate of the hemisphere’s regional integration initiatives. In

particular, the U.S. vision for hemispheric integration, the Free Trade Area of the Americas

(FTAA), has stalled largely because of opposition from within Mercosur, which in turn has

focused on its own, albeit limited, expansion.

The Mercosur pact calls for an incremental path to a full integration, but after 15 years, only a

limited customs union has been achieved. From the outset, Mercosur struggled to reconcile a

basic inconsistency in a pact of partial economic union: how to achieve economic integration,

while also ensuring that the benefits would be balanced among members and that each country

would retain some control over its trade, production, and consumption structure. This delicate

balance faced overcoming serious structural and policy asymmetries that became clear when

Brazil and Argentina experienced financial crises and deep recessions. These economic setbacks

disrupted trade flows among members, causing friction, the adoption of protectionist measures,

and a retreat from the commitment to deeper economic integration.

For now, Mercosur has turned to expanding rather than deepening the agreement. Many South

American countries have been added as “associate members” and Mercosur has reached out for

other South-South arrangements in Africa and Asia – all limited agreements and unlikely paths to

continental economic integration. Internal conflicts have highlighted Mercosur’s institutional

weaknesses and slowed the integration process. On July 4, 2006, Venezuela signed an accession

agreement to become its first new full member, making Mercosur the undisputed economic

counterweight to United States in the region, but raising questions about how Venezuela’s

membership may shift regional political and trade dynamics.

It appears that Mercosur has opted to emphasize its expansion both in the region and with other

developing countries over agreements with its largest developed country trade partners, looking

to the World Trade Organization (WTO) as the preferred alternative for achieving many of its

trade policy goals. Nonetheless, U.S.-Mercosur commercial and economic ties are expanding and

the United States is pursuing deeper bilateral trade relations with Uruguay that could provide new

ideas for a broader integration commitment. The alternative may be for Mercosur and the United

States to expand their mutually exclusive bilateral agreements, increasing the potential for

overlapping trading systems, which few, if any, view as either economically or administratively

optimal.

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U.S.-Mercosur Trade Prospects....................................................................................................... 1

Formation and Institutional Development....................................................................................... 3

Intra-Mercosur Trade and Internal Dynamics ................................................................................. 5

Intra-Mercosur Trade Trends..................................................................................................... 6

Asymmetries: Country Perspectives ......................................................................................... 8

Argentina............................................................................................................................. 8

Paraguay and Uruguay........................................................................................................ 9

The “Pulp Mill” Conflict......................................................................................................... 10

Mercosur External Issues ...............................................................................................................11

Mercosur Outreach...................................................................................................................11

Venezuelan Accession ............................................................................................................. 12

Mercosur and the Doha Round ............................................................................................... 14

The Mercosur-Israel Free Trade Agreement ........................................................................... 15

China-Mercosur Trade ............................................................................................................ 15

Implications for U.S. Trade Policy ................................................................................................ 15

Figure 1. U.S.-“Mercosur-4” Balance of Merchandise Trade ......................................................... 2

Figure 2. Intra-Mercosur Exports as Percent of Total Mercosur Exports, 1990-2007 .................... 6

Table A-1. U.S. Merchandise Trade with Mercosur ...................................................................... 17

Table A-1. Intra- and Extra-Mercosur Merchandise Trade by Country......................................... 19

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Appendix A.................................................................................................................................... 19

Author Contact Information .......................................................................................................... 20

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n March 26, 1991, Brazil, Argentina, Uruguay, and Paraguay signed the Treaty of

Asunción, establishing the Common Market of the South (Mercado Común del Sur—

Mercosur) with the intention of strengthening sub-regional development and cooperation

through economic integration. Since then, Mercosur has struggled to achieve deep economic

integration, but has maintained a cooperative economic and political framework, which has also

become an influential voice in determining the fate of the hemisphere’s regional integration

initiatives. In particular, the U.S. vision for hemispheric integration, the Free Trade Area of the

Americas (FTAA), has stalled largely because of opposition from within Mercosur.1 Venezuela’s

July 2006 signing of an accession agreement only reinforces Mercosur as the undisputed

economic counterweight to the United States in the region and raises further doubts over the

prospects for a hemispheric-wide trade agreement. This report examines the evolution of

Mercosur as it relates to U.S. trade policy in Latin America. It will be updated periodically.

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The Mercosur countries are experiencing an extended period of strong economic growth after a

deep recession caused by financial crises in Brazil (1999) and Argentina (2001). They currently

have competitive exchange rates, stable macroeconomic conditions, and strong growth in exports

and foreign direct investment largely because of the global commodity price boom. Commodity

prices, however, cut two ways. Although strong agricultural prices have fueled export growth, the

rising price of oil has offset some of these gains for the net oil importers (Venezuela being the

exception), contributing to deteriorating current account balances over the past year. Within

Mercosur, Brazil dominates the trade relationship, running a sizable and growing trade surplus

with the rest of the pact.2

Mercosur has a well-diversified trade relationship with the world. In 2006, the European Union

(EU) was Mercosur’s largest trade partner, capturing 25% of total trade, followed by Asia with

22%, and the United States with 19%. By contrast, the four Mercosur countries together

accounted for only 3.0% of total U.S. trade. With the recent addition of Venezuela, the “Mercosur

5” make up 3.6% of total U.S. trade, the increase accounted for almost entirely by U.S. imports of

Venezuelan oil. Collectively, the “Mercosur 4” would rank 9th for U.S. exports and 14th for U.S.

imports, slightly ahead of Brazil by itself, the largest economy in South America, responsible for

80% of total Mercosur trade with the United States.3

For more on the FTAA, see CRS Report RS20864, A Free Trade Area of the Americas: Major Policy Issues and

Status of Negotiations, by (name redacted).

Inter-American Development Bank (IDB). Integration and Regional Programs Department. Mercosur Report No. 12:

2006-2007. Washington, D.C. February 2008. pp. 4-6.

U.S. Department of Commerce data as presented in the World Trade Atlas.

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Figure 1. U.S.-“Mercosur-4” Balance of Merchandise Trade

Source:

U.S. Department of Commerce.

Patterns in U.S. merchandise trade with the “Mercosur-4” appear in Figure 1 (country data for all

five appear in Table A-1). Note that trends are heavily skewed by Brazil’s large economy. U.S.

imports of Mercosur goods rose steadily from 1996 to 2006, paralleling growth in the U.S.

economy. Expansion of U.S. exports, by contrast, was flat from 1996 to 2001 and then fell as

import demand collapsed around deep recessions in Brazil and Argentina. U.S. exports rebounded

in 2004 as the Mercosur economies recovered, and by 2007, the U.S. trade balance turned from

deficit to surplus for the first time since 2001. The U.S. trade surplus reflects growth in demand in

all four Mercosur countries. For Brazil, U.S. imports actually declined slightly in 2007, as U.S.

exports rose by 28%. U.S. exports have been helped by Brazil’s strong economic growth resulting

in increased demand for U.S. inputs such as aircraft engines and parts, as well as the strong

appreciation of Brazil’s currency relative to the U.S. dollar.

Major U.S. exports to Mercosur include mostly capital and high technology goods such as

mechanical and electrical machinery (computers, vehicles, aircraft, medical equipment, and

pharmaceuticals). The primary U.S. imports are components for machinery and vehicles,

agricultural products, and oil if Venezuela is included. Specifically, the United States imports

primarily machinery and mineral fuel from Brazil, mineral fuel and processed foods from

Argentina, sugars and woods from Paraguay, and meat and woods from Uruguay. Despite being a

relatively small U.S. trade partner, Mercosur contains two of South America’s largest economies,

and so prospects for growth in trade and investment drive, in part, ongoing U.S. interest in

maintaining cordial and cooperative relations, as does the expectation for deeper Western

Hemisphere integration, perhaps including, at some point, the FTAA.

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Mercosur evolved from a series of 1980s bilateral agreements between Brazil and Argentina. It

was conceived as a way to foster new levels of political and economic openness and cooperation

following a prolonged period of mutual distrust, much of it taking place under military

dictatorships in both countries. In addition, as the South American economies moved away from

an import substitution model of development to one based increasingly on trade openness, a

regional trade agreement made sense given the four countries were “natural trade partners,”

sharing geographical, cultural, and economic complementarities.4 In fact, Uruguay and Paraguay

pressed hard to expand the arrangement to a four-country common market to improve their trade

prospects, or at the least, ensure that they would not be isolated by a bilateral economic pact

between their two largest neighbors.5

Mercosur, therefore, evolved from economic and political circumstances that emphasized the

need to preserve and enhance the Brazil-Argentine bilateral relationship, while fostering cautious

ambitions for sub-regional economic integration that could also serve as a platform for the four

countries’ insertion into the global economy. Ultimately, as one scholar has observed, meeting

expectations is critical, and Mercosur’s success rests on the provision of consistent reciprocal

market access and a “framework for cooperation” that promotes mutual economic growth and

development.6 It is the difficulty in achieving this standard, as shall be seen, that has been at the

root of persistent discontent within Mercosur.

Formally, the Treaty of Asunción established Mercosur as a common market among Brazil,

Argentina, Uruguay, and Paraguay for the stated purpose of accelerating economic development

and social justice. The goal envisioned improved living conditions for all member countries

through “balanced and managed growth in trade flows.”7 The treaty followed guidelines

compatible with the Latin American Integration Association (Asociación Latinoamericana de

Integración—ALADI), a regional trade organization that provides a common, yet flexible

framework for establishing sub-regional trade pacts that encourages inclusiveness and minimal

harm to non-members. These pacts may be both “regional and partial in scope,” in contrast to the

U.S. free trade agreement (FTA) model that tends to be comprehensive. For example, Mercosur

adopted as basic tenets “gradualism, flexibility, and balance,” and allows for the negotiated

accession of other countries.8

Vaillant, Marcel. Mercosur: Southern Integration Under Construction. IPG. February 2005. p. 53.

The addition of Uruguay and Paraguay raised a fundamental debate about Mercosur’s purpose. Despite the charter

having well-defined integration and development goals, Brazil and Argentina have viewed Mercosur as a political

project as well. Paraguay and Uruguay, by contrast, have emphasized its economic priority, with some observers

insisting that Mercosur gets off track when it operates from a political agenda. See Lacalle de Herrera, Luis Alberto.

Mercosur: Project and Perspectives. Diplomacy, Strategy & Politics Review. Brasilia: April/June 2007, pp. 186-193.

(Note, Mr. Lacalle was president of Uruguay 1990-1995 and played an instrumental role in the negotiation and creation

of Mercosur.)

Vaillant, op.cit., pp. 53-54.

Costa Vaz, Alcides. Trade Strategies in the Context of Economic Regionalism: The Case of MERCOSUR. In:

Aggarwal, Vinod K., Ralph Espach, and Joseph S. Tulchin, eds. The Strategic Dynamics of Latin American Trade.

Washington, DC. Woodrow Wilson Center Press. 2004. pp. 234-35.

Porrata-Doria, Jr., Rafael A. MERCOSUR: The Common Market of the Southern Cone. Durham: Carolina Academic

Press. 2005. pp. 14-16.

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Mercosur followed 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)

based on a schedule of automatic tariff reductions. The formal jump to a common market was

made on January 1, 1995, but in reality, Mercosur became (and remains) only a partial customs

union.9 It adopted a common trade policy and a schedule of common external tariffs (CETs) that

applies to 80% of tariff line items, but with some very important exceptions for sensitive sectors

such as sugar, automobiles, capital goods, computers, and other technology products. The

exceptions were to be phased out by 2006, but many have been extended to 2011, requiring a set

of complex rules of origin.10

In addition, there are weaknesses with the CET, a core requirement of a true customs union. The

CET can be levied twice, first when a good initially enters a Mercosur country, and again if it

crosses into another member country. Between the double taxation and multiple exceptions

problems, resolving application and uniform enforcement of the CET remains an important

unaddressed issue. The double taxation issue is a particular problem for Paraguay, which will

suffer significant revenue losses without some type of comprehensive customs revenue sharing

plan because most goods enter the Mercosur area through one of the other three countries.11 The

incompleteness of the customs union fosters asymmetry issues (discussed below) that are at the

root of Mercosur discontent, and that also suggest that the achievement of a full common market

remains a distant, if not illusory goal.

The Treaty of Asunción also provided for macroeconomic policy coordination and harmonization

of policy legislation at the sectoral level (e.g. energy, agriculture, industry, technology). Some

macroeconomic policies, such as exchange rates, have been forced toward complementarity by

economic events, but differences remain significant and full coordination of policy is not

currently feasible. The rationale for sectoral cooperation rests on inter-country factor mobility

being pursued gradually, allowing comparative advantage to work, while easing the integration

adjustment process. Nonetheless, sectoral issues and disputes remain a continuing challenge,

especially between Brazil and Argentina, as does cross-border movement of goods both within

Mercosur and to third country markets.

All parties were required to accept a common set of rights and obligations (Article 2), with little

allowance for special and differential treatment for smaller economies. There were many followon 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.12 Dispute settlement,

however, is largely unenforceable and reflects a continuing problem of Mercosur’s institutional

effectiveness.

A free trade agreement (FTA) eliminates tariffs on goods exchanged among participating countries. In a customs

union, 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

members.

IDB. MERCOSUR Report No. 10: 2004-2005. February 2006. Washington, D.C. p. 70 and Vaillant, op. cit. p. 55.

IDB. MERCOSUR Report No. 11: 2005-2006. February 2007. Washington, D.C. pp. 45-47.

For details on the legal documents, see Porrata-Doria, MERCOSUR: The Common Market of the Southern Cone.

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Three more recent developments call into question Mercosur’s functional institutional capacity.

First is the expansion of its membership. Venezuela signed an accession agreement on July 4,

2006 (discussed in detail below), but has been reticent to take on all commitments of the customs

union, especially the CET. In December 2006, Bolivia also requested to upgrade its status from

associate to full member, although it is reluctant to relinquish its membership in the Andean

Community of Nations (Comunidad Andina de Naciones—CAN), as would be required under

Mercosur rules.

Second is the new Mercosur Parliament established in December 2006 and headquartered in

Montevideo. It comprises 18 representatives from each full member country and has as its

primary goal to work toward harmonization of national laws and policies, but it has no authority

over national government bodies.13 Already a point of contention, it has come under criticism for

being either too weak to be meaningful, or risking unequal national representation relative to the

participating countries’ population. In either case, it is viewed by some as raising even more

questions over the institutional strength of Mercosur.14

Third is creation in 2006 of a $100 million Structural Convergence Fund, financed mostly by

Brazil and Argentina, effectively amounting to a transfer of resources to the smaller countries to

help ameliorate the inequalities of Mercosur. It provides funding for development and

infrastructure projects, destined primarily for Uruguay and Paraguay, but may not be a sufficient

response as a compensatory mechanism for acknowledged trade asymmetries within the pact.15

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Intra-Mercosur trade relations have had an uneven and at times troubled history. A combination of

internal policy contradictions, diminishing expectations, and a hostile external economic

environment in the late 1990s resulted in uneven trade benefits and recurring recriminations

against the incomplete customs union. The return of a highly beneficial global economic

environment has alleviated some friction, but has not eliminated the need to make policy

adjustments or to address concerns raised by the two smallest members of Mercosur. These issues

again collectively point to a consistent criticism of Mercosur: its weak institutions and incomplete

integration. Too frequently, decision making is the product of political agreement, often on a

bilateral basis rather than a rules-based bloc-wide determination. This ad hoc approach to process

generates much of the conflict within the customs union, raising questions about the level of

commitment to completing the quadrilateral economic integration scheme.16

Latin American Weekly Report. Mercosur Meeting Ends on Sour Note. December 19, 2006. p. 7.

The Argentine Chamber of Exporter, for one, has raised concerns over the inherent weaknesses of the Mercosur

Parliament. Camara de Exportadores. Instituto de Estrategia Internacional. Parlamento del Mercosur: ¿La Voz de los

Ciudadanos en la Integración? Buenos Aires, July 2006. pp. 6-7 and 27-28. See also: Lacalle, op. cit., p. 190.

IDB, MERCOSUR Report No. 12, pp. 40-41.

Phillips, Nicola. The Southern Cone Model: The Political Economy of Regional Capitalist Development in Latin

America. London: Routledge, Taylor & Francis Group. 2004. p. 96.

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As Mercosur lowered tariffs, intra-Mercosur trade was expected to grow relative to trade with

third-party countries. As seen in Figure 2, this was the initial response from 1991 to 1998, with

the jump in intra-Mercosur exports also due to its growth from an initially small base, other

economic reforms, and the decade’s lengthy global economic expansion. There is, however, an

equally evident sudden collapse of intra-Mercosur exports, which fell from 25% of total trade in

1998 to 11% in 2002, before renewing an upward climb to 15% by 2007.17 This setback reflects a

fall in aggregate demand linked to the region’s economic crises, intra-Mercosur tariff increases in

response to internal Mercosur problems, and Argentina’s pressure to lower the CET on capital

goods, demonstrating a still strong dependence on trade with developed countries for products not

available in the region.18

Figure 2. Intra-Mercosur Exports as Percent of Total Mercosur Exports, 1990-2007

Source:

Inter-American Development Bank. Mercosur Report No. 12, p. 20.

From the outset, Mercosur struggled to reconcile a basic inconsistency of partial economic union:

how to balance trade integration and equity of member benefits, while retaining some semblance

of national control over trade, production, and consumption structure. Natural or structural

By comparison exports are 60% of intra-EU trade. Intra-Mercosur trade dependence varies by country. In 2005,

Mercosur captured 9.8% of Brazil’s total trade (exports plus imports) compared to 26.7% for Argentina, 38.8% for

Uruguay, and 50.8% for Paraguay.

Phillips, op. cit., pp. 89 and 94-95.

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asymmetries are at the heart of the problem given the pact integrates four economies with huge

discrepancies in size, structure, resource endowment, and level of development. In addition to the

absolute differences in size, relative differences can fluctuate widely over time. For example, the

size of Argentina’s economy (GDP) tends to be half that of Brazil’s, yet this metric has ranged

from a high of 60% in 1992 to a low of 22% in 2002 because of dramatic shifts in relative

economic performance, in this case punctuated by the prolonged recession and financial crisis in

Argentina.19

These structural 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 dramatically alter commercial flows, causing large trade imbalances that can

threaten the stability of intra-Mercosur relations as seen in Figure 2. When they operate in

tandem, the Mercosur policy adjustment framework has proven to be vulnerable, particularly at

times when the countries face external economic shocks.20

Such a confluence of events occurred in the 1990s following a series of global shocks that spilled

over into Mercosur. The July 1997 Asian financial crisis was the first shock, followed by the

Russian default in the summer of 1998. These crises directly affected investor confidence in

Brazil, causing extensive capital flight in the fall of 1998, which in turn led to Brazil’s steep

currency devaluation in January 1999 and the abandonment of its fixed exchange rate

stabilization program. With Argentina’s strict dollar convertibility regime still in place at the time,

the two countries faced a significant “exchange rate policy asymmetry” that altered trade patterns.

The sudden trade imbalance was compounded by Argentina’s lengthy recession that also began in

1998, leading to its own, far more serious, financial crisis. Argentina’s crisis led to the

abandonment of its fixed exchange rate regime in December 2001 and subsequent sovereign debt

default.

Mercosur’s leaders, aware of macroeconomic weaknesses exposed by these crises, proposed a

Mercosur Relaunch program as early as May 2000. It formally reaffirmed a commitment to

deeper integration, but the Relaunch enthusiasm soon faded as it proved unable to overcome the

effects of the financial crises, including the spread of recession to Uruguay and Paraguay and the

dramatic fall in trade between Argentina and Brazil (90% of intra-Mercosur commercial

exchange).21 Intra-Mercosur relations became increasingly strained, with Argentina applying

temporary restrictions on Brazilian imports, further reducing trade and diminishing incentives for

deeper economic integration.

By 2002, the Mercosur economies had all hit bottom and began to rebound, as reflected in intraMercosur trade. Problems with intra-bloc trade imbalances, however, remained. As the data in

Table A-1 demonstrate, all four countries show a linear increase in intra- and extra-Mercosur

trade and, with the exception of Paraguay, expanding trade surpluses in their extra-Mercosur trade

relations. A core issue remaining is the persistent and growing trade deficits that each country

runs with Brazil. A related concern involves the accumulating trade deficits that Paraguay and

Uruguay have with Argentina.

Heymann, Daniel and Adrián Ramos. MERCOSUR in Transition: Macroeconomic Perspectives. United Nations.

Economic Commission for Latin America and the Caribbean (ECLAC). Santiago, Chile. December 2005. p. 17.

For details, see IDB, MERCOSUR Report No. 10, pp. 39-41.

Bouzas, Roberto. Mercosur After Ten Years. In: Tulchin, Joseph S. And Ralph H. Espach, eds. Paths to Regional

Integration: The Case of Mercosur. Woodrow Wilson International Center for Scholars. Washington, DC. 2002. p. 120.

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The specific asymmetry issues discussed above manifest differently for each country. Two

commonly cited threads are the expanding trade deficit with Brazil, particularly since the region

began its economic recovery (see Table A-1), and unequal investment and trade in industrial

goods. Brazil is seen as the undisputed winner on both counts and is the most ardent supporter of

Mercosur for political as well as economic reasons. Interestingly, it is also the least trade

dependent member of Mercosur, with total Mercosur trade amounting to no more than 10% of its

world trade. By contrast, intra-Mercosur trade accounts for 25%-30% of Argentine trade. The two

smaller countries are even more dependent on their larger neighbor’s markets, but Mercosur has

fallen to only 38% of their total exports, down from recent highs of 59% for Uruguay and 41%

for Paraguay. This trend may suggest that both countries are reacting to perceived inequalities and

structural impediments by diversifying their trade outside of Mercosur.

Both Paraguay and Uruguay have made numerous formal proposals to solve the asymmetry issue.

To date, some changes in rules and other technical requirements have been made to improve trade

opportunities for the small countries.22 The most salient development was creation of the

Structural Convergence Fund, which has been slow in becoming operational and has only

approved its first projects in 2007. So far the asymmetries issue has not been resolved and

remains a major challenge to the long-term success of Mercosur.

Argentina has numerous trade disputes with Brazil, heightened since the post-crisis period when

it began to run large trade deficits with Brazil (see data in Table A-1). The structure of these

deficits were a particular problem because they were weighted toward high value-added industrial

goods, competing directly with Argentina’s plans to restart its own industrial sector.23 The

imbalance became increasingly severe; Argentine exports fell from 14% of Brazilian imports in

1998 to 9% in 2007. Brazilian exports, in contrast, rose from 22% to 33% 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 postrecession jump in Argentine aggregate demand; 3) Brazil’s export promotion policy emphasizing

greater use of domestic inputs, and structural factors in the trade composition of the Mercosur

countries.24

An analysis of Mercosur trade composition suggests that Brazil’s trade surplus is driven

considerably by falling import shares of the smaller Mercosur economies, presenting two

structural problems not easily addressed. First, the export supply produced by the Mercosur

countries does not correspond strongly with Brazil’s import demand. Second, Argentine and

Uruguayan exports may be less competitive relative to those from countries outside the Mercosur

bloc. They also compete closely with one another in the Brazilian market. Together these trends

suggest that a natural correction in the Mercosur trade flows may not be likely, leading to

See IDB, Mercosur Report No. 12, p. 37 for a discussion of the specific rule changes.

IDB, MERCOSUR Report No. 11, pp. 30-32, Heymann and Ramos, MERCOSUR in Transition, p. 20, and World

Trade Atlas.

Ibid.

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Argentina’s continued demand for administered remedies to address certain chronic sectoral trade

imbalances (e.g. appliances, textiles, paper).

Current administered agreements include the use of voluntary export restraints, quotas, and export

taxes.25 One important example is the Competitive Adaptation Mechanism (CAM) agreed to by

Brazil and Argentina in February 2006, over the strong objections of Brazilian industry. It permits

protective measures in cases where imports “cause or threaten to cause damage” to a domestic

product or industry (safeguards). A convoluted process, it allows for both voluntary export

restraints and tariff rate quotas. The CAM was a major policy shift for Mercosur and raises

multiple issues. First, it is a bilateral arrangement established under the ALADI system and so not

governed by Mercosur. Second, import restrictions represent a retreat from the stated free trade

philosophy of Mercosur. Third, the CAM has no enforcement mechanism under ALADI. In short,

it compounds existing institutional problems and may undermine the Mercosur agreement even as

it attempts, so far unsuccessfully, to restore balance to the largest bilateral relationship within it.26

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The two smaller Mercosur partners face similar trade asymmetries, but also react against the

uneven exercise of power. Linked to Mercosur by a natural trade relationship, both Paraguay and

Uruguay have still had to respond to structural impediments to their exports. In part, trade

asymmetry is a function of their relatively small economies, but the major issue is the disparity

between Mercosur’s stated intent to help all members attain their development goals and the

actual functioning of the agreement itself. The treaty’s incomplete integration can impede

Paraguay’s and Uruguay’s exports, does not provide special and differentiated treatment, and

often allows bilateral “diplomacy” to circumvent formal decision-making mechanisms.27 The

safeguards mechanism adopted by Brazil and Argentina is one example, which appears to

contradict the principle of reciprocity in rights and obligations. Ad hoc restrictions on trade are

another major area of complaint.

Paraguay and Uruguay are not in identical situations and so each has advocated different

remedies. Historically Paraguay’s economy has been the most dependent on Mercosur. As a small

agricultural economy, geographically remote and landlocked, it depends on its neighbors for

export routes to third countries, particularly when river access is seasonally limited. Paraguay is

also the poorest and least developed Mercosur member, and so relies on the Mercosur’s promises

of market access, enforceable obligations, and integration for its fledgling manufacturing

industries. Paraguay’s exports have at times been blocked by bureaucratic restrictions in both

Brazil and Argentina and private sector complaints have had little success in resolving what they

believe amounts to protectionist non-tariff barriers (NTBs). Paraguay has expressed interest in

exploring the possibility of receiving trade preferences within Mercosur as one remedy, but

cannot envision leaving Mercosur.28

IDB, MERCOSUR Report No. 10, p. 47 and MERCOSUR Report No. 11, pp. 35-39, 128.

Haskel, David. Bilateral Agreements: Argentina, Brazil Start Safeguard System To Shield Industries from Mutual

Imports. International Trade Reporter. February 7, 2006. p. 247, Inter-American Development Bank. Southern

Common Market: New Integration and Co-operation Agreements Between Argentina and Brazil. http://www.iadb.org/

intal, and IDB, MERCOSUR Report No. 11, pp. 52-58.

Phillips, op. cit., p. 99.

Osava, Mario. Latin America: Mill Conflict Continues to Delay Integration. Inter Press Service. January 4, 2008, and

author’s interviews with public and private officials in Asunción, November 2007.

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Uruguay faces many of the same NTB problems as Paraguay, but with a higher per capita income,

developed port network (direct access to third countries), and more diversified economy, its

options for trade expansion both within and outside of Mercosur are greater. It too looks to the

Mercosur agreement to fulfill its promises of market access and enforceable obligations. Finding

a balance both within and outside Mercosur, including exploring deeper bilateral relationships

with the EU and the United States is the challenge for Uruguay. Frustrated by past vulnerability to

Argentina’s financial crisis and Brazil’s periodic barriers to trade, Uruguay has opted to diversify

its trade with the world where possible, but its policy options are hindered because it cannot

change or ensure enforcement of the Mercosur agreement, it cannot leave Mercosur, nor can it

formally negotiate outside it.29

The asymmetry issue suggests a certain implicit political hold that Brazil has over the Mercosur

derived from its disproportional economic power. By presiding over an incomplete customs

union, it can selectively limit the free movement of imports to suit its sectoral needs (at a cost to

the other countries equal to the high tariff on capital goods or forgone trade for example), and can

also inhibit movement of goods from the smaller countries bound for countries within Mercosur

or outside it. Brazil’s dominant economic and political-institutional control over the Mercosur has

therefore at times fostered a resentment among the smaller countries, increasing their interest in

pursuing third country trade arrangements.

Uruguay has responded in part by exploring deeper trade affiliations outside the pact. On

November 4, 2006, following U.S. Senate approval, a Bilateral Investment Treaty (BIT) between

the United States and Uruguay went into force. Uruguay also sought and received permission

from Brazil to explore an FTA with the United States. It subsequently decided to pursue a Trade

and Investment Framework Agreement (TIFA) with the United States, which was signed on

January 25, 2007. A Joint Commission on Trade and Investment provides the means for ongoing

U.S.-Uruguay discussions regarding opportunities for specific trade deals.

The TIFA approach is flexible and allows Uruguay to deepen trade relations with the United

States without compromising its Mercosur commitments. Uruguay has linked its desire to

develop closer U.S. trade ties with its concern over increasing “bilateralism” between Argentina

and Brazil. In December 2006, Argentina responded by criticizing Uruguay for attempting to

circumvent Mercosur in its quest to diversify its trade relations, again pointing to an internal strife

based on a trade pact that does not appear to operate as promised.30 Many in Uruguay are not

indifferent to this viewpoint and in an ideal world would like to pursue an FTA with the United

States in a way that would not compromise its standing with Mercosur.

ȱȃȱȄȱȱ

Uruguay’s construction of a pulp mill opposed bitterly by Argentina is another conflict within

Mercosur. Constructed by a Finnish firm on the Uruguay River, the mill represents the largest

single foreign investment project in Uruguay and is expected to provide significant long-term

employment opportunities.31 Argentina alleges that Uruguay is in violation of a bilateral

Ibid and IDB, Mercosur Report No. 12, p. 40.

Haskel, David. Uruguayan President Turns Down Offer to Negotiate Free Trade Agreement with U.S. International

Trade Reporter. BNA, Inc. October 5, 2006, p. 1440 and Argentina Blasts Uruguay’s Pursuit of Free Trade with NonMercosur Nations. International Trade Reporter. BNA. Inc. January 4, 2007, p. 22.

Latin American Weekly Report. Pressure Builds Over Pulp Mill. August 9, 2007. Originally, the dispute involved a

(continued...)

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environmental protocol the two countries signed in 1975 and that the plant presents potentially

harmful environmental effects that could negatively affect Argentina’s national territory,

including a resort area across the river from the construction site.

A World Bank review concluded that the plant poses no serious environmental problems, but did

suggest that construction and production design changes could reduce the risk of environmental

hazard even further. The World Bank’s International Finance Corporation provided $100 million

to finance the project and the issue continues to spawn protests and diplomatic flare-ups.

Periodically, Argentine protesters continue to block bridges over the Uruguay River, disrupting

trade and tourist traffic between the two countries. Uruguay has responded at times by closing the

border. It also turned to the Mercosur system for dispute settlement. A September 2006 ruling by

the Mercosur Ad-Hoc Arbitration Tribunal found that Argentina had failed to live up to its

commitment to ensure the free movement of people, goods, and services under the pact, but no

award was made.32

Argentina also filed a petition for arbitration with the International Court of Justice (ICJ) at The

Hague. The ICJ denied Argentina’s request for an injunction to terminate construction. It also

declined to require that Argentina take actions to remove protesters. Uruguay subsequently filed a

counter claim, arguing that Argentina has failed to take such action. Additional mediation efforts

in Madrid and New York ameliorated the conflict temporarily, but the pulp mill began operations

in November 2007 even as the parties awaited a final ruling from the ICJ. Brazil has chosen not

to mediate and the ongoing dispute highlights the lack of an effective dispute settlement system

within Mercosur.33

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Although Mercosur began strictly as a four-party integration plan, changing internal and external

circumstances led the customs union to consider expanding its membership in various ways and

to consider the merits of seeking trade arrangements with third party countries and trade groups.

As part of its charter, Mercosur remains formally open to the addition of new members.

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In 1996, Chile and Bolivia joined as the first “associate members.” Since then, Mercosur has

continued to enter into “economic complementarity agreements” with most of South America,

under ALADI guidelines. Associate membership is a limited arrangement, largely focused on the

long-term pursuit of a free trade agreement, often emphasizing sector-specific agreements and

(...continued)

second plant to be built by a Spanish firm. This plant has been relocated, defusing it as an issue.

Inter-American Development Bank. Institute for the Integration of Latin America and the Caribbean. Dispute

Between Argentina and Uruguay: Arbitration Tribunal Award. INTAL Monthly Letter. September 2006 and Latin

American Weekly Report. November 15, 2007. This episode points to what one scholar observes to be Mercosur’s

highly politicized dispute settlement and decision-making processes, which can allow for resolutions based on

“political whim, unilateral action, and non-observance of agreed policy commitments.” Phillips, op. cit., p. 99.

One Year On, Small Dispute Threatens to Fracture Mercosur. Latin American Regional Report. Brazil and Southern

Cone. April 2006. p. 1 and Osava, Mario. Latin America’s Mill Conflict Continues to Delay Integration. Inter Press.

January 4, 2008.

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cooperation. It does not convey membership status per se, and while members may attend

meetings, they have no voting rights, do not participate in the internal functions of Mercosur, and

are not required to adopt the CET.34

In October 2004, after years of talks, Mercosur and the Andean Community signed a trade pact,

giving all Andean countries the equivalent of associate membership. Two months later, this

breakthrough led directly to creation of the South American Community of Nations, later

renamed the Union of South American Nations (UNASUR), a loosely-conceived pact including

12 countries (those in Mercosur, CAN, along with Chile, Guyana, and Suriname). The CAN and

UNASUR in many ways are not true regional agreements; they have some common rules, but

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 UNASUR agreement would be completed.35 These constraints limit prospects for deep

continental integration. Nonetheless, sectoral initiatives, such as the proposed South American

gas pipeline, already reflect increased cooperation and collective self-determination in the region,

which is also now alive in the institutional presence of the CSN.

Mercosur’s other negotiations have experienced mixed success. Trade talks with the EU for a

joint Mercosur-EU FTA and the Western Hemisphere countries for a proposed Free Trade Area of

the Americas (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 for “WTO-plus”

arrangements on market access for industrial goods, services trade, enforceable intellectual

property rights, and investment provisions. Continuing interest will depend in part on the

outcome of the Doha Round.36 South-South trade talks have advanced 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 has moved

beyond a simple framework agreement.37

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On July 4, 2006, Mercosur agreed to accept Venezuela as the first additional full member of the

pact. The accession protocol was accelerated in mid-2006 at the behest of President Hugo

Chávez, who viewed it as supportive of his effort to unify South America and advance his

“Bolivarian agenda” that generally stands in opposition to U.S. influence in the region. The

accession takes full effect only after formal parliamentary approval by all four Mercosur

countries. To date, only Argentina and Uruguay have voted to approve.38

The early stages of the accession process was expected to be longer and more involved because of

two significant hurdles: Venezuela’s membership in the CAN, which would not have been

allowed under Mercosur protocols; and the requirement to adopt the Mercosur CET. Venezuela

dispensed with the first issue by defiantly withdrawing from the Andean trade pact in April 2006.

Porrata-Doria, MERCOSUR: The Common Market of the Southern Cone, pp. 123-124.

IDB, MERCOSUR Report No. 10, p. 93.

Unlike the United States, which will consider engaging the Mercosur countries in bilateral talks, the EU prefers to

negotiate bloc-to-bloc, which would reinforce rather than diminish Mercosur’s functioning as a customs union.

IDB, MERCOSUR Report No. 10, pp. 90 and 96-100.

United Nations. Economic Commission on Latin America (ECLAC). Latin America and the Caribbean in the World

Economy 2006. Santiago, August 2007. p. 132.

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Citing Peru and Colombia’s negotiations for FTAs with the United States as contrary to CAN’s

and Latin America’s best interests, President Chávez left the pact specifically to join Mercosur. To

address the second issue, Mercosur, under Brazil’s leadership, negotiated to give Venezuela four

years to comply with the CET, with other obligations of the pact not completely phased in until

2014.39

Mercosur may have many incentives to bring Venezuela into the fold. The addition of a fifth

member adds to the economic strength of the bloc, which would comprise three-quarters of South

American GDP. Venezuela also promised immediate selective duty-free treatment for imports

from Paraguay and Uruguay, with no requirement for reciprocal treatment until 2013. Venezuela

may increase the potential for intra-Mercosur trade as a relatively large Latin American market

that also offers sectoral complementarity and energy security with its vast oil reserves and plans

for a regional pipeline.

A more thorough analysis of the potential trade effects, however, suggests that the trade and

economic benefits for Mercosur may be easily overstated. Currently, Mercosur trades little with

Venezuela and estimates of trade growth are modest at best, given limitations in the accession

protocol (exemptions and other restrictions) and current tariff preferences that already apply to a

high proportion of goods expected to benefit from the agreement. Trade between Mercosur and

Venezuela averages no more than 3% of the pacts total world trade, with the exception of

Uruguay where crude oil constitutes 12% of total imports. The energy sector promises the

greatest benefit through deeper cooperation in energy supply, but which could also be achieved

without Venezuela’s full integration into Mercosur. In addition, Venezuela’s access will

complicate trade policy coordination within the expanded bloc, both regionally and

multilaterally.40

The political motivations and ramifications for Venezuela’s accession may be even more of an

issue. Concern has grown, for example, over certain of President Chávez’s policies that may be

construed as hindering democracy, which in turn could be considered a direct challenge to

Mercosur’s democratic clause. Brazilian Foreign Minister Celso Amorim has reaffirmed his view

that Mercosur’s primary goal from the start has been to consolidate democracy in South America.

Chávez’s decision to close a key radio station (viewed by some as suppressing freedom of

speech) and his one-time plan to alter the Venezuelan Constitution to abolish presidential term

limits (viewed by some as a direct assault on the democratic process) raised concern over real and

perceived undemocratic behavior in Venezuela. This issue has escalated with some members of

the Brazilian Senate continuing to argue for postponement of a vote to consider Venezuela’s

accession.41

Mercosur. Protocolo de Adhesión de la República Bolivariana de Venezuela al Mercosur. Articulo 4. July 4, 2006.

Haskel, David. Mercosur, Venezuela Agree on Protocol for Caracas Accession to Trading Bloc. International Trade

Reporter. BNA, Inc. June 1, 2006. p. 837. The accession process has been criticized by, among others, former Brazilian

Ambassador to the United States Rubens Barbosa, who stated that “In the European Union they negotiate the terms of

entry, and then the country joins. Here, we’re doing it the other way around, which is craziness...” Rohter, Larry.

Venezuela Wants Trade Group to Embrace Anti-Imperialism. The New York Times. January 18, 2007.

A detailed analysis of the potential trade effects of Venezuela’s access may be found in: IDB, Mercosur Report No.

11, pp. 99-117and see also, ECLAC, Latin America and the Caribbean in the World Economy, pp. 132-134.

See Magalhaes, Luciana and Katia Cortes. Brazil Senator Says Venezuela Deadline on Mercosur ‘Unfeasible.’

Bloomberg. July 4, 2007, Haskel, David. Venezuela’s Mercosur Partners Downplay President Chávez’s Nationalization

Pledges. International Trade Reporter. January 18, 2007, and Wheatley, Jonathan and Richard Lapper. Left Turn

Ahead? How Lula’s Plan Could Condemn Brazil to Mediocrity. Wall Street Journal. February 21, 2007.

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Although Venezuela remains a non-voting member until the accession is ratified, it does have a

voice in Mercosur affairs, increasing its influence on intra-pact and external trade negotiations.

The marginal effect may be to strengthen resolve by some countries to challenge U.S. influence in

South America, although there are also moderating influences in all countries. Uruguay and

Paraguay could also view Venezuela as having a diluting force on Brazil’s political dominance in

the pact, but opinions seem divided at present in both countries.

Venezuela’s accession, however, may have unintended regional consequences should countries

outside Mercosur be put in a position of having to choose between a U.S. or Mercosur trade

agreement. Peru has even suggested forming a new trade bloc, the Community of the Pacific,

which would include countries with complementary trade arrangements: the United States,

Canada, Mexico, the Central American countries, Panama, Colombia, Peru, and Chile.42 This

prospect may be further reinforced by Bolivia’s request to become a full member of Mercosur,

although it appears reluctant to give up its membership in the CAN and accept the tariff

convergence challenge inherent in adapting to the Mercosur CET.43

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The current, and now long-extended, WTO multilateral round of trade negotiation highlights

other interesting institutional constraints within Mercosur. As a customs union with a supposed

common external trade policy and CET, Mercosur would theoretically need to approach the Doha

Development Round with some common, if not identical, trade negotiation objectives, or risk

differing country policies undermining the integration scheme. Mercosur has responded by

creating an ad hoc consultation and coordination group to address the Doha negotiations. The

bloc, however, does not approach the WTO as a united voice, but Doha negotiations are exploring

the possibility of a more flexible approach to address the interests of the customs union.44

Brazil has taken the negotiating lead and perhaps has the most to gain from the Doha Round on

both political and economic grounds, but it is not clear that positions benefitting Brazil will

always be those supported by the other Mercosur countries.45 Although there has been broad

agreement in the realm of agricultural issues, as part of the broader developing country

consolidated response to developed country WTO positions, there is less agreement in the areas

of nonagricultural market access and services. The most sensitive areas with respect to

maintaining a cohesive customs union are in setting tariff levels and determining sensitive

product lists that each country may elect to receive special treatment under a WTO agreement.

Given there will be limits on the number of tariff lines permitted, large differences in both these

areas among Mercosur countries could lead to either a breech of the customs union rules, or those

of the Doha agreement. Balancing these goals in the WTO negotiations is a challenge for the four

Chauvin, Lucien O. Peru Proposes New Trade Bloc of Hemisphere Nations on Pacific Coast. International Trade

Reporter. BNA, Inc. August 3, 2006. p. 1172. For a detailed summary of the environmental, legal, and economic

issues, see IDB, MERCOSUR Report No. 11, pp. 69-76.

ECLAC, Latin American and the Caribbean in the World Economy, p. 132.

IDB, MERCOSUR Report No. 11, p. 94 and Costa Vaz, Trade Strategies in the Context of Economic Regionalism:

The Case of MERCOSUR, p. 256 and Washington Trade Daily. US, EU Brazil on ‘Flexibilities.’ March 11, 2008.

On Brazilian trade strategy and the WTO, see CRS Report RL33258, Brazilian Trade Policy and the United States,

by (name redacted), pp. 5-6 and 15.

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Mercosur countries and should the Doha Round stall indefinitely, it is possible that alternative

paths to global integration may take on renewed emphasis.46

ȱȬ ȱȱȱȱ

On December 18, 2007, after four years of negotiations, Israel signed a free trade agreement at

the Mercosur Summit with the four member countries, the first such agreement with a country

outside the Western Hemisphere. The agreement is limited largely to market access for

merchandise trade, allowing for full free trade to be phased in within 10 years. Mercosur and

Israel have a near even balance of trade in their $1 billion commercial relationship. Mercosur

exports mostly agricultural products and imports technology goods. Although this arrangement is

highly complementary, treatment of agricultural exports and capital goods imports has been a

stumbling block for the Mercosur countries, and particularly Brazil, in trade negotiations with the

EU, the United States, and at the Doha Round. Safeguards and other restrictions will apply during

the transition period to full free trade.47

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Mercosur and China have no formal trade agreement in effect, but bilateral trade has grown

tremendously in recent years. In 2007, Mercosur exported $16.1 billion of goods to China,

importing $19.7 billion. China represented 7.2% of Mercosur’s exports and 11.2% of its imports.

Total trade between China and the four Mercosur countries ranges from a low of 11% of total

foreign trade for Uruguay to 18% for Argentina and Brazil, and a high of 28% for Paraguay

(importing mostly computer and other electronic equipment).48 Mercosur’s commodity exports

and imports of labor-intensive goods explain most of the recent strong growth in this

relationship.49 Such strong trade growth also presents problems for Mercosur because

manufactured imports displace local products. China’s expanding trade surplus would be even

bigger were it not for the world prices of agricultural commodities currently driving Mercosur’s

export values, suggesting that as China becomes a larger trade partner, the deficit could widen.

The prospect for a deteriorating bilateral trade balance has led both Brazil and Argentina to

pursue anti-dumping cases and resort to use of import licenses, voluntary export restraints, and

higher tariffs.50

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Mercosur came to life as both a Brazilian-Argentine political project and a broader economic

integration scheme among four contiguous, but highly differentiated countries. Mercosur has

fostered a prolonged period of cooperation in a region with a long history of conflict, an

important achievement in both political and economic terms. Still, it is a limited customs union

IDB, MERCOSUR Report No. 11, p. 94-97.

Global Insight. Mercosur Signs Deal with Israel. December 19, 2007 and Haskel, David. Mercosur Concludes FTA

with Israel. International Trade Reporter. December 20, 2007.

World Trade Atlas.

IDB, Mercosur Report No. 12, pp. 23-24

Ibid., pp. 24 and 45-46.

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and remains intact despite its “incompleteness” in part because: 1) there is no simple alternative

for its members; 2) there is an unknown, but perceived serious downside risk to its dissolution,

and; 3) there is always the vague hope that promises of institutional improvements will produce

more equitable outcomes. The result remains an uncomfortable status quo in which form (e.g. the

new Parliament) often supersedes function (e.g. deeper integration).

Economic integration based on mutual growth in trade and development is at the heart of the

Mercosur charter, but given shortfalls in achieving this goal, it is likely that a persistent

dissatisfaction among the smaller partners may continue, particularly given Brazil’s political and

economic dominance and Mercosur’s inability to address institutional disagreements. Deeper

economic integration promises to resolve some problems, but there appears to be little chance for

movement in that direction in the near future.

Instead Mercosur has opted to pursue new institutional bureaucracies (the Parliament) and

outreach to third countries, albeit on a very limited basis. The Parliament is in its infancy and

Mercosur has not been able to consummate a trade agreement with its most important trade

partners, the United States and the EU. South-South agreements and expansion of associate

membership to South American countries has progressed, but only as limited market access

arrangements. The big, but questionable move is the accession invitation to Venezuela, which has

also had problems. Venezuela has been given leeway in adopting Mercosur commitments, which

has undermined the pact’s cohesiveness,51 and could end up shifting the political orientation of

Mercosur, while providing only relatively small trade effects.

Historically, the United States has supported Mercosur as a potential complementary path to

meeting its own goal of Western Hemisphere economic integration, but U.S.-Mercosur trade is

small and Mercosur has shown little enthusiasm for supporting U.S. initiatives for a hemisphericwide trade agreement. The addition of Venezuela would likely solidify this position. Although

Mercosur has resisted the FTAA as envisioned by the United States, Venezuela is the only country

in Latin America to reject the idea unequivocally.