Reference no: EM133185425

Mercosur RIP? South American integration

The Economist

Mounting protectionism and the rule-breaking admission of Venezuela have fatally undermined a once-promising trade block

IT WAS such a good idea. In 1991 Brazil and Argentina set aside decades of rivalry and, together with smaller Uruguay and Paraguay, founded Mercosur as a would-be common market. The project went hand-in-hand with a broader opening of inward-looking economies. Diplomats got to work on harmonzing trade rules. Cross-border trade and investment boomed.

Yet Mercosur, like the European Union (EU) on which it was modeled, ran into difficulties. Brazil's devaluation in 1999 caused Argentina to seek, and obtain, emergency restraints on imports from there. Politically negotiated exceptions to the block's rules became the norm. Nevertheless, a dispute-settlement body and a small secretariat were eventually set up. In 2010 the presidents finally agreed on a common customs code, to avoid outside goods having to pay tariffs more than once.

But under left-wing governments, Brazil and--especially--Argentina have become more protectionist. They have come to see Mercosur as a fortress, rather than a bridge: outside South America, the only trade deals concluded by the block in the past decade were with Israel and the Palestinian Authority. Negotiations with the EU, begun in 1999, have languished. Although intra-Mercosur trade has continued to rise in absolute terms, it represents a much smaller share of each member's total exports than at its peak in 1997 (see chart). That is partly because the commodity boom has lifted the group's exports to the rest of the world. But it also because Mercosur has not evolved into the seamless single market its founders dreamed of.

Since January 2011 Argentina has increased (to 600) the items for which import licences are not automatic--a measure accepted by the World Trade Organisation (WTO) that allows countries to detain imports for up to 60 days. Exporters to Argentina complain that the delays are even longer. Since February, it has required importers to swear an affidavit with the tax agency before ordering goods. That has prompted a host of complaints against Argentina at the WTO. Its Mercosur partners have not been exempted: so far this year, Brazil's exports to Argentina are down 15% on the same period in 2011, while Uruguay's are down by 10%. Brazil has responded by imposing some barriers on Argentine exports.

Mercosur now faces a new, self-inflicted, problem--one that could potentially break it apart. Meeting on June 29th in Mendoza, Argentina, the presidents suspended Paraguay for a year, following the lightning impeachment the previous week of Fernando Lugo, the country's left-wing president. His ousting, by 39 votes to four in the Senate, was abrupt and misguided--but constitutional. Nevertheless, the others decided it offended Mercosur's "democracy clause". They went on to admit Hugo Chavez's Venezuela as a full member of the group; Venezuela's application had been held up for years because Paraguay's Senate had refused to approve it.

Violating due process

All this was legally questionable. Mercosur's rules require decisions to be unanimous, with all members given a fair hearing. The envoy of Paraguay's new government was turned away in Mendoza. Its foreign ministry denounced the suspension as "not only illegal but illegitimate and in violation of due process". Bernadino Hugo Saguier, the country's ambassador to the Organisation of American States, said: "if we took a poll, 90% of Paraguayans would vote to quit" Mercosur.

What makes these decisions more perverse is that Venezuela's democracy is as flawed as Paraguay's, albeit in different ways. Mercosur was set up to be a group of liberal democracies advancing free trade in South America. Mr Chavez is unenthusiastic about these causes. He has variously called for a "new Mercosur", with a dose of "political Viagra" that would "decontaminate neoliberalism" in the block, and instead "prioritize social concerns".

Although Mr Chavez agreed in principle to adopt Mercosur's common external tariff, his government has yet to implement this--or indeed any but one of the 131 formal decisions taken by the block so far, according to Paulo Roberto de Almeida, a dissident Brazilian diplomat. Under Mr Chavez, the state has taken over many industries, and non-oil exports have shrivelled. But Venezuela's oil wealth has offered opportunities to Argentine and Brazilian companies, especially in government contracts. Its entry is of "strategic interest" to Mercosur, Brazil's foreign minister, Antonio Patriota, said this week.

To a greater or lesser extent, the governments of Brazil and Argentina share Mr Chavez's view that Mercosur should primarily serve the cause of political union, and act as a rival project to what they see as the free-trade agenda of the United States in Latin America. "The founding idea that Mercosur would be an instrument of trade liberalization has disappeared," says Rubens Barbosa, a former Brazilian diplomat involved in the block's creation. "What we have today is a political and social forum, and micromanagement of trade."

The decision to admit Venezuela is already prompting buyer's remorse. Uruguay's vice-president, Danilo Astori, called it perhaps the most serious "institutional wound" in Mercosur's history; the country's foreign minister also criticized the way the decision was taken.

Turning Mercosur into a political union has in practice meant that its decisions are based on the preferences of the current left-of-centre governments, rather than on long-term national interest. It also means that it is hard to spot the difference between Mercosur and the South American Union, a broader but shallower group.

This is a costly moment for Mercosur to neglect its primary purpose. In June Brazil's seasonally adjusted trade fell into deficit for the first time since 2000, says GlobalSource Partners, a consultancy. The commodity boom looks to be drawing to a close. Credit growth is slowing; retail sales fell in May . Brazil's manufacturers are losing markets to China.

The fastest-growing part of South America is the free-trading Pacific countries (Chile, Colombia, and Peru), which have shunned full membership of Mercosur. Brazil has chosen as its main allies protectionist Argentina and Venezuela, which practices an archaic state socialism. To revive economic growth, Brazil needs to put more stress on competitiveness and market-opening trade diplomacy. Mercosur once aspired to do precisely that. A group that now consists of little more than bear-hugs and kisses among companions serves little purpose in a harsher world.

Discussion:

What benefits does Uruguay enjoy by being part of Mercosur?

How can Uruguay create a competitive advantage?

Is the Mercosur a stumbling block for global integration?

Is being a smaller country compared to Brazil and Argentina an advantage or disadvantage for Uruguay?