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South America Can Still Save Its Trading Bloc

The Mercosur-European Union trade agreement is back in the deep freeze, its ratification iced by the insistence of France’s President Emmanuel Macron on more muscular enforcement of environmental standards in Brazil and last-minute reservations raised by Argentina’s outgoing President Alberto Fernandez about its impact on domestic industries. This setback puts more at stake than an uptick in tariff-free South American beef and vegetables in European supermarkets and more affordable European cars and clothing on the streets of Sao Paulo and Buenos Aires. The failure may well end the 32-year-old South American customs union itself, leaving the region out in the cold as the world divides up into regional trading blocs.

Mercosur began in 1991, as a series of nuclear and other diplomatic accords between once estranged South American nations blossomed into a commercial agreement. Brazil, Argentina, Uruguay and Paraguay formed a customs union with aspirations for a common market not unlike the one then emerging in parallel across the Atlantic in Maastricht, Netherlands.

By the late 1990s trade between the members had grown fivefold, increasingly comprised of manufactured goods, and buttressed by incipient cross-border supply chains developing for cars, chemicals, and foods.

It was around then that Mercosur decided to begin negotiating with Europe, seeking to bring together economic blocks that now encompass nearly 800 million people and 20% of global GDP. Finally signed in 2019, the pact has been stuck in ratification limbo ever since over European deforestation concerns and Brazilian sovereign prickliness over extraterritorial environmental sanction plans. The return of Luiz Inácio Lula da Silva as Brazil’s president, with his green bona fides and star power on the global stage, wasn’t enough to overcome the naysayers at last week’s Mercosur summit.

During the course of the nearly two decades of negotiations with the European Union, Mercosur’s own regionalizing momentum faded. Brazil’s 1999 currency devaluation and Argentina’s 2001 financial crisis spurred protectionist backlashes and myriad exemptions to the deal’s ground rules for its two biggest economies.

Mercosur Deflates

China’s rise and resource avarice further undermined South America’s commercial links: The Asian nation became Brazil and Uruguay’s biggest overall trading partner in the 2010s and gained ground in Argentina vis-a-vis its neighbors. Chinese imports also ate away at manufacturing in the region, boosting the importance of commodities in three of the four partners (Paraguay started from a less industrialized base, and since it still recognizes Taiwan diplomatically, trade has been curtailed).

As Paraguay assumes Mercosur’s presidency from Brazil, there is a lot of upbeat chatter about the block jump-starting trade negotiations with Vietnam, the United Arab Emirates, South Korea, Japan and Indonesia. But after watching the ratification debacle with the EU, any nation will surely think more than twice about signing up for years-long negotiations. The election of the self-described “anarcho-capitalist” Javier Milei as Argentina’s new president will inject new tensions into the bloc, as will the addition of turmoil-ridden Bolivia to its ranks.

Mercosur now faces an existential challenge. Its purpose is to promote and shape trade and economic growth for those in the club. But as a customs union, not a free trade agreement, the members must maintain a common external tariff. They can’t have different levies or trade policies (a high bar that is one reason why most of Mercosur’s neighbors, including Chile, Colombia, Ecuador, Guyana, Peru, and Suriname, never wanted to be more than associates). In essence, as the recent EU foot-dragging shows, this means no trade policy at all.

Uruguay is already eager to bail: It is negotiating bilateral trade agreements with China and Turkey and has put itself on the list to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). President Luis Lacalle Pou even floated the idea of taking on bilateral tariffs with the United States during a recent state visit. If any of these deals come to fruition, Uruguay would be out of Mercosur.

Mercosur’s end would leave its members even less able to compete in the global economy. Losing the preferred access and economies of scale that the customs union affords, even with its weaknesses, would undercut South America’s industries. Nearly 60% of what these nations trade with each other involves medium to high levels of technology, much more sophisticated than these nations’ trade with economies further afield.

Meanwhile, the rest of the world is forging more of the market- and trade-based bonds that South America is allowing to languish. Fifteen Southeast and East Asian nations have expanded their market access through the Regional Comprehensive Economic Partnership (RCEP), 54 African nations have signed onto the African Continental Free Trade Area (AfCFTA), and 11 economies and counting are part of the CPTPP. These clubs provide their members preferred rules and fees, economies of scale and scope, and common standards and rules of origin that unlock new customers and attract foreign and domestic capital.

South America’s nations can’t grow and prosper without hooking into global supply chains and trade. And for that, they will need partners. Their neighbors still remain compelling options, particularly as leaders aspire to diversify and increase the sophistication of their economies. Tariffs and trade rules aren’t the only hindrance to closer commercial ties. As big a challenge is logistics: It costs more to move goods in and around South America than to send them farther away. To make regional supply chains viable, these nations need to stand up more border crossings, connecting roads and rails, and ensure more regional flights and container ship ports of call. The impediments aren’t just physical. Streamlining customs paperwork and reducing bureaucratic red tape through automation and digitization would lower the time and cost of doing business between South America’s economies as well.

Such improvements may lack the panache of summitry and treaties. But tackling these barriers could spur much needed investment and commerce, and, with the proverbial proof in the infrastructure pudding, perhaps rescue South America’s regional trade agreement from its demise.

Source: CFR