Articles

Volume 42, Number 1, Thunderbird International Business Review, January-February 2000, pp. 1-7

Introduction

MERCOSUR is the Spanish acronym for the Common Market of the South, which groups Argentina, Brazil, Paraguay, and Uruguay. Bolivia and Chile are currently associate members of what is now the third largest economic bloc in the world (after the European Union and NAFTA). The last several months have made it clear that MERCOSUR’s early, heady days are over. For one thing, the explosion in intra-regional trade flows that since 1991 saw average annual increases of 25%, experienced no growth in 1998 over the year before. More importantly, the credibility of MERCOSUR as a viable economic integration project is now at stake as member countries begin to tackle issues that initially were ignored because they were deemed too controversial at the time. Ironically, though, the January 1999 maxi-devaluation of the Brazilian real will likely strengthen MERCOSUR, albeit not necessarily in ways that free trade purists will welcome.

The Temporary Collapse Of The Common External Tariff Regime

The theory underpinning MERCOSUR’s Common External Tariff (C.E.T.) regime is that all goods that enter into the national territory of one of the four core member states (i.e., Argentina, Brazil, Paraguay, and Uruguay) from outside the trade block should pay the same duty. When the C.E.T. came into effect on January 1, 1995, some 85% of the items listed in MERCOSUR’s Harmonized Tariff Schedule were assigned duties ranging from 0% to 20%. Specifically excluded from the C.E.T. regime were capital goods, computers and related software, telecommunications equipment, and, until 2001, up to 300 tariff classification headings (399 until the year 2006 in the specific case of Paraguay) found on each country’s so-called list of exceptions. In the case of capital goods, each MERCOSUR country was authorized to charge whatever tariff it wanted until January 1, 2001, when the duty rates in Argentina and Brazil must converge at 14% (Paraguay and Uruguay are given an additional five years to comply). In the case of computers, software, and telecommunications equipment, each country was allowed to charge its own individual tariff rates, with a commitment that they will all converge at 16% by the year 2006.

In November of 1997, Argentina proposed to Brazil that MERCOSUR’s C.E.T. be raised by three percentage points after a World Trade Organization (W.T.O.) panel in Geneva found that Argentina’s 3% statistical tax levied on all non-MERCOSUR imports violated the country’s W.T.O. obligations. The Brazilians, trying to bring their growing current-account deficit under control so as to fend off the need to sharply devalue their own currency, quickly acquiesced and immediately imposed the 3% hike. The Argentines waited until after the Common Market Council (i.e., MERCOSUR’s highest institutional body) issued Decision 15/97 on December 15, 1997. Following Decision 15/97, all the MERCOSUR countries were authorized to raise their C.E.T.-bound tariffs three percentage points higher until December 31, 2000. A significant number of tariff classification headings were allowed to remain at 0%. In addition, the final decision as to the manner and extent of the increase was left to each country. Paraguay and Uruguay took full advantage of this option and there are many items on which they did not raise import duties. In addition, Paraguay had already adopted a maquila law in June of 1997, which exempts qualifying foreign companies setting up export-oriented factories in Paraguay from paying import duties on capital goods and inputs used in making the final product for up to 19 years. The end result of all these maneuvers has meant the collapse of what had been MERCOSUR’s partial C.E.T. regime until at least 2001.

The temporary collapse of MERCOSUR’s C.E.T. means that resolution of a pressing issue that has prevented foreign exporters from distributing all their products from one country within the MERCOSUR will not be resolved any time soon. In a true customs union, once a product enters the territory of a member state and pays the appropriate C.E.T., it can then be circulated duty-free among the member states. Even before the collapse of MERCOSUR’s C.E.T. regime, however, any foreign good that entered the territory of one member state, paid the C.E.T., and was then re-exported to another MERCOSUR country (without undergoing some sort of transformation so as to satisfy rule of origin requirements) was levied the C.E.T. again.

The Decision On A Uniform Mercosur Automobile Regime Is Postponed

Despite news stories in otherwise reputable U.S. newspapers such as The Wall Street Journal, which from time to time berate a “protectionist MERCOSUR automobile regime,” the fact is there is no such animal. At present, each MERCOSUR country maintains its own national policy with respect to import tariffs charged on automobiles and auto parts. Intraregional trade in automobiles and auto parts (which represents a significant 30% of intra-MERCOSUR trade flows) is governed by bilateral agreements that exist among at least three of the member states (Paraguay is excluded since it has no auto assembly or manufacturing facilities) that pre-date MERCOSUR. While the MERCOSUR countries had committed themselves to have a common MERCOSUR automobile policy in place by the year 2000, the Common Market Council’s December 1998 meeting in Rio now has postponed implementation of such regime until at least 2004.

The inability to reach a uniform MERCOSUR automobile regime by the original target date of 2000 is based, in part, on Brasilia’s inability (or lack of political will) to rein in state governments that have offered exemptions from the hefty state-imposed I.C.M.S. tax (as well as other credit and fiscal incentives) as an inducement to get foreign automobile manufacturers to build plants within their jurisdictions. In addition, neither the Paraguayans or Uruguayans are happy at the prospect of having to increase their import tariffs on automobiles to the 35% level proposed by both Argentina and Brazil.

Still Waiting For Liberalization Of The Services Sector

In December of 1997, the Common Market Council approved Decision 13/97 to which was annexed the Protocol of Montevideo on the Trade of Services within MERCOSUR. The Protocol covers the offering, receipt, purchase, and use of any type of service (except those denominated as government services) by a service provider from a MERCOSUR country in another member state. Under the Protocol, all four MERCOSUR countries are under an obligation to ensure that service providers from each member state receive a treatment that is no less favorable than that granted to their own nationals or to those from third countries. In addition, the MERCOSUR countries cannot place nationality limits on employees or impose income or activity requirements on service providers from other member states operating within their national territory.

Unlike the North American Free Trade Agreement (NAFTA), where all services were liberalized unless specifically excluded in Annexes to the NAFTA., the Protocol of Montevideo on the Trade of Services only authorizes the liberalization of services specifically included in the Annexes. More than a year after the Decision approving the Protocol was issued, however, the MERCOSUR countries have yet to decide what particular services will actually be included in the annexes to the Protocol. All that exists at present are proposals made by each country as to what services it is willing to open up to competition from the other member states. In the case of Argentina, this consists of professional, construction and engineering, distribution, financial, tourism, and transportation services. Brazil’s list (as well as those of the two smaller member states) is similar but leaves out distribution and includes communication services. The fact that Brazil has placed financial services on its list is significant because, while Brazilian banks can presently open up branches and transact all types of business in the other MERCOSUR countries, financial institutions from the three smaller countries currently confront all sorts of restrictions when doing business in Brazil.

The Impact Of The Maxi-Devaluation Of The Brazilian Real

With 160 million inhabitants, Brazil is by far the largest economy within the 200 million person MERCOSUR and is responsible for some 70% of the trade bloc’s G.D.P. and most of its industrial production. Accordingly, an economic crisis in Brazil is bound to have a significant impact on the economies of its smaller, Spanish-speaking MERCOSUR partners. Even so, the dire predictions concerning MERCOSUR’s future made by many U.S. investment banks in the wake of the maxi-devaluation of the Brazilian real in mid-January of 1999 are based on faulty reasoning that ignores several crucial aspects about the Southern Cone economic integration process.

One reason why some have asserted that MERCOSUR is on the verge of collapse is based on protectionist talk that has emanated of late from Argentina about resurrecting intra-MERCOSUR import duties to combat an expected surge of suddenly cheap Brazilian imports. However, the bulk of what Brazil exports to the other MERCOSUR countries is made up of manufactured goods, such as cars, trucks, and tractors, many of which are heavily dependent on foreign inputs that have now been made more expensive as a result of the real maxi-devaluation. Accordingly, predictions of a giant surge of suddenly cheap imports from Brazil are unlikely to materialize. In any event, this is not the first time in this decade that Argentines have had to confront a Brazilian currency that was significantly undervalued as opposed to their peso, which has been pegged one-to-one with the U.S. dollar since 1991. The same scenario occurred between 1992 and 1994, but, while Argentina did have a trade deficit with Brazil during those three years, Argentine exports to Brazil were actually expanding an average of 31% per year during that same time period.

Another factor that is not fully appreciated outside the region is that threats of renewed Argentine barriers to Brazilian imports are oftentimes rhetoric intended to force Brazil to make concessions on other long-standing issues that bother Argentine producers. These threats appear to have been successful in that, within weeks of the maxi-devaluation of the real, Brasilia promised to end subsidizing exports of consumer products under its PROEX program to the other MERCOSUR countries.

Yet another important factor overlooked by outsiders is that MERCOSUR is a trade agreement that falls under the umbrella of the Latin American Integration Association (ALADI). This means that the MERCOSUR countries have full access to ALADI’s central-clearing-house mechanism that facilitates trade deals between all the Spanish-speaking countries of South America, Brazil, Mexico, and the Dominican Republic by funneling them through the Central Reserve Bank of Peru in Lima without the need to make immediate hard-currency payments. Only at the end of each four-month period are national accounts settled, with payment in hard currency only required to cancel outstanding debits. The merchants actually involved in such deals either pay for their purchases or receive payment for sales in their respective national currencies. The ALADI central-clearing-house mechanism not only ensures that Brazil will continue to favor purchases from its MERCOSUR neighbors, but also will encourage managed trade deals (which could prove detrimental to exporters from outside Latin America). This same ALADI feature that permitted Colombian-Venezuelan trade to increase significantly during the mid-1990’s despite a sharply devalued Venezuelan bolivar and currency exchange controls.

One positive aspect sparked by the latest economic crisis in Brazil is the heightened awareness of the need for the MERCOSUR countries to coordinate their macroeconomic policies, an aspirational goal included in the 1991 treaty that created MERCOSUR. The devaluation of the real has renewed efforts to create a formal institutional mechanism through which finance and economics ministers from the MERCOSUR counties can apprise each other of domestic macroeconomic developments. In a speech in Miami in February of 1999, former Brazilian Central Bank President Gustavo Laboissiere Loyola speculated that this increased macroeconomic coordination might eventually lead to the introduction of a common MERCOSUR currency, something that has long been advocated by Argentine President Carlos Menem.

Perhaps the most crucial aspect about MERCOSUR, and the one most frequently overlooked by outsiders, is that it is not just an economic project, but also an undertaking with important political dimensions. The greater economic interdependence encouraged by MERCOSUR states has contributed to ending centuries of mutual suspicion and hostility between Brazil and its Spanish-speaking neighbors in the River Plate region. This reconciliation has, in turn, allowed financially strapped governments to cut military defense budgets and redirect some of the savings to more pressing needs like improving education and transportation infrastructure systems. MERCOSUR has also given its members greater clout in international fora and multilateral trade negotiations. Therefore, too much is at stake politically to allow the project to whither away.

Undoubtedly Brazil’s economic woes will detrimentally affect some exporters in the other three MERCOSUR countries. For example, some automobile and auto-parts manufacturers with a presence in both Argentina and Brazil have shifted production in favor of their Brazilian plants because of the new currency advantage. However, these are short-term moves that should not undermine the long-term prospects for increased efficiency encouraged by an expanded single Southern Cone market. The fact is that each of the MERCOSUR countries enjoy particular comparative advantages both subregionally and in the global market that will not disappear just because of one member state’s long overdue currency readjustment.

Conclusion

The MERCOSUR economic integration project has entered a crucial new stage in its development where it will finally have to confront and resolve controversial issues it has long relegated to the back burner. Interestingly, the January 1999 maxi-devaluation of the Brazilian real actually may strengthen the Southern Cone integration process by forcing the member states to take steps to coordinate their respective national macroeconomic policies. In addition, a greater emphasis will be placed on promoting new intra-regional managed trade arrangements and sourcing inputs locally as a way to avoid the further depletion of hard-currency reserves. Such moves will undoubtedly accentuate the importance of the Southern Cone integration process as a means of restoring regional economic stability.

The author is President of Mercosur Consulting Group, Ltd., a legal and economic consulting firm based in Washington, D.C. that advises companies in devising strategic business plans for their South American operations. He is a dual national of the United States and Chile and author of Latin American Trade Agreements (Ardsley, N.Y.: Transnational Publishers, Inc.).