Argentina Crisis Puts Trade Bloc at Risk

As Argentina wrestles with its latest economic woes, one unintended victim of the crisis could be trade relations and a possible death blow to Mercosur, the trading partnership that comprises Argentina, Brazil, Paraguay and Uruguay.

Born amid great hopes, Mercosur was supposed to provide a regional market for home-grown commodities and services. Instead, critics say, it has institutionalized the instability and inefficiency of its members.

“It’s gone, disintegrating and disappearing,” said Sebastian Edwards, a professor at UCLA’s Anderson School and a former top World Bank economist. “Mercosur is going to be one more chapter in a long history of failed attempts at Latin American integration.”

Not every economist is so pessimistic. But even the optimists say the road ahead will be very difficult. Acknowledging that Mercosur is in a “real time of testing,” senior fellow Gary Hufbauer of the Institute for International Economics in Washington said the bloc has “more lives than a cat” and that the alternative of going back to protectionist ways would be ill-advised.

“I think they soldier on ahead. They get over this crisis and figure out that it’s in their best interest to keep open trade and commercial interests in common,” Hufbauer said.

Technically a customs union, Mercosur was seen as a stepping stone for Latin American countries as they emerged from closed economic systems that effectively had discouraged trade. After World War II, many countries had pursued the so-called import substitution economic model that protected domestic industries from foreign competition by screening out imports.

But by the 1980s, with many countries in the region swamped by indebtedness and high inflation, countries turned to the new gospel of trade, hoping for salvation in open borders for imports and foreign investment. The four Mercosur countries came together in 1991 and by 1995 had agreed on a common external tariff covering 85% of all goods originating outside the zone.

The pact aimed at eliminating all tariffs on products and services produced and traded among the countries. The idea was to confer economies of scale and guaranteed protected markets for members, while giving consumers new choices, said Mauro Guillen of University of Pennsylvania’s Wharton School in Philadelphia.

There was very little trade among the four member countries at Mercosur’s inception. But it soon grew, expanding from just $4.1 billion in 1990 to five times that in 1997, said Gerardo Esquivel, a professor at Colegio de Mexico, a Mexico City university. By then, it had become the world’s third-largest trade bloc, trailing only the European Union and the North American Free Trade Agreement zone.

But Mercosur has been slowly eroding for years, and by 1999, the latest year for which there are figures, trade dropped 25% to $15.1 billion. Trade almost certainly showed little if any improvement last year, as Argentina descended deeper into recession. In recent months, its tinkering with currency exchange and tariff policies has severely undermined trade relations with Brazil.

Perhaps the biggest casualty has been casting aside the union’s defining characteristic--economic policies that are commonly decided upon, imposed and upheld. Both Brazil and Argentina, which between them are responsible for 97% of all Mercosur trade, have taken unilateral action. Argentina ignored Mercosur’s charter earlier this month by reducing tariffs on non-Mercosur computers and telecommunications goods, hurting Brazil.

But Argentina has a right to complain as well. The key to Mercosur’s success through most of the 1990s was that both Brazil’s currency, the real, and Argentina’s peso, were stable and each closely matched to the dollar, leveling the playing field.

But Brazil’s 1999 devaluation changed all that. Its real, which was worth slightly less than $1 in mid-1998, is worth less than 40 cents, while Argentina’s currency remains chained to the dollar. That has given Brazil, Argentina’s biggest trading partner, a huge advantage in foreign markets and in Argentina. The upshot has been a sharp loss of competitiveness by Argentine products both at home and in markets where it competes with Brazil. The drop off in trade is one of the reasons Argentina is in its current fix.

Last month, Argentina moved away from the strict one-to-one dollar peg by setting up a different currency exchange rate for trade. This effectively devalued the peso by 7% for trade purposes, a policy that Hufbauer says has never really worked in countries that have tried it.

“Corruption and leakage usually kill it,” Hufbauer said.

Meanwhile, the trade bloc’s tariffs against high-technology goods produced outside Mercosur cost the partnership enormous productivity gains during the Internet boom of the 1990s, said Steve Hanke, a professor of applied economics at Johns Hopkins University in Baltimore.

“The big problem was that it raised the cost of capital goods imports at a time when high tech should have been pouring into the area. It has really slowed down the modernization of the region,” Hanke said.

Argentina tacitly recognized the policy’s failure this month when it unilaterally lowered tariffs on high-tech and telecommunications goods coming in from Asia, the United States and Europe, depriving Brazil of its privileged position as a favored high-tech source.

The action amounted to a unilateral lifting of the common external tariff that was the backbone of its Mercosur partnership, and Brazil reacted with predictable outrage.

Brazilian President Fernando Henrique Cardoso abruptly canceled commercial negotiations between the two countries this month. While denying that Mercosur was in danger of collapsing and assuring Argentina that Brazil was willing to help it find a way out of its crisis, Cardoso took the opportunity to warn Argentina not to take unilateral measures.

“They shouldn’t resolve their problems by taking measures that create problems for others,” Cardoso told reporters.

But with Argentina sinking deeper into crisis and facing default on $128 billion in external debt, the near future could bring additional shocks to Mercosur, including Argentina’s possible abandonment of the dollar peg altogether, a measure that many observers believe is inevitable.

Pressures are mounting from within and outside the bloc to either join a larger trade bloc such as the Free Trade Area of the Americas (FTAA) or for a splintering off that would allow each country to pursue its own bilateral trade deals in the style of Chile, the subcontinent’s most successful exporter. In 1996, Chile joined as an associate Mercosur member, followed by Bolivia in 1997 under agreements that allowed the two to keep their lower external tariffs in place, while their products gradually were to receive tariff-free status within the trade bloc.

But Chile in the last two years has served notice it will pursue its own free trade path, signing a score of bilateral agreements with individual countries, a path that some say Mercosur countries should follow.

Proponents add that Mercosur nations cannot count on joining a hemispheric FTAA given protectionist sentiments in the U.S. Congress that may keep it from ever happening. The FTAA would be a virtual extension of the North American Free Trade Agreement to include 34 countries in North, Central and South America and the Caribbean.

Paulo Levy, an economist at IPEA, a government-affiliated economics research agency in Rio de Janeiro, said Mercosur even now is providing its members with a valuable negotiating front in discussions to form a free trade pact with the European Union, a bond that might have a better chance of coming about than the FTAA.

Esquivel of Colegio de Mexico describes Mercosur as a “strait jacket” that only makes stability more difficult to achieve for its members in times like these.

“Mercosur might not break,” Esquivel said, “but will remain weak.”

“Mercosur should not have been done in the first place, because it brought together two countries that have historically been unstable,” said UCLA’s Edwards of the Argentina-Brazil relationship. “For all intents and purposes it’s not working now, and it’s highly unlikely that it ever will.”

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Trade Slowdown

Mercosur, the trading bloc in South America, has seen trade decline among its four members since Brazil devalued its currency and Argentina entered a three-year recession.

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1999 (most recent figure available): $15.1 billion

Source: Mercosur