AN OVERALL VIEW OF MERCOSUR'S DEVELOPMENT

1.1

Background to MERCOSURs current stalemate

Most Latin American (LA) countries have been very active participants in regional integration initiatives. Most of these agreements, however, have made scant progress. During import substitution industrialization, intra-regional trade liberalization collided rapidly with national development strategies. Once the easy phase of reciprocal trade liberalization was left behind (usually involving goods not produced locally), the exchange of preferences based on a positive list approach strengthened the leverage of import-competing interests, who effectively blocked progress. The demise of the Latin American Free Trade Association (LAFTA) and its substitution by the Latin American Integration Association (LAIA) in 1981 confirmed the inclination of LA countries towards discretion and flexibility in regional integration affairs.

MERCOSUR member states made active use of the instruments provided by LAFTA and LAIA to expand bilateral trade. In fact, Argentina and Brazil (jointly with Mexico) were the most active users of sector complementation agreements in the 1960s and 1970s, leading to a rapid increase in reciprocal trade. At the end of the 1970s nearly 80% of Argentine-Brazilian bilateral trade was conducted under LAFTA preferences.

However, geo-political tensions, disparate national development strategies and an adverse international economic environment worked against regional integration initiatives. In less than a decade the region suffered two large external shocks (the oil and the external debt crisis) that sharply lowered intra-regional trade. International credit rationing and a foreign exchange shortage in the early 1980s led to a significant increase in protection regionwide. As a result, between 1980 and 1985, Argentine-Brazilian bilateral trade nearly halved, reducing the share of Argentina as a market of destination for Brazilian exports to a meager 3% (down from over 6% in 1966-70).

Against this background, the Argentine-Brazilian Programa de Intercambio y Cooperacin Econmica (PICE) signed in 1986 and the Treaty of Asuncin of March 1991 establishing the Common Market of the South (MERCOSUR) were path-breaking events. A stylized account of the history of MERCOSUR can analytically distinguish six phases:

a) The PICE as an antecedent to MERCOSUR (1985-89);

b) The foundations of MERCOSUR: the Acta de Buenos Aires and the Treaty of Asuncin (1990-91); c) Transition towards the customs union (1991-94); d) MERCOSURs paradoxical "golden age" (1995-97); e) Conflict escalation (1998-2000); f) MERCOSUR in a stalemate (2001-?)

1.1.a) The PICE as an antecedent to MERCOSUR (1985-89)

Three factors converged in the mid-1980s to produce a major change in the political and economic environment of regional integration in the Southern Cone. First, democratization in Argentina, Brazil and Uruguay created new incentives to redress bilateral relations, especially between the two largest countries, making military, energy and trade cooperation the main ingredients of new good neighbor policies. Second, the macroeconomic and regulatory crisis of Argentina and Brazil made evident the exhaustion of a development model based on protection and widespread state intervention. The external debt crisis also contributed to a perception of common challenges vis--vis the world economy. Third, the proliferation of regional integration initiatives worldwide underlined the risk of marginalization and the potential contribution of regional cooperation to strengthen the voice and muscle of the region in international affairs.

In this new environment the Argentine and Brazilian governments signed in 1986 the Programa de Integracin y Cooperacin Econmica (PICE), laying the framework for increased cooperation on a sector basis (through, among other means, trade liberalization and technological cooperation). The performance of the PICE shared many of the features typical of LAFTA and LAIA: after an initial period of intra-regional liberalization and rapid trade growth (that restored trade flows to the levels recorded prior to the external debt crisis), the exchange of concessions slowed down and trade flows reached a plateau. In 1988 the two governments signed a Tratado de Integracin, Cooperacin y Desarrollo aimed at establishing a common market in a period of ten years. The Tratado de Integracin served to reaffirm the political commitment to promote regional cooperation, but it shared the lack of precision and enforcement mechanisms typical of most LA integration efforts. However, by the turn of the decade bilateral trade flows had experienced a two-fold increase over 1985

levels. Moreover, the radical change experienced by the predominant attitude towards bilateral relations on the part of the Argentine and Brazilian governments laid the foundation for a more ambitious approach.

1.1.b) The foundations of MERCOSUR: the Acta de Buenos Aires and the Treaty of Asuncin (1990-91)

The late 1980s witnessed the initial steps towards unilateral trade liberalization in Argentina and Brazil, a process that speeded up in the early 1990s.1 The turn of the decade was also a watershed for the predominant development model: market-oriented reforms gained growing predicament in public debates and policy-making. This change in focus had a major impact on regional integration initiatives: its major outcome was the signing of the Acta de Buenos Aires in June 1990. The Acta adopted an approach to trade liberalization that emphasized an automatic, linear and universal mechanism of tariff elimination. According to the agreed schedule, by the end of 1994 Argentina and Brazil would apply 100% preferences over MFNs` tariff rates on a reciprocal basis. The Tratado de Asuncin signed in March 1991 extended these commitments to Parag7uay and Uruguay and created the Common Market of the South (MERCOSUR).

The Tratado de Asuncin included four mechanisms to move towards a common market, namely: a) a Trade Liberalization Program (TLP) to be concluded by December 31 st 1994; b) the adoption of a common external tariff (CET) as of January 1st 1995; c) the coordination of macroeconomic and sector policies and d) sector agreements to deepen and speed up the liberalization of intra-regional trade flows. However, only the TLP included detailed enforcement mechanisms. All member states undertook essentially the same commitments, except for a larger number of transitory exemptions and one additional transition year to reach 100% preferences over MFNs tariff rates in the case of Paraguay and Uruguay.

The approach to intra-regional trade liberalization adopted by MERCOSUR was shaped by the structural asymmetries as well as by the domestic conditions that prevailed in
1

Argentina implemented a trade liberalization program in the late 1970s, but it was abandoned after the financial crisis of the early 1980s. The external debt crisis led to further increases in protection.

the region (particularly the imperative of structural reform and the reluctance to resign autonomy in domestic policy making, except as a lock-in device for trade liberalization). These conditions help to account for: 1) the adoption of automatic mechanisms to ensure trade liberalization (thus freeing the process from domestic pressures) and 2) a soft institutional design that did not involve a significant pooling of national competences.

1.1.c) Transition towards the customs union (1991-94)

The period of transition towards the customs union was characterized by tensions emerging from divergent macroeconomic policies and performances. The adoption of a currency board in Argentina in 1991 brought inflation down and laid the basis for fast aggregate demand growth. In the meantime the Brazilian economy remained dominated by high volatility and a disappointing growth performance. In this context bilateral trade imbalances rose sharply, fueling domestic demands for protection (especially in Argentina). Given the lack of flexibility to tinker with tariffs, non-tariff barriers (NTBs), private sector agreements and other ad hoc initiatives (such as Brazilian purchases of Argentine wheat and oil) served as safety valves. The rapid growth of Brazilian industrial exports to the region (particularly to Argentina), gave rise to a significant domestic coalition in support of MERCOSUR. Higher Brazilian manufacturing exports were heavily concentrated in sectors traditionally influential in foreign trade policy-making (such as steel, chemicals, motor vehicles and textiles). For many of these industries higher exports to the region was a partial compensation for the loss of domestic market share as a result of unilateral and multilateral liberalization. Other governmental and non-governmental actors (such as the legislatures and the trade unions) also took increasing interest in MERCOSUR.