Summary

In the face of a shifting international trade landscape and Brazil’s desire to diversify its trade partners, the future of the Southern Common Market, known by the Spanish acronym Mercosur, is in doubt. Mercosur’s utility has been questioned for years: The bloc imposes trade barriers among its own members and restricts their ability to strike free trade agreements with outside partners. It serves primarily as a governing framework for trade between the region’s two largest economies: Brazil and Argentina. While Venezuela, Paraguay and Uruguay have full membership, their roles are peripheral – and Venezuela is currently suspended from the group. 

Brazil is undisputedly the dominant force driving Mercosur, but it has grown increasingly dissatisfied with the bloc, which Brasilia believes prevents it from pursuing its foreign relations and trade agenda in full. Blame for Mercosur’s uncertain future has been placed on the bloc’s most recent and most vocal critic, Brazilian President-elect Jair Bolsonaro. But Brazil’s relationship with Mercosur was tenuous long before his election. The bloc has failed to achieve its founding objectives, and Brazil has outgrown its potential benefits. In the coming years, Brazil will have to redefine its relationship with Mercosur. This Deep Dive explores how Brazil’s ties with the bloc have reached a tipping point, and how Mercosur has joined the ranks of trade blocs facing the need to modernize or risk dissolution.

The Birth of Mercosur

Mercosur was the product of timely economic and political forces in the region and around the world: increasing globalization of trade and the collapse of military governments in South America. But its origins can be traced to 1960 and the formation of the Latin American Free Trade Association.

LAFTA was the first attempt to replicate European regional economic integration in South America, but the effort failed. Member states were still in a phase of government-supervised industrialization, which included the imposition of trade barriers to discourage imports and coerce consumers into buying domestically produced goods. These countries saw large-scale free trade as a threat to their industrialization, their utmost economic priority. In 1980, the region made a second, more successful attempt at economic integration with the creation of the Latin American Integration Association. ALADI, unlike its predecessor, took a gradual approach to free trade, brokering agreements piecemeal in the short term and aiming for a common market in the long run.

Also in the 1980s, a rapprochement was emerging between Brazil and Argentina. Until that point, the two had been rivals in the struggle for regional dominance. They competed for external markets and over nuclear energy development, and in the 1970s, the rivalry devolved into a political crisis over the Itaipu Dam’s construction. But by the 1980s, both were facing economic uncertainty and dealing with political transition, and they couldn’t afford to continue the rivalry any longer. In 1983, Argentina held democratic elections after nine years of military junta rule, and in 1985, voters ousted Brazil’s military dictatorship. These fledgling governments were tasked with enacting political democratization and establishing new institutions against the backdrop of a regional debt crisis and the Cold War. Their vulnerabilities and interests aligned, Buenos Aires and Brasilia overcame their political differences and decided to pursue economic integration. The two saw improved ties as a way to protect domestic industry from global competition and an opportunity to gain influence over each other’s international economic relationships.

In 1990, they signed an economic complementation agreement, a bilateral accord under the ALADI framework that opens specific market segments to trade. In 1991, Paraguay, Uruguay, Brazil and Argentina used existing ACEs to create a basic framework for a common market. Upon this foundation, they built the Treaty of Asuncion, establishing Mercosur. (Venezuela would not join until 2012.)

Despite having five members, it’s clear that Brazil dominates the bloc. Brazil’s population and economy are far larger than any of its neighbors – though Argentina isn’t too far behind. According to the most recent International Monetary Fund figures, the five Mercosur countries’ combined gross domestic product is $2.58 trillion. Of that sum, Brazil accounts for $1.91 trillion and Argentina $475 billion. This roughly reflects the proportions of their respective populations: The bloc has 293.4 million inhabitants, 71 percent of whom live in Brazil and 15 percent in Argentina. From the outset, therefore, Brazil has played an outsize role in Mercosur. Including Paraguay and Uruguay in the bloc helped Brazil and Argentina manage their relationships with other countries in the region, while the two smaller economies benefited from having better access to major economies.

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Mercosur’s Faulty System

The new economic bloc set out with four progressive goals for economic cooperation, each building on the last. First, the group would establish a free trade zone with no restrictions on the circulation of goods among member states. Second, it would form a customs union wherein common external tariffs would be uniformly applied across the group. Third, Mercosur would create a common market to allow free movement of labor and capital. And finally, the bloc would synchronize member states’ macroeconomic and trade policies. Nearly three decades later, Mercosur has established relatively free trade practices and components of a customs union, but a complete common market is still a long way off.

Over time, Mercosur increasingly restricted trade relationships both within the group and between members and nonmembers. The Protocol of Ouro Preto established the bloc’s basic structure and required unanimity for major decisions – including the addition of new members and signing of free trade agreements with non-ALADI countries. The unanimity requirement made it nearly impossible to get anything done. And without enforcement mechanisms, decisions weren’t always carried out. This has become particularly problematic for Brazil: Despite being the uncontested power of the group, it risks being blocked from pursuing its economic interests by many of its much smaller neighbors.

To overcome the gridlock, the bloc has devised ways to circumvent the unanimity requirement on some issues. Members can selectively deviate from the bloc’s tariffs, for example, and set their own rates for specific goods. Much as in the days of ALALC, member states don’t want to jeopardize their economic development – they still need to protect domestic industries and maintain decent employment rates. Within the bloc, they do so at the expense of fully open trade. Each Mercosur country can select goods it believes could be harmed by lifting tariffs and continue charging duties on those products within the bloc. Similarly, each member can select products for exemption from the common external tariff, charging higher rates instead.

These workarounds have created two major weaknesses for Mercosur. First, it is not truly a free trade bloc, as hundreds of tariff exemptions have already been granted. New exemptions are constantly being negotiated, which has led to temporary trade blockades as members retaliate against each other’s higher tariffs or lobby for approval of their own hikes. Second, if a member imports cheap goods from a nonmember country, those goods can bleed into the regional market, and this can result in conflict. Paraguay, for example, imports cheap Chinese electronics and basic manufactured goods; Argentina, on the other hand, places higher tariffs on these products to protect domestic industry. But the goods imported by Paraguay could make their way into Argentina, which Buenos Aires sees as a threat.

Second, Mercosur’s unanimity requirements make free trade agreements with nonmember states extremely difficult to execute: No single member can sign a bilateral FTA with an external state without the bloc’s consent. In a group with widely different economic needs and interests, consent is often unfeasible. Terms that favor one member might hurt another. But again, Mercosur has found ways to mitigate this problem using the ALADI framework (although only with ALADI member states). Since Mercosur is ALADI’s successor, expanding trade ties with fellow ALADI members shouldn’t interfere with Mercosur’s rules. In fact, Mercosur’s founders originally wanted to use ALADI to facilitate the gradual addition of other regional economies to the new trade bloc.


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But Mercosur’s restrictions, along with regional political disagreements, mean that further economic integration with other ALADI states may not happen. Adding other ALADI members to Mercosur would require modifying a series of ACEs, expanding them to further open up the market. Some non-Mercosur ALADI members have such arrangements in place with Mercosur. The ACEs, however, are typically developed bilaterally with each member of Mercosur, and not all Mercosur countries are eager to sign such agreements with other ALADI states. For instance, Mexico has significantly expanded its ACE with Uruguay. Yet Mexico’s contentious relationship with Brazil in areas like the automotive industry has prevented the two from significantly expanding certain ACEs. Similarly, Chile and Brazil recently agreed to a broad expansion of several ACEs, but Argentina’s legislature hasn’t approved similar deals with Chile.

More broadly, Mercosur members’ hands are tied when it comes to signing bilateral free trade agreements with non-ALADI countries. The bloc’s selectively protectionist measures and controversial ideological stances make it less attractive to external partners, so major trade agreements with global economic powers like the U.S. and China won’t happen any time soon for Mercosur. Thus far, the bloc has only cemented free trade agreements with Egypt and Israel, a general macroeconomic agreement with Morocco and basic preliminary trade agreements with India and the Southern African Customs Union. Another 14 agreements are progressing slowly or have completely stalled. There’s growing hope that Mercosur will sign a free trade agreement with the European Union – but those talks began in 2000, took a hiatus, picked up again in 2010, were paused in 2012, and were again revived, so nobody’s holding their breath.

Brazil, in particular, wants to redefine its foreign relations by pivoting away from Latin America toward the Northern Hemisphere. Trade is essential to this strategy, but Mercosur membership is constraining its ambition. Under the bloc’s current structure, Brazil has no chance of signing any significant bilateral trade agreements with partners outside of Latin America.


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Less Economics, More Politics

Mercosur’s failure as a trade block is attributable to more than just its structural dysfunction. Over the past decade, its agenda has been dominated not by trade but by politically and ideologically driven projects. The lack of progress on economic integration and the increasing politicization was initially tolerable for Brazil given its economic boom and political climate. But both its economic outlook and its politics have shifted drastically in the past couple of years, making Mercosur’s dysfunction extremely problematic for Brazil.

What economic measures Mercosur has managed to advance have had minimal benefit for Brazil. In 2002, the bloc introduced a dispute settlement mechanism, but enforcement of decisions made in the bloc was still weak. In 2017, members signed the Intra-Mercosur Cooperation and Facilitation Investment Protocol, designed to boost investment among Mercosur’s four main economies. This agreement has a clear drawback for Mercosur’s largest economy: While Brazil can now more easily invest in other member states, it’s unlikely that they will reciprocate with the level of investment Brazil needs. Rather, the key sources of investment that Brazil needs are outside the bloc – and this agreement does nothing to help Brazil attract those investors.

Similarly, in 2005, Mercosur established its Structural Convergence Fund to finance and develop infrastructure projects that would boost the bloc’s connectivity and competitiveness. The fund’s portfolio includes more than 40 projects worth about $1.4 billion. Because of the economic and development discrepancies within the bloc, Brazil became the primary funder of the projects, though the fund’s resources were mainly allocated to the other member states. In the fund’s early years, Brazil’s economy was thriving, and that dynamic worked. But Brazil’s 2015-2016 recession caused its economy to contract by over 7 percent, and the recession was accompanied by a major corruption scandal that changed how Brazil invests in development and infrastructure. Now Brasilia needs funds to rebuild its economy and can no longer afford to foot the bill for its neighbors’ economic development.

Meanwhile, the bloc was becoming increasingly political. Mercosur had flirted with taking a political stance in 1998 with the passage of the Ushuaia Protocol, which stated the bloc’s support for democracy and rejection of illegal changes of government. (The protocol was updated in 2011 to allow but not require Mercosur countries to take concrete measures, like sanctions and border closures, against member states that violate this agreement.) In the 2000s, a wave of populist leaders ascended to power in South America, including in Mercosur member states. Beginning in 2007, the bloc began to establish politically oriented bodies to pursue social and political objectives. This included a social policy research institute, a human rights policy institute and a social participation unit. Mercosur also helped Venezuela cope with its economic crisis through food-for-oil exchanges and leniency on payments for imported goods.

The bloc’s increasing politicization created new layers of institutional dysfunction. The strongest manifestation of this was the 2012 suspension of Paraguay – the culmination of several years of political posturing within the group. Paraguay had been blocking Venezuela’s membership in the bloc for years due to its disapproval of the Chavez government – even though the remaining Mercosur members had agreed to let Venezuela into the group. After Paraguayan President Fernando Lugo was impeached in 2012 (a move described by opponents as a parliamentary coup), Mercosur seized on the opportunity to suspend Paraguay’s membership and admit Venezuela as a full member. Paraguay was reinstated in 2013 after elections, and in 2017, Venezuela was also suspended over concerns about democratic institutions. Mercosur used Ushuaia Protocol-related clauses as the basis for both expulsions but did not impose punitive measures. In other words, the suspensions had no serious consequences.

While it has put in place controls to promote democracy, Mercosur members can’t agree on how to enforce them – and if they can’t get on the same page, the group risks looking weak. Any punitive measures Mercosur imposes on members could be seen as meddling in domestic affairs. Furthermore, many states are reluctant to impose punitive measures on other members for fear that they, too, could one day face the same fate – they’re not eager to set that precedent.

Such political dysfunction, often paired with divergent economic needs and governments’ heavy-handed approach to domestic economic policies, has made Mercosur less appealing as a trade partner and weakened the bloc’s institutional functions.

A Changing Brazil

Brazil in 2018 is not the country it was in 1991. In Mercosur’s early years, Brazil found itself in an economic and currency crisis, in a region mired in debt. Mechanisms like Mercosur could help Brazil access global markets and keep Argentina in check. Prior to 2015, Brazil’s economy was booming, its markets attracted foreign investment and its politics aligned fairly well with those of other Mercosur members, so the cost of dealing with Mercosur’s constraints was palatable for Brasilia. But today, it’s crawling out of a steep recession and trying to recover economically. It’s also facing a bleak global outlook, so structural reforms and improved economic ties are time-sensitive. The main benefit Brazil derived from Mercosur – a market for manufactured and semi-manufactured goods – has diminished. It sees more potential in other markets, like the United States. Brazil, then, needs the freedom to access markets that best serve its interest and the leeway to navigate the current trade environment and a slowing global economy. Furthermore, Bolsonaro’s election and its political and foreign policy implications have shunted Brazil further from the bloc. Membership in Mercosur is no longer in Brazil’s interest.

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In other words, Brazil has reached a breaking point. Its economy is indispensable to Mercosur, and until now, Brazil has not used its economic and geopolitical weight to challenge or threaten the bloc. But the costs and benefits of membership have changed. Brazil’s ability to pursue its own domestic and foreign policy imperatives is more important to Brasilia than the well-being of Mercosur and its members. Brazil can strike deals and attract investment by itself, but to do so would mean turning its back on South American relations.

Brazil has three options: maintain the status quo, leave Mercosur or reform the bloc. Clearly, Brazil cannot remain in Mercosur in its current state. Leaving the bloc would burn political bridges and potentially undermine Brazil’s existing trade relationships with ALADI countries – a sizable bloc itself. The most likely scenario is that Brazil will seek to reform Mercosur. This could mean a formal modernization of the Ouro Preto protocol, the signing of an entirely new agreement, shifting trade focus to purely Mercosur partners and loosening it up for non-Mercosur trade or simply striking out on its own with the understanding that the bloc will not inflict punitive measures. Mercosur’s fate will ultimately depend on domestic political forces in the bloc’s member states, but for Brazil, the geopolitical path is clear: It will find a way to extract itself from the current confines of Mercosur.

Allison Fedirka
Allison Fedirka is a senior analyst for Geopolitical Futures. In addition to writing analyses, she helps train new analysts, oversees the intellectual quality of analyst work and helps guide the forecasting process. Prior to joining Geopolitical Futures, Ms. Fedirka worked for Stratfor as a Latin America specialist and subsequently as the Latin America regional director. She lived in South America – primarily Argentina and Brazil – for more than seven years and, in addition to English, fluently speaks Spanish and Portuguese. Ms. Fedirka has a bachelor’s degree in Spanish and international studies from Washington University in St. Louis and a master’s degree in international relations and affairs from the University of Belgrano, Argentina. Her thesis was on Brazil and Angola and south-south cooperation.