Trade Patterns and Regional Economic Integration

Trade Patterns and Regional Economic Integration

Underlying much of the debate over trade policy in Brazil in the 1990s is an implicit choice between regional trade arrangements or a more nonpreferential policy that would not discriminate by national origin or destination. Brazil's most important current regional trade initiative is the Common Market of the South (Mercado Comum do Sul--Mercosul; see Glossary). With the ratification of the North American Free Trade Agreement (NAFTA; see Glossary) among Canada, Mexico, and the United States in 1993, it was inevitable that Brazilian participation in even larger regional trade arrangements than Mercosul would be discussed increasingly.

Despite the rhetorical prominence of Latin American trade in debate over Brazilian trade policies, Brazilian trade flows do not reflect a particularly strong orientation to other Latin American countries. However, with Mercosul, other Latin American countries may gain in relative importance. By the mid-1990s, trade with the other Mercosul partners, particularly Argentina, was one of the most rapidly growing sectors of Brazilian foreign trade.

In the 1980s, Brazilian exports to the rest of South America had averaged less than 10 percent of all exports; exports to Mexico, Central America, and the Caribbean added another 2 percent. Brazilian exports were directed overwhelmingly to the United States and Canada (about 30 percent) and to Western Europe (about 30 percent).

Brazilian export patterns in the 1980s and early 1990s were little different from earlier decades, when they were also dominated by trade with the United States and with Europe. This trade orientation reflected several historical influences, including the structure of Brazilian international transportation channels and the composition of Brazilian exports. Only in the 1970s did Brazilian exports shift from being dominated by primary and semiprocessed products to manufactures. Major markets for all these products were primarily in high-income countries; for example, Brazil long depended on the United States as its major market for coffee. Other important primary products, such as sugar, soybeans, and iron ore, were also sold mainly in high-income countries (see table 17, Appendix).

Finally, and possibly most important, Brazilian export patterns reflected the relatively strong inward orientation of most of Brazil's Latin American trade partners during most of the early post-World War II decades. The strong influence of the import-substitution industrialization doctrines of the Economic Commission for Latin America and the Caribbean (ECLAC; see Glossary) in most of the Latin American economies in the 1950s had by the early 1960s led to extensive import-substitution industrialization, particularly in Brazil and its larger trading partners, notably Argentina and Mexico. The inevitable result was that the more open economies of Europe and North America continued to provide the most important markets for Brazilian exports. Only with the concurrent liberalization of trade in a number of other Latin American economies, especially Argentina, did Brazil's exports begin to reflect the importance of its Latin American trade partners.

Brazil's export orientation toward North America and Europe is also noticeable in its import pattern. In addition, the Middle East is a significant trade partner because of the high value of petroleum imports. The large trade deficit with this region was financed primarily by surpluses with other regions, notably the United States and Europe. Brazil's imports from the rest of Latin America accounted for only about 12 percent of the total value of its imports in the 1980s.

Despite the approximately equal shares of Latin American trade in both Brazil's exports and its imports, during most of the 1980s Brazil had a large trade surplus with the region, exceeding US$800 million in most years. This surplus, which was generated primarily in trade with Argentina, Bolivia, and Paraguay, helped finance Brazil's oil imports from two of the region's oil exporters, Mexico and Venezuela. The value of Brazilian imports of petroleum from these countries was greatest in the early 1980s and declined with the fall in petroleum prices.

Brazilian attempts to expand formal regional trade agreements beyond bilateral preferential trading arrangements date from 1958, when the government joined Argentina, Chile, and Uruguay in discussions that led to the Treaty of Montevideo, signed in February 1960. Under the treaty, which was expanded subsequently to most of the economies of South America and to Mexico, the members agreed to negotiate mutual tariff reductions on a permanent basis.

Despite its professed intentions, the organization created by the treaty, the Latin American Free Trade Association (LAFTA--also known as Asociación Latinoamericana de Libre Comercio--ALALC; see Glossary) was only a limited success. Part of the reason lay in the departures of many of the agreements from the nondiscriminatory provisions of Article 24 of the General Agreement on Tariffs and Trade (GATT--see Glossary), which regulates regional trade agreements. Although the intent of LAFTA was to create new trade rather than to divert trade flows from efficient sources outside the region, its success in this respect was minimal. Another provision of the agreement, which required the formation of a free-trade area within a specified time period, was ignored. The deadline for LAFTA to create such an area was first extended from 1972 to 1980; when the 1980 deadline was not met, LAFTA was replaced by the Latin American Integration Association (LAIA--also known as Associação Latino-Americana de Integração--ALADI), which had more modest goals. The real blow to LAFTA/ALADI trade came after 1982, when international capital markets were closed to most Latin American borrowers following the onset of Mexico's external debt crisis. Like most Latin American governments, Brazil reacted by sharply restricting its imports, including those from other ALADI members. As a result, intraregional trade fell significantly in the first half of the 1980s.

Argentina historically has been Brazil's most important Latin American trade partner by a wide margin, both in imports from Brazil and exports to it. For this reason, virtually all Brazilian regional trade initiatives have been based on this bilateral trade relationship. Well behind, and of comparable importance, are Chile, Mexico, and Venezuela. One feature of Brazil's regional trade is the substantial surpluses that it has run with several of its neighbors, among them Bolivia, Colombia, and Paraguay. In the case of Paraguay, this surplus may reflect an underreporting of imports as a result of the high value of contraband and unreported consumer good imports from Paraguay to Brazil. Another prominent feature of Brazil's trade with the rest of Latin America is the importance of imports from the temperate-zone Southern Cone countries. With the exception of the oil exporters, Brazilian imports from other tropical Latin American economies are relatively unimportant, despite the importance of several of them as markets for Brazilian exports.

During the 1970s, Brazil's trade with the United States, historically its most important trade partner, declined in relative importance as trade with Western Europe and Japan grew. On the export side, this trend ended in the early 1980s, as the United States economy grew more rapidly than Europe's and the real appreciation of the dollar made the United States a relatively more attractive market in which to sell. The tendency toward a greater trade surplus was reinforced by Brazil's efforts after 1982 to restrict imports, especially from traditional suppliers like the United States.

Brazil's export-led growth (see Glossary) since the 1980s has been oriented decidedly toward the industrialized countries. As a result of their already large share of Brazil's export market and their rates of growth, the United States and Canada were responsible for nearly half of Brazil's export growth during the late 1980s and early 1990s. Brazil's most rapidly growing market in the period was the rest of South America, with annual growth exceeding 10 percent. However, its relatively modest initial share of the Brazilian export market placed South America behind Asia and the Pacific and Western Europe, as well as the United States and Canada, in its contribution to total Brazilian export growth.

Brazilian import growth in the 1980s and early 1990s presents a similar picture. The total value of Brazilian imports in this period grew very slowly, as the decline in the value of oil imports nearly offset the rise in the value of imports from Western Europe and North America. As was the case with exports, the industrialized countries were far more important trade partners for Brazil than were the less developed regions. Brazilian imports from other Latin American trade partners fell in value after 1983, as modest increases in imports from the rest of South America and the Caribbean were more than offset by the fall in imports from Mexico and Central America.

Until the early 1990s, both Brazil and Argentina had a tradition of inward-oriented industrial policy, and it is therefore not surprising that trade between the two economies fell far short of its probable potential. The 1986 trade agreement between Brazil and Argentina was a partial attempt to address this problem and formed the nucleus of the regional trade agreement for Mercosul.

President Sarney and Argentina's Raúl Alfonsín (president, 1985-89) signed twelve protocols in July 1986 and additional protocols in December 1986. Most of the protocols aimed at strengthening Argentine-Brazilian economic cooperation, although cooperation in other areas also was included. In November 1988, following extensive consultations between the two governments, Alfonsín and Sarney signed the final Argentine-Brazilian Agreement, which was ratified subsequently without modification by the congresses of the two countries in August 1989.

Both governments hailed the agreements as major steps toward economic integration, as well as a Latin American response to what was perceived as the formation of economic blocs, such as the plans of the United States-Canada Free Trade Agreement (FTA) and the European Community (EC; see Glossary). In reality, the protocols were more statements of intention than the detailed results of negotiations in the areas covered. The Argentine-Brazilian Agreement was a short, five-page general statement summarizing the objectives of the July 1986 protocols. Unlike the massive United States-Canada FTA, it in effect deferred much of the specific negotiation involved in the agreement's implementation to the future. It was nevertheless an ambitious document, appearing to promise a level of cooperation and coordination analogous to that of the EC.

The Argentine-Brazilian protocols signed between 1986 and 1988 paved the way for an even more ambitious regional trade agreement. Following negotiations with Uruguay and Paraguay, the foreign ministers of the respective governments agreed in March 1991 in Asunción, Paraguay, to establish a common market among the four countries by the end of 1994; the Treaty of Asunción, which established Mercosul, explicitly recognized the potential participation of additional members. Like the earlier bilateral Argentine-Brazilian agreements, the 1991 Mercosul agreements were long on promises and left much for future negotiations. The agreements envisioned a full common market. Article 1 of the treaty provides for free circulation of goods, services, and factors of production (see Glossary) among the member countries; elimination of tariff and nontariff barriers; establishment of a common external tariff; coordination of policies in regional and international forums; and coordination of macroeconomic and sectoral policies.

During the transition period from 1991 through 1994, the accord called for a progressive "linear and automatic" reduction in tariffs, which was to be accompanied by the elimination of nontariff barriers to trade among the contracting parties. The December 31, 1994, target was to be a zero tariff among the members. As more recent entrants, Paraguay and Uruguay were given an additional year to comply with the terms of the treaty.

Compared with some earlier declarations of intent, the Treaty of Asunción was considerably more specific about how the common market was to be created. A schedule for tariff reductions was established; cuts were to be made at six-month intervals between June 30, 1991, and December 31, 1994. These reductions were to be calculated as a percentage of the lowest tariffs applied to members outside the Mercosul group and were based on the ALADI tariff classification.

Several other provisions of the treaty give it a positive bias toward greater economic openness. Tariff reductions are based on the rates prevailing before the signing of the treaty. Any external tariff reductions that lower the base from which intra-Mercosul tariffs are calculated was to apply to all signatories. The treaty also contains a type of "most-favored-nation" clause, which guarantees that any trade concession extended to nonmembers of Mercosul by any member will be extended automatically by all other contracting members.

The Treaty of Asunción allowed each nation to submit a list of exceptions to the tariff reduction list. Brazil and Argentina submitted 324 and 394 tariff exceptions, respectively; Paraguay, allowed 439; and Uruguay, 960. Although it is impossible to quantify the degree to which these exemptions undercut the main thrust of the treaty, their most important feature was that they were temporary. Argentina and Brazil agreed to reduce their exception list by 20 percent annually, while Paraguay and Uruguay were allowed an extra year (to the end of 1995) to eliminate their lists.

Brazil and many of its neighbors have tended to view Brazilian trade preference options as geographically defined and relatively local. Whatever the outcome of the Mercosul regional initiative, the existing pattern of Brazilian trade flows suggests that Brazil's long-term trade interests extend well beyond such regional boundaries. Indeed, Mercosul and the European Union (EU, the former EC; see Glossary) have been discussing the creation of a free-trade area between the two groups. Two alternatives to Brazil's South American-focused regional trade policy are participation in a hemispheric FTA or more open, nonpreferential trade with the entire world. The former would follow the Mexican example by negotiating Brazil's entrance into the NAFTA, which is composed of the United States, Canada, Mexico, and potentially, Chile. The second strategy is to follow a Chilean approach, avoiding preferential trade liberalization and making Brazil more open to all trade flows, whatever their geographical source.

Compared with membership in an expanded NAFTA, Brazilian participation in Mercosul represents a much more modest regional trade arrangement. Canada alone has a larger GDP than do all of the Mercosul economies combined; the four Southern Cone members have a combined GDP totaling less than 10 percent of the total GDP of the NAFTA countries. Given recent rates of economic growth, this gap has actually widened in recent years.

The great disparity in the sizes of the two regional trade groups has a number of implications for alternative Brazilian trade strategies. Membership in the current group, in which Brazil is by far the dominant economy, offers political influence and the possibility of shaping many of Mercosul's external commercial policies to match Brazilian trade objectives. In many manufacturing areas, Brazil faces little competition from the other Mercosul countries. If Brazil were to become a member of the larger hemispheric trade group (NAFTA), the country would account for only about 5 percent of the association's joint product.

In addition to the size difference between Mercosul and a hemispheric FTA, other features of the two regional trade arrangements have important cost and benefit implications for Brazil. The Treaty of Asunción is in many ways more ambitious than is NAFTA. Its stated objective is the creation of a true common market similar to the EU. In such a regional trade arrangement, trade barriers among the member countries are eliminated and external tariffs against third countries, fiscal policies, and exchange-rate policies are integrated.

Brazilian participation in a hemispheric FTA would in principle require less coordination of fiscal, monetary, exchange-rate, and foreign capital policy than is required by the Treaty of Asunción. One may question how seriously the Brazilian government or other Mercosul members are prepared to implement the integration implied by a common market. The replacement of LAFTA by ALADI in 1980 suggests that in the choice between national sovereignty and the benefits of greater economic integration, the former may prevail. But, if the explicit commitments of the four governments in the Treaty of Asunción are to be taken at face value, it would appear that a relatively high degree of policy independence would be sacrificed for economic integration benefits, which are likely to be considerably more modest than those attainable by membership in a hemispheric FTA.

Another option for Brazil would be to follow a Chilean approach of greater trade openness on a nonpreferential basis. Such an approach has three main advantages, which in principle make it superior to other trade strategies. First, the possibility that inefficient trade diversion will occur is eliminated. The lowest cost or most efficient producers would be able to supply Brazil without facing trade barriers, because no such producer would be eliminated from among Brazil's potential suppliers under a nonpreferential open-trade policy. Brazilian demand would thus be supplied by the most efficient suppliers in the world market, rather than those in a more restricted area.

Second, a nonpreferential approach in Brazilian trade policy would be more easily administered because it is in effect a unilateral policy, not dependent on negotiations with potential trade partners. However, this approach may not be perceived as an advantage from a political standpoint, as it appears to sacrifice Brazil's "bargaining chips."

Third, a nonpreferential strategy may better position Brazil to respond to changes in world markets. Until the mid-1990s, Brazilian trade had not grown faster in the Mercosul region than in other areas. In fact, the United States, Canada, Western Europe, and Asia all contributed more to the growth of Brazilian trade until the mid-1990s than did other Latin American economies. Although Brazilian membership in a hemispheric FTA might ensure greater access to the United States, Canada, and Mexico, it would offer little prospect of trade expansion with Europe or Asia.

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