COHA Report: The EU and Mercosur – Can the EU Get its Foot in the Door of Mercosur, Latin America’s Most Dominant Market?

With US foreign policy heavily focused on Iraq and the WTO Doha Round negotiations all but paralyzed, the European Union (EU) seems to be disregarding the wide open door to further regional integration and economic influence in Latin America that could be achieved through a free trade arrangement with Mercosur.

Economists would argue that the factors of production and the respective natural endowments of both regions meet textbook standards for mutually beneficial trade. The Mercosur economies (Argentina, Brazil, Venezuela, Uruguay, Paraguay) hold a comparative advantage in producing agricultural goods due to the favorable climate and the abundance of arable land and (low-skilled) available labor. The European Union, on the other hand, has a comparative advantage in producing capital and skilled labor-intensive manufactured goods and services. The EU, with a GDP of 10,820 Billion Euro, represents the biggest extant market in the world economy. Mercosur is the biggest market in Latin America. The trade volume between the two markets increased by 170 percent in the last 15 years, from 19 Billion Euros in 1990 to 51 Billion in 2005. The EU is currently exporting four times more and importing 123 percent more than it did in 1990. For Mercosur, the European Union is its most important trading partner, accounting for 23% of its exports.

However, notwithstanding the opportunity for both regions to yoke economic growth, the absolute trade volume between the two regions remains relatively diminutive as a consequence of market-access restrictions imposed on each other. The EU currently has free trade agreements with only two Latin American nations, Chile and Mexico, neither one a member of Mercosur. In the past, the strong opposition of sharply defined interest groups, in particular the European farmers, on several occasions impeded the establishment of a free trade agreement (FTA) with Mercosur. In 1999, the European Union initiated negotiations on a bilateral FTA with Mercosur. Talks were scheduled to be completed in October 2004, but the two sides failed to agree on each other’s final offer. Mercosur requested better access to European markets for its most important source of trade revenue and its prime venue for applying its comparative advantage: agricultural goods. The EU, meanwhile, wanted to increase its access to Mercosur’s manufacturing sector, in particular, its telecommunications, marine shipping and banking areas. In November of 2006, negotiations were re-launched in Rio de Janeiro, once again without significant progress being recorded.

The EU’s External Trade Commissioner, Peter Mandelson, argued in December that it is more convenient “to concentrate” on a successful outcome for the WTO Doha negotiations while “keep[ing] different bilateral free trade options open, one of which is Mercosur.”

His many critics insist that Mandelson is not adequately recognizing that the EU is currently missing a historic chance not only to gain more political and economic influence in Latin America, but also ending up with a good business deal as well. Several power brokers suggest that the EU should become more actively engaged in dialoguing with Mercosur before that now open door is effectively closed.

WTO Doha Round Stalled

First of all, the likely completion of the WTO Doha Round that Mandelson seems to focus on is not clearly in sight. Although key members of the World Trade Organization agreed at a meeting in New Delhi on April 13 to conclude the long-delayed “Development” Round by the end of this year, the different positions of the organization’s members have made such an agreement unlikely. The last meetings in Hong Kong and Geneva failed also because of the obvious unwillingness of the US and EU to increase at this time significant access to their agriculture sectors.

It is questionable if anything will be different in upcoming negotiations, considering the formidable domestic political realities in the U.S. hindering any opening at this time, as well as existing current animosities among some of the major players; “We need new numbers from the U.S. on what they are ready to do to reduce their trade distorting agricultural subsidies,” said WTO Director Pascal Lamy in March, supporting claims of Brazilian foreign minister Celso Amorim, who urged the US to make bigger cuts in its farm subsidies to its agricultural sector. Another obstacle is based on the expiration of Bush’s Trade Promotion Authority (TPA) by the end of June.

It has been widely speculated that the Democrat-controlled Congress may not readily renew the White House trade promotion authority, which allows the president to negotiate trade deals that allow Congress to only approve or reject without permitting any emendations in up-and-down votes. After its expiration, Congress will once again be able to amend or filibuster any agreement, further delaying the negotiation process. Therefore, with stalled WTO negotiations, Mercosur constitutes a promising alternative for the European Union. The EU would be wise to capitalize on its increasing bargaining power in bilateral negotiations since Mercosur’s economies—especially some of the smaller ones— are counting on the Doha negotiations to gain access to foreign markets.

Competition at a Low

The EU should also take into consideration that the foreign policy focus of its major competitor in the region, the United States, is tied to the war in Iraq. There are currently no major efforts by the US to advance negotiations for a free trade agreement of the Americas (FTAA). Moreover, the aforementioned expiration of President Bush’s trade promotion authority (TPA) in June will make prospective US trade partners, such as the Mercosur economies, more reluctant to negotiate with Washington.

In general, the mood in Latin America is currently not in favour of the US-backed free trade agreement, in part because of the negative public opinion over the North American Free Trade Agreement (NAFTA) and long simmering animosities between leftist regional leaders and the Bush administration. Under this White House, anti-Americanism has been rekindled across the region, highlighted by protests and riots throughout Latin America during President Bush’s far from successful six-day tour in March, as well as the rising influence of Venezuela’s President Hugo Chavez and his regional supporters.

The proposed EU-Mercosur integration seems to be in line with the trade and center-left political priorities of the Southern Cone’s trade bloc. President Lula of Brazil, Nestor Kirchner of Argentina, and Venezuela´s Chavez have all taken issue with US unilateralism. For President Bush, trade efforts in Latin America are currently limited to bilateral negotiations with smaller Latin American markets, such as Guatemala and Mercosur’s Uruguay, where the U.S. holds most of the cards, without having to make significant concessions. In particular, these small countries have a strong incentive to negotiate with the EU in an attempt to escape the present impasse with the U.S. Taking all this into consideration, the EU is currently more likely to obtain favorable terms now as opposed to the future, when the US could resurrect itself as a competitor, through shifting its focus back on trade policy while seeking political reconciliation with Latin America under a new, and more palatable, U.S. administration.

Public Opinion Shift in Europe

The biggest obstacle to reaching an agreement in the past has been the refusal of the EU to increase access to its own agricultural sector, in particular by means of cutting farm subsidies. With regards to cutting subsidies, France has always posed the most obdurate opposition to such an accommodation. The traditional need of its government to protect farmers from competition is no longer universally nor tenaciously shared in much of Europe. The collapse of the European Union Summit in Brussels in 2005, which led the EU into a deep internal crisis as a consequence of disputes over the allocation of subsidies, clearly spotlighted some noteworthy shift on this issue. Farm subsidies in the EU have been controversial for years, not only due to questions of transparency, but also because of its negative economic implications. The 90 billion-dollars now being spent annually by EU member nations to block cheaper food prices for European consumers through curbing competition from the developing nations, has ultimately prevented more competitive Latin American and African farmers from increasing their sales to the lucrative European market. These subsidies may, in fact, be unnecessary concessions which serve only to a minor part of the European workforce, although not one without considerable political clout. Opponents of the status quo claim that the existing subsidies should be used to initiate other land use programs, finance market transition payments and create institutions that encourage uncompetitive farmers to focus on other products or business models.

Not only are governments subsidies responsible for nursing the illusion that EU farmers are still competitive in world markets, they also violate the Union’s democratic-precepts at a time when presently 40 percent of the organization’s budget is spent on farming subsidies while 5 percent of the population is employed in the agricultural sector, which accounts for only 2 percent of EU’s total output.

In economic jargon, a trade agreement, like the one proposed with Mecosur, gives the EU the chance to allocate its resources more efficiently as well as harness its economic growth. From a political point of view, the EU has the chance to send a signal to its own citizens that the European Union is democratic and not blindly submissive to politically powerful, if not entirely germane voting blocs. It also can prove to Latin America that, unlike Washington, it is willing to make major concessions in favor of economic reality.

Growth Potential

Currently, only 1.8% of EU exports are earmarked for the Mercosur countries, hence leaving considerable space for growth. With Europe suffering a constant population decline and with its economic growth rather remaining modest (averaging 1.8 percent in the last 5 years), a necessity exists to secure expanding major markets for EU products. An agreement would almost immediately spark a strong surge in the current 50 billion Euro a year trade total between the two regions, triggering export growth for European manufactured goods, technology and service products. But this door is likely to close sooner than later for the EU. “In recent years, Latin America has been the centre of China’s attention” says Claudio M. Loser from the Centre for Hemispheric Policy in Miami. “Latin American countries offer large markets for China’s manufactured exports” he continued. In turn, China is very attractive to Latin America because of that Asian country’s almost never ending demand for agricultural goods and raw materials. The trade volume between the two grew from $200 Million in 1975 to $2.8 Billion in 1988 and to $49 Billion in 2005. If the EU remains sluggish in advancing its negotiations with Mercosur, Latin America’s demand for manufactured goods could be met by China instead of the EU.

Furthermore, the EU’s comparative advantage in high-tech manufacturing and services is diminishing; the manufacturing sector has grown substantially over the last decade in Latin America. “The combined production of seven Latin American countries (Argentina, Brazil, Chile, Colombia, Costa Rica, Mexico, Venezuela) increased 93 percent between 1991 and 2000, rising from $27 billion to $52 billion” according to Derek Hill from the National Science Foundation. The recent wave of regional integration in Latin America is yielding a knowledge spillover from more technologically advanced countries like Brazil, further reducing the regional technology gap. Thus, the demand for manufactured goods from the EU is likely to decline in the future, which makes it almost urgent for the EU to use its market potential now or await its near demise.

Beyond Economics

A trade agreement would not only foster economic growth and allocate resources more efficiently, but also decrease administrative costs by rationalizing and simplifying the management of economic interchanges. A report introduced in the European Parliament in October 2005 estimated the cost of failing to have a free trade agreement in place in the short run at 5 Billion Euros per year. The proposed Mercosur agreement would also instutionalize the growing interest of the European business community in the region. A Mercosur/European Union Business Forum (MEBF) has been launched by the business communities of Mercosur and the EU. In its VI Plenary Conference in November of 2006, more than 140 business leaders gathered in Buenos Aires to advance a bi-regional agreement intended to foster competitiveness in both blocs and to encourage officials to resume negotiations towards an Association Agreement between the EU and Mercosur.

Apart from the economic arguments, a trade relationship of equals would constitute an important step towards allowing some European countries, in particular Spain and Portugal, to consolidate historical and cultural ties to the region. The former prime minister of Portugal, Antonio Guterres, also emphasized the geo-strategic significance of a trade agreement: “Considering this strategic role, we must look to negotiate with an open spirit, in good faith, to achieve agreements with the countries of Mercosur (…) If the EU and Mercosur do not develop a firm relationship, integration toward the US will be inevitable, which will move Europe further away.”

Risk Factors

The integration of the two markets could spark conflict with the US, a the present time a major EU’s trading partner. EU exports to the US amounted to €108.6 billion in 2004 while EU imports from the US amounted to €93.0 billion. The political and economic consequences of the present US-EU relationship has to be taken into consideration in any cost-benefit analysis of an achieved EU-Mercosur Free Trade Agreement. As Washington is currently pushing for bilateral and regional trade accords throughout the hemisphere, EU-Mercosur negotiations will be recognized as an alternative road to leading away from U.S. influence.

Moreover, recent policy actions of some Latin American leaders, such as the expropriations that have occurred in Bolivia and Venezuela, indicate a risk for Foreign Direct Investment which has to be taken into consideration. This is especially relevant, since one of the demands made by the Europeans is for increased access to telecommunication services and the banking sector, which require heavy physical investment.

Sleeping Europe

Despite strong opposition from the French side, with that country’s traditional strong protection of its farmers, the European Parliament voted with an overwhelming majority of 489 to 75 in favour of a free trade agreement with Mercosur in October of 2006. As a result, representatives from both regions met on November 7, 2006 and then again on April 20 of this year to discuss the possibility of establishing a free-trade mechanism between the two blocs, without reporting progress in the negotiations. Despite the strong majority vote in the European Parliament in favour of an agreement, it seems that only a few countries are currently advocating major EU concessions in order to reach an agreement. Spain, for example, recognizes the importance of compromise in order to continue the negotiations with Mercosur. “The EU is definitely the stronger party in the talks with Mercosur and should be more generous” Spain’s Secretary of State for Iberoamerica, Trinidad Jimenez, observed on November 26, 2006. On several occasions, the Spanish Foreign Minister, Miguel Angel Moratinos, has urged all parties not to focus entirely on profit maximization.

The door to Latin America is currently wide open. The EU has the chance to strengthen the economic and cultural ties between the two regions. A free trade agreement between them would involve 700 million people and constitute the largest common market in the world. The question is whether the EU is willing to make the concessions necessary to take advantage of this bonanza market.