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STRATFOR GLOBAL INTELLEGENCE: 

Brazil Seeks Incremental Change to Mercosur

August 12, 2013

Though Brazil is not seeking to abandon the Mercosur bloc, the trade bloc is still evolving radically, albeit slowly. Brazil will not seek to negotiate unilaterally with the European Union for a bilateral free trade agreement, the Brazilian Ministry of External Relations said in an effort to refute comments by the Financial Times, Brazilian newspaper Estadao reported Aug. 12. According to the ministry, Brazil has no intention of breaking with Mercosur. Indeed, such a scenario is quite unlikely. However, it is clear that Brazil is increasingly open to changes in trade policy, and the sheer weight of Brazil's ongoing economic shifts will be the driving force behind changes in how Mercosur operates.

Analysis

Despite its many challenges, the Common Market of the South, better known as Merocsur, is still an important political and economic tool for Brazil. Dragged down in recent years by the increasingly delicate economic situation in Argentina, the bloc nevertheless remains the main organizing principle for industrial relations between Brazil and Argentina. Beyond its economic role, the bloc is also a forum for constant diplomatic interaction between the two major powers of the southern cone and is an important geopolitical tool for Brazil. The importance with which Brazil views Mercosur is evident in ongoing efforts to expand the bloc. Brazil championed Venezuela's membership efforts, which were ultimately successful in 2012, and both Ecuador and Bolivia are currently in the process of joining the group, with Brazil's full support. 

But in addition to expanding its political influence in the region by supporting the expansion of the bloc, Brazil is also on an urgent huntfor an increased export market share. The economic crisis did not cripple Brazil's growth as it did many other countries around the world, but it didtrigger significant changes. Commodity exports to China, investments in capital-intensive extractive industries and a consumer credit boom were instrumental in sustaining growth in the wake of the global financial crisis. Brazil's manufacturing sector, however, has not done so well. Exports of higher value added goods to the traditional markets of the European Union, United States and Argentina collapsed as demand fell, and sustained upward pressure on the national currency made an already poorly competitive sector even less so. Added to these factors is Brazil's reclassification as an upper-middle income country, which will eliminate in 2014 Brazil's preferential trade access to the European Union that came with being a developing economy. 

As a result, Brazil's industries have put enormous pressure on the government to find growth alternatives and including the small consumer markets of Venezuela, Ecuador and Bolivia in Mercosur is not enough. For most other countries, this would be a classic market access challenge that would simply require bilateral trade negotiations to drop tariffs and align regulatory regimes. For Brazil, however, it is much more complicated. Mercosur has tied Brazil's fate to that of Argentina, and although Brazil has pressing reasons to want Mercosur to reduce barriers to trade (particularly to the European Union), Argentina's brewing balance of payments crisis calls for protectionism. Unfortunately for Brazil, trade deals outside of Mercosur require unanimous support from Mercosur members.

Brazil's efforts to balance these competing needs will most likely result in a compromise policy. Brazil appears to be negotiating an outcome that would still require approval by full Mercosur members but could allow for flexible application of new trading rules on a country-by-country basis. Such a compromise would be similar to the Andean Community's split over a trade deal with the European Union in 2007, though the exact outcome would probably differ in the details. The biggest constraint on this effort will be whether Argentina would be willing to accept such a compromise. Brazil could also face resistance from Venezuela and potential future members Ecuador and Bolivia (Paraguay and Uruguay would support closer integration with the European Union and have even shown interest in Mercosur's rival bloc in South America, the Pacific Alliance), but Argentina has significantly more leverage in its negotiations with Brazil. 

Whether or not Argentina is willing to outright block Brazil is difficult to say at this moment, however, no matter how fast it comes, change will not be overnight. Brazil's commitment to the bloc as a political tool remains strong, but the economics of the situation dictate that Brazil begin seeking outside options.