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Jan 29, 2013 | 15:38 GMT

Brazil Considers the Prospect of Free Trade

Brazil Considers the Prospects of Free Trade
PEDRO LADEIRA/AFP/Getty Images
Summary

Diverging interests of Mercosur's most dominant members, Brazil and Argentina, are stressing the trading bloc's unity. Brasilia needs sustainable economic growth and thus is searching for other consumer markets. In fact, the government recently has come out in favor of speeding up negotiations with the European Union for a free trade agreement. But Brazil's main trading partner in Mercosur, Argentina, is much less enthusiastic, and Buenos Aires can be expected to prolong the negotiations as long as possible. This is a troubling prospect for Brasilia, given that any free trade agreement requires unanimous Mercosur approval. 

Mercosur boasts an idiosyncratic regulatory system that is managed by and built for the purpose of protecting interests in member countries. In practice, Mercosur is dominated by two countries: Argentina and Brazil. From a strategic perspective, the bloc provides a way for these two economic heavyweights to keep each other in check through continuous, careful negotiation. But the benefits of the organization — a common labor market and special market access for smaller member states, for example — are counterbalanced by strong trade restrictions placed on member states.

Currently, Argentina relies on various import restrictions and export incentives to maintain as large a trade surplus as possible. These import restrictions have affected several of its trade partners and have been particularly vexing for Brazil. Rising energy import costs and strong redistribution programs have put enormous pressure on the country's coffers and its balance of payments. Argentina remains alienated from international capital markets, and access to foreign exchange is of paramount importance. Any actions that threaten that policy, such as a trade agreement that could take down trade barriers and introduce unwanted competition into Argentina's domestic market, are anathema to Buenos Aires.

Brazil is in an altogether different situation. The country weathered the financial crisis in large part because of rising Chinese demand for Brazilian commodities and sharp increases in domestic consumption. Although Brazil's export sector is only 12 percent of its gross domestic product, its decision to prioritize primary commodities as Argentine and U.S. consumption of higher value-added goods declined demonstrated the flexibility and diversity of Brazil's economy. However, external conditions left Brazilian export manufacturers searching for ways to expand their businesses. Brazilian President Dilma Rousseff's administration has attempted to address some of the more pressing challenges to Brazilian businesses. Brazilian companies face a range of challenges that cut into their profit margins. Known as the "Brazilian Cost," these include corruption, poor infrastructure and high taxes. Rousseff has tackled many of these challenges over the past two years of her administration.

Brazil nonetheless faces rising labor costs at home and only a moderate economic growth forecast of 3.1 percent for 2013. The boom in consumer spending has sustained and expanded the domestic economy. However, expanded market access outside Brazil would create new growth opportunities for manufacturers and employers across the board.

But there would also be challenges. Mercosur imposes a common external tariff, and Brazilian businesses are protected from competition by a range of tariff and nontariff barriers even within the framework of Mercosur. Introducing a free trade dynamic would disrupt this system, likely causing inefficient businesses and industries to fail. In turn, these failures would upset powerful labor groups, which can be politically dangerous for any government. Conversely, a free trade element would open up opportunities for more competitive companies and could improve the further development of Brazil's diverse business sector.

Continued Protectionism?

The prospect for new opportunities is what has compelled Brasilia to support speeding up the EU negotiations this month. Taken together, the European Union forms the largest export destination for Brazilian goods. Most of these goods are raw commodities, like iron ore, and agricultural byproducts; Brazil exports only small quantities of manufactured goods to Europe. The possibility of a free trade agreement could enable Brazil to edge into Europe's enormous consumer market, which still imports around $2.4 trillion worth of goods annually form outside the European Union despite the ongoing financial crisis.

Protectionism and relatively conservative but consistent state intervention characterize Brazil's domestic economic system and are unlikely to be undone completely. Brazil may not be ready to open up to trade for some time, and there are dangers inherent in abandoning Mercosur. But pressure is rising for Brazil to consider very serious structural changes, and increased openness to trade with the world's largest importing market will drive the Brazilian government and subsequent administrations to consider changing the nature of its relationship with Mercosur and with Argentina.

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