Why Mercosur Lags the Pacific Alliance
Past efforts to establish trade zones across South America have failed.
Mercosur members have shown a lack of commitment to free trade.
The recently formed Pacific Alliance shows early promise.
Trade liberalization boosts productivity and growth.
Trade integration has long been seen as a path to faster growth in Latin America. But efforts to achieve this have been hindered by policy differences among governments. The region’s trade agreements have long divided the continent into two groups.
Brazil, Argentina, Uruguay and Paraguay formed the Mercosur customs union in the early 1990s, with the ultimate goal of full South American economic integration. Prior to Mercosur, the region’s largest custom union was the Andean Pact, formed in 1969 by Bolivia, Chile, Colombia, Ecuador, and Peru. Venezuela joined in 1973, but Chile withdrew in 1976, and Venezuela quit in 2006 when it became a full member of Mercosur.
Mercosur and the Andean Pact gained relevance in the 1990s, as economic policy turned more market-based and trade barriers came down across the region. This proved only temporary, however, as the region turned left in the 2000s amid a historic commodity boom. As a result, Mercosur and the Andean Pact lost relevance although they continue to function, with the Andean Pact renamed the Andean Community. In 2008, a new organization, Unasur, was formed in an effort to integrate Mercosur and the Andean Community.
Not all value free trade
Regarded as a political rather than an economic union, Unasur's scope is both wider and less specific than that of the two trade blocs. It was also designed as a response to the failed Free Trade Agreement of the Americas, which aimed to unite South and North America in one broad trade accord. The FTAA was rejected by the mid-2000s by most Mercosur members, who claimed it would mainly benefit North America.
Even after joining Unasur, some South American countries sought bilateral trade agreements within the region as well as outside. Chile, Peru and Colombia have been consistent about pursuing trade to increase development, and all three have signed comprehensive free trade agreements with the U.S. in recent years. By contrast, Mercosur bars its members from participating in other trade agreements.
Thus in 2011, Chile, Colombia and Peru joined Mexico to form the Pacific Alliance. Its initial goal was to further free trade with a clear orientation toward Asia. The four member nations are for the most part more open to trade and markets than are their counterparts in Mercosur.
Contrasting alliances
The two trade blocs are similar in size but have notably different legal frameworks and trade policies. Mercosur members represent a combined population of about 280 million, compared with 215 million in the Pacific Alliance. At market exchange rates, Mercosur economies recorded a combined GDP of US$3.3 trillion in 2013, while the total GDP of Pacific Alliance countries was US$2.1 trillion.
However, valued at purchasing power parity, Mercosur’s GDP was US$3.5 trillion in 2013, while the Pacific Alliance's was US$3.4 trillion. Thus per-capita GDP, a better gauge of living standards, is higher among Pacific Alliance economies than in the Mercosur region.
In its more than 20 years of existence, Mercosur has failed to achieve its initial goals. Mistrust within the bloc, a deficient legal framework and a lack of commitment from its members are to blame. By contrast, in the short time since its formation the Pacific Alliance has made good progress. Several fundamental differences help explain the disparity.
An important founding principle of Mercosur was a common tariff, to prevent re-exportation within the bloc. However, each country was allowed exceptions, and these have proliferated to include most meaningful exports and imports, making the common external tariff moot. The Pacific Alliance, meanwhile, has concerned itself less with equalizing tariffs and more with the free movement of goods, capital and labor.
The Pacific Alliance also seeks to create a common equity market. The Mercado Integrado Latinoamericano includes the Peruvian, Chilean and Colombian stock exchanges, and Mexico's IPC is in the process of joining.
Autonomy versus collective action
The two blocs differ markedly in the autonomy that member nations are allowed in negotiating trade agreements. Mercosur requires its members to negotiate as a group. Trade talks are thus often delayed by individual nations' protectionist concerns.
Over its lifespan, Mercosur has signed only three external free-trade agreements, with Israel, Egypt and Palestine. Ongoing negotiations with the European Union have stumbled over Argentina's opposition to the EU’s agricultural subsidies. Uncharacteristically, the other members of Mercosur are considering an exception for Argentina to avoid derailing the talks.
In contrast, the Pacific Alliance does not require all trade agreements to be negotiated as a bloc. In February, the group set free-trade terms for 92% of goods traded within the bloc. The remaining 8% are primarily agricultural goods, and eliminating tariffs on these will take longer.
Trade and economic performance
Mexico and Chile are among Latin America's more open economies. Chile was the first in South America to aggressively pursue bilateral trade agreements, in an effort to expand its exports beyond copper. Trade liberalization was accompanied by macroeconomic stabilization measures that have lifted growth rates and given Chile the region’s highest per-capita GDP by purchasing power.
Trade makes up an even larger part of GDP in Mexico than in Chile, thanks largely to the North American Free Trade Agreement signed in 1993. Mexico’s per-capita GDP is the region's second highest after Chile, despite the negative impact of drug-related violence on growth in recent years.
Trade has a well-known correlation with growth. Developing Asia's success in recent decades is widely attributed to its dynamic export sector. Colombia and Peru began to liberalize trade later than Mexico and Chile, but have made sustained progress in recent years. The creation of the Pacific Alliance is part of that, as was the signing of bilateral free trade agreements with the U.S. in recent years.
The export performance of Pacific Alliance countries has been remarkable in recent years. The value of shipments rose 90% from 2005 to 2013 to US$560 million, a record high. Mercosur exports also rose sharply in that period, reaching US$427.3 million in 2013, up 96% from 2005 although down from US$442.2 million in 2001.
Yet the picture changes after correcting for the effect of high commodity prices. According to the U.N.'s Economic Commission for Latin America and the Caribbean, export volumes from Pacific Alliance countries increased 33% between 2000 and 2012, while Mercosur export volumes increased just 7.6%. Meanwhile, Mercosur import volumes soared 100% in the same period, reflecting a deepening external imbalance. Pacific Alliance import volumes also increased, but more slowly.
Free trade policies help resource-reach countries to diversify exports and reduce their exposure to large swings in commodity prices. Trade liberalization also boosts competitiveness, allowing domestic producers to better compete with imports.
Foreign direct investment
Brazil has long been Latin America's largest recipient of foreign direct investment, given its large domestic market and abundant resources. Yet in 2013, Pacific Alliance countries received US$85.5 billion in foreign direct investment to Mercosur’s US$79.6 billion, according to ECLAC. Similar disparities occurred in 2008 and 2009, during the global crisis. Since 2011, FDI flows to Mercosur have been flat or declining, as Brazil's growth slowed. Mercosur’s other two large economies, Argentina and Venezuela, receive almost no FDI amid soaring inflation and increasing state control of the economy.
Foreign investment to Pacific Alliance countries has risen at a healthy pace in recent years, as international firms invest despite slower recent growth. Mexico has attracted investment in its auto sector, which is geared toward the U.S. market, while Colombia, Peru and Chile continue to draw investment in mining and energy.
Outlook
Pacific Alliance nations will experience aggregate economic growth of 3.1% in 2014, up from 2.3% in 2013. Mercosur’s aggregate GDP will expand only 1% this year, down from 2.3%. Since 2011, Pacific Alliance economies have outpaced those of Mercosur, a trend that is likely to continue.
Trade liberalization and macroeconomic stability have helped Pacific Alliance countries boost growth and productivity. Inflation across the trade bloc averaged just 3.7% annually as of June 2014, compared with 18.2% across Mercosur. Central banks in Pacific Alliance countries operate independently and follow inflation-targeting policies. Within Mercosur, only Brazil's and Uruguay's central banks target inflation, and inflation remains stubbornly high because of high levels of government spending.
To grow faster, Mercosur countries must begin to deregulate their economies. This includes removing trade barriers and seeking new free trade alliances. Mercosur must be reformed or dismantled, as the current legal framework makes the necessary changes all but impossible. Unfortunately, this seems unlikely in the near future. As a result, the gap in performance between the two trade blocs will widen.
Juan Pablo Fuentes is an Economist at Moody's Analytics.
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