The German Development Institute (DIE) Playing with Fire - Brazil's Dilemma in the EU-Mercosur Trade Agreement

After nearly 20 years of ongoing stop-and-go negotiations, the EU and the South American trade bloc Mercosur, comprised of Argentina, Brazil, Paraguay and Uruguay, concluded a mutual trade agreement at the end of June 2019. After the pending ratification, the agreement will establish the largest free trade zone in the world. More than 90 percent of the existing customs duties will be eliminated over a transitional period of ten years, and the outgoing European Commission President Jean-Claude Juncker has already lauded the agreement as a “historic moment”. It is a positive sign for multilateralism in a world in which trade protectionism is apparently becoming the norm once again.

As part of the agreement, Mercosur aims to significantly liberalise its market, previously protected by high external tariffs, for more complex industrial goods such as cars or machines. In return, EU tariffs on agricultural products will be waived. There is a lot at stake with this agreement, especially for Brazil. The country hopes to increase its agricultural exports to the EU – for example, beef, ethanol and soya – with the intention of stimulating investment and economic growth. A recent study by the London School of Economics confirms this view and predicts an increase in Brazilian exports, in particular beef, to the EU.

Dr. Frederik Stender

Criticism of Brazil’s Environmental Policy

However, there is a risk that the ratification of the agreement will lead to an impasse. The stumbling block in this case is not least the role of Brazil, where public disapproval of the trade agreement is on the rise. According to critics of the agreement, Brazil’s export ambitions are on clear collision course with the country’s environmental and climate protection objectives as defined in the Paris Climate Agreement. This impression is reinforced by the toothless environmental policy of Brazil’s current president, Jair Bolsonaro. On the contrary, his policy even explicitly legitimises the exploitation of the country’s natural resources through environmental deregulation. For example, during his time in office, authorization was given to clear and burn rain forest areas for agricultural exploitation. It is a strategy that appears unsustainable in many ways.

Opponents of the agreement see the devastating Amazon fires last summer as validation of their criticism. They received high-profile support from French president Emmanuel Macron. Under the new trade agreement, the EU and the Mercosur states agree to uphold the guidelines of the Paris Climate Agreement. In addition to France, however, Ireland, Luxembourg and Austria also announced their refusal to ratify the agreement in the European Council. They are calling for an enforceable sanctioning mechanism to be included in the agreement in the event of failure to comply with environmental and climate protection objectives. By contrast, those in favour of the agreement see it as an effective way – perhaps the only way – to ensure Brazil’s commitment to the Paris Agreement, given that the Bolsonaro government is already seeking to establish a free trade agreement with the US, and it is highly unlikely that, under the presidency of Donald Trump, the environmental and climate protection aspects will be taken into account within such an agreement.

The Flip Side of the Agreement

However, to say that Brazil benefits unilaterally from the trade agreement does not tell the whole story. On the contrary, in addition to legitimate concerns about the sustainability of land use, Brazil’s enthusiasm for agricultural exports also raises questions about Brazil’s long-term industrialization strategy. The price of access to the EU market may even prove to be too high for the emerging country over time. Brazil would then draw the short straw in two respects.

While European environmental activists and agricultural organisations fear a flood of Brazilian agricultural products, Mercosur is threatened in turn by a glut of more competitive European industrial products. In this situation, opportunities and risks are very unevenly distributed among the four South American members. Argentina, Paraguay and Uruguay are likely to benefit from lower prices and technological expertise. For Brazil, however, the rules of the game will change significantly as for many years, the country overwhelmed its smaller neighbours with products ranging from beer and clothes to cars. There is hardly a supermarket shelf in Argentina or Uruguay without goods bearing the origin label ‘industria brasilera’, and hardly a street in Asunción without a VW Gol manufactured in Brazil.

In this regard, empirical research has shown that Brazil mainly exports goods that are not globally competitive to the other Mercosur countries. In other words, Brazil uses intra-Mercosur trade to develop its domestic industries. The reasons for Brazil’s regional supremacy date back to the time before Mercosur was created. Like almost all Latin American countries, Brazil adopted an import substitution industrialisation policy in the 1970s and 1980s, in an attempt to promote domestic production by imposing trade barriers. Due to economies of scale, this trade policy was relatively successful in Brazil. It has therefore already established suitable industrial structures to leverage within the Mercosur bloc.

While Brazil was previously able to exploit its regional competitive advantage within the internal Mercosur market protected by external tariffs, thereby ensuring an effective industrial policy, the EU-Mercosur agreement is now removing this artificial protection zone. Overall, it is unlikely that Brazilian industry will be able to stand up to the pressure of European competition. If sales of Brazilian industrial products are no longer sufficient, production capacities will have to be rolled back, with severe consequences. After the agreement was announced, Brazil’s foreign trade secretary Lucas Ferraz acknowledged the possibility of integrating Brazilian industry into global value chains. But, conversely, European multinational companies (such as Volkswagen) could have fewer incentives to build plants in Brazil for on-site production in the future as the new agreement allows them to supply the entire Mercosur market without any duties. In the long term, the EU-Mercosur agreement could therefore threaten not only Brazil’s natural resources, but also its degree of industrialisation. Taken to an extreme, the worst case scenario would see Brazil regress to a purely agrarian state without a rain forest.

About the Author:

Dr Frederik Stender is an economist and works as a researcher at the German Development Institute (Deutsches Institut für Entwicklungspolitik, DIE). His research focuses on trade policy.

Cited Studies:

  • London School of Economics (2019). Sustainability Impact Assessment in Support of the Association Agreement Negotiations between the European Union and Mercosur. Draft Interim Report.
  • Moncarz, Pedro, Marcelo Olarreaga & Marcel Vaillant (2016). Regionalism as Industrial Policy: Evidence from MERCOSUR. Review of Development Economics, 20(1): 359-373.