MERCOSUL, the ambitious common market of the south, was created by the Treaty of Asuncion signed on the 26th of March, 1991 by Argentina, Brazil, Paraguay and Uruguay, as a result of mostly a political agenda. Towards the end of the 80s, all of those countries had overcome years of disastrous military regimes and were in the process of reinstating the rule of law and democratic regimes. Their new civilian and democratic leaders considered such a project important defusing traditional regional rivalries that not only kept alive the possibility of military confrontation, but also allowed manipulation of hegemonic powers such as the United States of America (USA). In addition, in these years, there was a great deal of frustration for developing countries in general with the multilateral trade regime of the General Agreement of Tariffs and Trade (GATT), perceived as an instrument of dominance by the traditional trade partners. This picture had been aggravated by the acrimony surrounding the Uruguay Round of the GATT, whose negotiations had stalled, for the first time in history, as a result of the stubborn resistance put up by developing countries to the wishes of the USA and the European Union[1] (EU) to introduce new areas (such as services, investments and intellectual property) into the multilateral system whilst maintaining the traditional areas (such as agriculture and textiles) of commerce excluded thereof.

There was thus, at that moment in time, for developing countries in general, a generalised sentiment of despondency with the GATT and its perceived use as a tool for trade dominance unscrupulously used by the main powers. In no other moment in the history of multilateral trade, had there been such a mushrooming of regional trade pacts. Even the USA, hitherto undoubtedly the greatest champion of the GATT, and not surprisingly its main beneficiary, had a change of heart about the multilateral system, as it could no longer influence it to the same extent, and applied for an exception under article 24 of the GATT with a view to form what later became known as the North American Free Trade Agreement (NAFTA). Accordingly, it was perceived in South – America that a regional trade pact could also bring some commercial benefits, in addition to the improvement of the geo-political atmosphere.

The extent to which commercial benefits would be reaped was not entirely known, only vaguely suspected, as the diplomatic agents of all countries concerned conducted the negotiations in an ivory tower, totally isolated from their respective civil societies and business circles, unquestionably still very much under the influence of the deplorable old governance habits inherited from the military dictatorships of the region. The consequently largely wistful objectives of the Treaty of Asuncion were determined as:

i) the free circulation of capital, goods, services and people;

ii) the creation of a common external tariff and trade policy; and

iii) the co-ordination of macro-economic policies.

The Brazilian government negotiated with a view to obtain regional political leadership, an important objective determined by its strategic policy formulators, to what the Argentines agreed, at the price of major economic concessions from Brazil, none the least ample and unrestricted access to its huge internal markets. The trade concessions made by Brazil were such that a substantial distortion in the attractiveness of investments was created, with the result that many companies chose to establish a commercial presence in Argentina having Brazil as their main markets, such as in the automotive industry. Similarly, Brazil abolished agricultural subsidies and thus permitted access of the Argentine wheat, which was not matched by Argentina in the sugar sector, where Brazil is more competitive. The other countries of MERCOSUL, Paraguay and Uruguay, with much smaller economies, could not afford to be alienated from a trade pact by their much larger neighbours, and had to play along, getting whatever puny advantages they could possibly extract in the negotiations.

The creation of a regional trade bloc did not have the power to remove the daunting inherent problems of the signatories of the trade pact overnight. These included, but without limitation thereof, immature political institutions and macroeconomic fragility in the member states. The former comprised a vast array of idiosyncratic laws inherited from the military regimes and the latter resulted from a historical chronic economic mismanagement, corruption and incompetence. The main, but by no means the only, corollary of the adverse macro-economic situation in both Argentina and Brazil was the monetary fragility in both countries. Brazil is still one of the few countries in the world administering exchange controls and Argentina saw fit to overcome the incompetence of its central bank by removing its attribution of formulation of monetary policy, by means of pegging the domestic currency to the US dollar. The nature of the dramatic discrepancy of the adopted monetary policies did not augur well for the future of MERCOSUL.

Another major strategic error on the part of the MERCOSUL negotiators was the eschewing of the creation of a credible and efficient system for the resolution of controversies, an imperative instrument for the prevalence of the rule of law, which also brings the benefit of defusing tensions among trade negotiators and politicians. This very serious fault can be undoubtedly attributed to the Brazilian diplomacy, who did not wish to subject the power of the regional leader to the rule of law; a duplicitous stance, as well as a very distorted view of what regional trade pacts should be. Accordingly, no private parties were allowed to utilise the dispute settlement mechanism without the concurrence of their own government[2]
, which instituted effective censorship and arbitrary control of the access to the jurisdictional system. No other trade pact in the world dared to have such a bizarre system. Conversely, the contemporary NAFTA instituted a very adequate dispute resolution system within the bloc. To the bemusement of most independent observers, Brazil stubbornly adheres to this unsustainable and unjustifiable position even today.

Nevertheless, MERCOSUL became a major trade success practically from its inception. This success was more the result of the prevalent adverse conditions of access of regional products in the multilateral markets than from trade diversion. Accordingly, regional trade went from US$ 5 billion in 1991 to US$ 10 billion in 1993, US$ 14 billion in 1995, US$ 20 billion in 1997 and in 1998, and back to US$ 18 billion in 1999, after the devaluation of the Brazilian currency. It is indeed worthwhile to note that 59% of MERCOSUL´s regional trade is comprised of agricultural commodities and products, which is clear and unmistakable evidence that the pact is a very sensible, if not the only, alternative to the exclusion of its agricultural products from the multilateral trade system. Brazil quickly became not only Argentina´s main trade partner and destination of 35% of its exports, but the buyer of 50% of Argentine manufactured products, many of which originated in brand new factories largely built to service the Brazilian market, such as the automotive sector. A common external tariff for the trade bloc was created and became effective in 1995, albeit with many exceptions, such as the automotive sector, information technology, sugar, etc.

In early 1999, triggered by an international financial crisis, the intrinsic adverse macro-economic conditions in Argentina and Brazil took their toll, which was only exacerbated by the dramatically diverse monetary policies in the two countries. Argentina´s currency was pegged to the US dollar, whose policy is domestically very popular, in spite of little economic sense as Brazil is by far the main destination of Argentine products rather than the USA. Contemporaneously, Brazil was forced to realign the value of its currency, which had been set at 35% above its value, as a means to make imports cheaper and thus help in the control of inflationary products, whilst the government was incapable of adjusting its fiscal policies. This development immediately altered not only the trade relations, but also affected the diplomatic relations between the two countries. Argentina had taken for granted an overvalued Brazilian currency, which allowed competitiveness to its manufactures which was not extant with any other country, as well as the resulting large trade surpluses.

Thus, the devaluation of the Real not only altered the trade conditions in favour of Brazil, but also affected the performance, if not the feasibility, of the many foreign investments in the form of new plants built to service the Brazilian markets, as the respective products became too expensive. As a result, many operations were transferred from Argentina to Brazil. The Argentine leadership chose not to alter its monetary policy, which has become popular over the years, as it has ensured stability for the currency in a country where volatility had been the rule. Accordingly, the only option available in Argentina was to sacrifice what there was of regional free trade in a desperate effort to maintain some degree of economic vitality. Therefore, Argentina established many restrictions, for the most part illegal, in sundry sectors of the economy, such as dairy products; shoes; steel; poultry; pork; automobiles; paper and pulp; textiles; sugar; capital goods and information technology. Such actions created acrimony in the relations with Brazil and the loss of diplomatic dialogue with the Menem administration, at the end of its term in office. Effectively, managed trade substituted free trade.

The absence of an effective dispute resolution system put enormous strain on the bilateral relations. Hopes for improvement of the situation with the advent of the De la Rua administration [3]
in Argentina by the end of 1999 were unfounded, as the economic quandary remains the same. However, it is too early to predict the demise of MERCOSUL from the perspective of a political initiative. It is expected that the regional trade bloc will remain largely popular in all of the signatory countries and that the political leadership will listen to the voice from the streets. As a result, the trade bloc will, for some time, remain an exercise of managed trade within a context of political good-will and with some degree of the traditional demagogic rhetoric that has plagued that part of the world for centuries.

Nevertheless, MERCOSUL may yet re-surge from the ashes of managed trade, as once again the institutional multilateral conditions are favourable to regional commerce, in view of the widely perceived failure of the World Trade Organisation (WTO) to promote generalised prosperity within a framework of legal order and equitable rules[4]
. This, however, will be highly dependant on how effectively Brazil deals with its macro-economic fundamentals and how stabilised its currency becomes as a direct consequence thereof. If this is achieved, and Brazil abolishes exchange controls as a result, we may yet see some convergence criteria, and the abandonment of the dollar parity in Argentina, with a view to having a monetary union in MERCOSUL in years to come. An alternative scenario would be for Argentina to privilege an association with NAFTA or a Free Trade Area of the Americas (FTAA) without Brazil. The shortcomings of this solution would be that the US and Argentine economies not only fail to be complementary but are highly competitive in the agricultural sector. Major progress in the World Trade Organisation could also alter the present picture and allow MERCOSUL, to have a quiet death and the well-deserved post it has undoubtedly earned in the history of both regional trade and of South-America.