The Potential China-Uruguay Trade Deal Risks Fracturing Mercosur

Since democratization in 1988, newly elected presidents in Brazil strictly follow a tradition: the first trip abroad is always to Argentina, followed by Uruguay. The visit is usually surrounded by a lot of pomp, congratulations and never-before-realized plans to transform Mercosur -a trade bloc that also includes Paraguay and Venezuela (suspended since 2016)- into the long-awaited common market provided for in the Asunción Treaty, signed in 1991. .

Luiz Inacio “Lula” da Silva, who recently began his third term as Brazil’s president, enjoyed a friendly atmosphere in Buenos Aires in late January, but reality caught up with him in Montevideo. On the agenda with his center-right counterpart, Luis Lacalle Pou, was the difficult task of preventing Uruguay from going ahead with a trade deal with China.

With its disproportionately large industry, human capital, and available land compared to other South American nations, Uruguay has always demanded more autonomy from Mercosur. The main opposition is to the so-called Common External Tariff (TEC), imposed by all signatories on imports from outside the bloc. The unilateral reduction of this tariff goes against Article I of the Treaty of Asunción, which provides for joint negotiations to establish “a common external tariff and the adoption of a common commercial policy in relation to third States or groups of States.”

Since the 1990s, Montevideo has attempted to circumvent this restriction on several occasions by negotiating a trade agreement with the United States, but was dissuaded from doing so. However, Pou’s election in 2020 brought back calls for greater economic independence. Last year, the Uruguayans submitted Uruguay’s request to join the Trans-Pacific Partnership, ignoring warnings from neighbors about possible legal and commercial action if they negotiate trade outside the bloc. Now China is the next big thing.

Plans for a free trade deal with Beijing have been on Pou’s desk since at least 2021. After talks with Chinese President Xi Jinping, Pou ordered officials at the Ministry of Trade and Foreign Affairs to work with their counterparts. Chinese in a feasibility study to be completed. by July 2022, eventually creating space for progress in the negotiations. In interviews with the national press, he repeatedly complained about Mercosur’s protectionism and highlighted the need for Uruguay to open up to the world.

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Pou has a good point. Mercosur is in fact the fifth most protectionist region in the world. In the more than 30 years since its creation, it has not been able to consolidate itself as a relevant platform for South American integration, and today it suffers from bad foreign trade figures. It is the integration block with the lowest foreign trade/GDP ratio (14.9 percent compared to the world average of 33 percent).

It is also true that Uruguay, as a smaller economy, has been dependent on its two largest partners, Brazil and Argentina, for far too long. Both have experienced periods of significant growth and political stability, but conditions have been exacerbated by the dismal economic indicators of the past decade.

Argentina registered an inflation rate of 94.8 percent in 2022, the highest rate in more than 30 years. It could break this record in 2023, when the figure is expected to reach 98 percent, according to local economists.

On the other hand, Brazil is in the middle of a perfect storm of political instability, low growth and the second highest real interest rate in the world. Lula has to live up to the expectations placed on him, but in his place he has been picking up lost battles. Just as an example, in recent days, Lula has lashed out at fiscal responsibility, hinting that he wants to review the autonomy of the Central Bank of Brazil, and his promised new formula to control public spending has yet to be revealed.

In theory, neither Lula nor Argentine President Alberto Hernández are opposed to discussing a joint trade agreement with Beijing. The condition is to first implement the treaty signed with the EU, which has not yet been sanctioned by the European members. In practice, however, it is unlikely that Mercosur will be able to consolidate agreements with China, since Paraguay has no relations with China and still recognizes the sovereignty of Taiwan. In addition, the region is going through a major phase of deindustrialization and competition with Chinese industrial products at lower prices represents a serious threat to the local economy.

Pou and Beijing are left with very few options. If it wants, Montevideo can continue with the negotiations and risk a possible expulsion from Mercosur, which could generate disputes with the neighborhood, but with much more important diplomatic implications for the rest of the bloc. As for Beijing, they would have to deal with the backlash in Argentina, the largest economy in South America for join the Belt and Road Initiativeand Brazil, the country with the highest volume of Chinese investment in the world. Is it really productive to dislike the major South American countries in a world increasingly hostile to the Chinese?

In this bet, there is more at stake than just the results of the trade balance.

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