FINAL OVERVIEW TRADE SIA EU-MERCOSUR · Food and Agricultural Organization of the United Nations . FDI : Foreign Direct Investment . FLEGT : Forest law Enforcement, Governance and

TRADE SUSTAINABILITY IMPACT ASSESSMENT (SIA)

OF THE ASSOCIATION AGREEMENT UNDER

NEGOTIATION BETWEEN THE EUROPEAN COMMUNITY

AND MERCOSUR

FINAL OVERVIEW TRADE SIA EU-MERCOSUR

MIDTERM REPORT

Consultation Draft

Interested Parties are invited to comment on this Consultation Draft: email address: [email protected]

JUNE 2008

Personal data in this document have been redacted according to the General Data Protection Regulation

2016/679 and the European Commission Internal Data Protection Regulation 2018/1725

This Report was commissioned and financed by the Commission of the European Communities. The views expressed herein are those of the Consultant, and do not represent

any official view of the Commission.

This Report has been prepared for the European Commission under Contract No: Trade 05-G3-01 - Specific Contract No 2

Trade SIA EU-Mercosur Partners IARC, Institute for Development Policy and Management (IDPM), University of Manchester

Chaire Mercosur Copenhagen Economics

ECOSTRAT Consultants, Brazil Estudio López Dardaine, Argentina

GRET (Groupe de Recherche et d’Echanges Technologiques) Land Use Consultants

Natural Resources Institute, University of Greenwich WISE Development (Women in Sustainable Enterprise Development)

With contributions from:

Mahrukh Doctor, Leonith Hinojosa, Tomasz Iwanow

Project website: http://www.sia-trade.org/mercosur

Project email address: [email protected]

SIA of Mercosur Negotiations – Final Overview SIA Mid-Term Report page ii

CONTENTS

ABBREVIATIONS .................................................................................................................. v

1. EXECUTIVE SUMMARY................................................................................................vii

1. INTRODUCTION................................................................................................................ 1 1.1 The EU Trade SIA Programme ........................................................................................ 1 1.2 The Trade SIA Methodology............................................................................................ 1 1.3 The EU-Mercosur Trade Association Agreement ............................................................ 5 1.4 The EU-Mercosur Trade SIA Programme........................................................................ 6 1.5 Structure and Content of the Mid Term Final Overview Trade SIA................................ 7

2. BASELINE CONDITIONS FOR EU MERCOSUR TRADE AND INVESTMENT FLOWS ................................................................................................................................... 11

2.1 Introduction .................................................................................................................... 11 2.2 Trade Flows .................................................................................................................... 11 2.3 Investment Flows............................................................................................................ 15

3. AGRICULTURE SECTOR .............................................................................................. 18 3.1 Introduction .................................................................................................................... 18 3.2 Negotiations in the Agricultural Sector .......................................................................... 18 3.3 Modelling Results for Agriculture.................................................................................. 19 3.4 Animal Welfare .............................................................................................................. 22 3.5 Food Standards and Safety ............................................................................................. 22 3.6 SIA Findings for Agriculture.......................................................................................... 23

4. MANUFACTURING SECTOR........................................................................................ 35 4.1 Introduction .................................................................................................................... 35 4.2 Negotiations in the Manufacturing Sector...................................................................... 36 4.3 Modelling Results for Manufacturing Sector ................................................................. 37 4.4 SIA Findings for Manufacturing .................................................................................... 39

5. SERVICES SECTOR ........................................................................................................ 49 5.1 Introduction .................................................................................................................... 49 5.2 Negotiations in Service Sector ....................................................................................... 52 5.3 Modelling Results for Services Sector .......................................................................... 55 5.4 Business and Professional Services................................................................................ 57 5.5 Environmental Services.................................................................................................. 67 5.6 SIA Findings for Services............................................................................................... 74

6. RULES BASED MEASURES........................................................................................... 79 6.1 Investment ...................................................................................................................... 79 6.2 SIA Findings for Investment .......................................................................................... 81 6.3 Public Procurement......................................................................................................... 85 6.4 SIA Findings for Public Procurement ............................................................................ 90

7. CROSS CUTTING ISSUES .............................................................................................. 95 7.1 Rural Livelihoods and Gender........................................................................................ 95 7.2 Foreign Investment and Growth: Automobile Sector................................................... 105 7.3 Mercosur Integration ................................................................................................... 121

8. CONSULTATION AND DISSEMINATION STRATEGY........................................ 135 8.1 Consultation Process..................................................................................................... 135 8.2 Ongoing Consultation Process...................................................................................... 142 8.3 Networking and Dissemination Activities.................................................................... 142

SIA of Mercosur Negotiations – Final Overview SIA Mid-Term Report page iii

9. CONTENT AND TIMETABLE FOR FINAL REPORT............................................ 144

REFERENCES..................................................................................................................... 145

ANNEX 1: THE EU-MERCOSUR COMPUTABLE GENERAL EQUILIBRIUM (CGE) MODEL .................................................................................................................... 153

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ABBREVIATIONS AVE Ad Valorem Equivalent BNC Bi-regional Negotiation Comity BNDES Banco Nacional de Desenvolvimento Econômico e Social CCA Causal chain analysis CET Common External Tariff CETM Copenhagen Economics Trade Model CGE Computable General Equilibrium DG Directorate General EC European Commission EDS Energy data set EU European Union FAO Food and Agricultural Organization of the United Nations FDI Foreign Direct Investment FLEGT Forest law Enforcement, Governance and Trade FTAA Free Trade Area of the Americas GATS General Agreement on Trade in Services GEO Global Environmental Outlook GDP Gross Domestic Product GNI Gross National Income GTAP Global Trade and Protection IADB Inter-American Development Bank IARC Impact Assessment Research Centre IDPM Institute for Development Policy and Management IMF International Monetary Fund ITTG Information Technology and Telecommunication Goods M and E Mitigation and Enhancement MDG Millennium Development Goals MENA Middle East and North Africa MFN Most-favoured-nation MFN Most-favoured-nation NAFTA North American Free Trade Agreement NAMA Non-agricultural Market Access NGO Non-governmental Organization NSDS National Sustainable Development Strategies NTB Non-Tariff Barriers OECD Organization for Economic Co-operation and Development PPP Purchasing Power Parity PSIA Poverty and Social Impact Assessment RIA Regulatory Impact Assessment SD Sustainable Development SEA Strategic Environment Assessment SIA Sustainability Impact Assessment SME Small and Medium-sized Enterprise SPS Sanitary and Phytosanitary Measures SSA Sub-Saharan Africa TPR Trade Policy Review TRIPS Trade-Related Aspects of Intellectual Property Rights TRQ Tariff Rate Quota UN United Nations UNCTAD United Nations Conference on Trade and Development

SIA of Mercosur Negotiations – Final Overview SIA Mid-Term Report page v

UNEP United Nations Environment Programme US United States of America WB World Bank WTO World Trade Organization WWF World Wide Fund for Nature

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1. EXECUTIVE SUMMARY This Mid Term Report for the Overview SIA EU Mercosur SIA reports on the progress made in meeting the requirements of the Final Overview SIA which will be completed in late 2008. It builds on the overall Preliminary SIA and the three sector reports (for agriculture, forests and automobiles) that were completed in Phase 1 of the programme, to provide an overall assessment of the potential impact of the trade aspects of the Association Agreement between the European Communities and Mercosur on sustainability in both regions. The mid term Report draws together the results of the earlier studies and complements them with further analysis of the priority and cross cutting issues that were identified at the completion of Phase 1 for more detailed study in Phase 2. In particular, the report provides an in-depth of the following priority and cross cutting issues:

Rural Livelihoods and Gender Mercosur Integration Foreign Investment and Growth Business Services Environmental Services Animal welfare Food Standards and Safety

Two other priority issues identified in the Phase 1 study are being examined in parallel in two further sectoral SIAs, for financial services and trade facilitation. The results of these sectoral studies will be incorporated into the overall findings in the final stage of the study. The report also provides information on ongoing consultation process and on networking and dissemination activities. The structure of the mid term report is as follows:

1. Introduction 2. Baseline Conditions for EU Mercosur Trade and Investment Flows 3. Agriculture Sector 4. Manufacturing Sector 5. Services 6. Rule Based Measures 7. Cross Cutting Issues 8. Consultation and Dissemination Activities 9. Content and Timetable for Final Report.

The consultants welcome comments on this draft Mid Term Overview Report, and can be contacted by email: [email protected].

1. INTRODUCTION 1.1 The EU Trade SIA Programme The European Commission has been engaged in conducting Trade SIAs as part of its trade policy-making process since 1999. The purpose of the Trade SIA programme is to inform trade negotiators and other interested parties on the potential economic, social and environmental impacts of the EU’s trade negotiations, in both the EU and Europe’s trading partners. The European Commission has defined the objective of its SIA studies (European Commission, 2002) as a means of integrating sustainability into European trade policy:

• by analysing the issues of a trade negotiation with respect to sustainable development; • by informing negotiators of the possible social, environmental, and economic

consequences of a trade agreement; • by providing guidelines to help in the design of possible flanking measures, the sphere

of activity of which can exceed the commercial field (internal policy, capacity building, international regulation), and which makes it possible to maximise the positive impact and to reduce the negative impact of the trade negotiations in question.

The Trade SIA programme applies a standard approach in conducting the assessment. This framework has two complementary elements: Trade sustainability impact assessment, comprising a balanced and integrated assessment of potential economic, social and environmental impacts. Consultation process, whereby consultation with, and dissemination of results to, partners and key stakeholders is an integral part of the assessment process. Consultation and transparency are essential processes for ensuring the credibility and legitimacy of the Trade SIA. The EC’s Trade SIA Programme uses a standard methodological framework, which is summarised in section 1.2. The modifications to this generic framework that have been introduced to meet the particular conditions and characteristics of the EU-Mercosur trade negotiations are also described in the next section. 1.2 The Trade SIA Methodology Sustainability Impact Assessment is increasingly being used as a method of assessing the potential impact of policies, programmes and plans in terms of the goal of sustainable development. SIA is an integrated approach to assessment, which aims to provide a balanced assessment of potential economic, environmental and social impacts of public authority interventions.1 To provide an integrated assessment, SIA draws together various techniques that are deployed in economic analysis, environmental impact assessment, and poverty and social impact assessment. Trade SIA is the application of the SIA approach to trade policy interventions. The purpose of the SIA is to support better policy making, by providing decision makers with an evidence-based assessment of the potential positive and negative consequences of their policy choices. To achieve this, the analysis strives to be credible, evidence-based, and transparent. The

1 See the Proceedings of the recent OECD Workshop on Sustainability Impact Assessment (OECD, 2008).

SIA of Mercosur Negotiations – Final Overview SIA Mid-Term Report page 1

results of the assessment also need to be provided to decision-makers at an early stage in the policy cycle, if they are to inform the decision-making process. The methodological framework for Trade SIA is described in the EC’s Handbook for Trade Sustainability Impact Assessment (EC, 2006). The cornerstone of the SIA methodology is causal chain analysis. Causal chain analysis (CCA) is used to identify the significant cause-effect links between the proposed trade measure (scenario) and its eventual economic, social and environmental impacts. The aim of CCA is to distinguish the significant cause-effect links in the chain, where the analysis is undertaken in logical sequence, from ‘cause’ to ‘effect’. The evidence that is used to explain the causal chain analysis is derived from theoretical reasoning, economic modelling, other quantitative techniques, existing studies, and expert opinion from key stakeholders. The causal chain analysis can be represented in the form of a causal chain diagram, which shows each of the main linkages in their logical order of causality (Figure 1). Figure 1: Causal Chain Analysis of Impact of a Trade Measure on Sustainable Development TRADE MEASURE OR

SCENARIO

INCENTIVES AND OPPORTUNITIES

PRODUCTION SYSTEM ECONOMIC

IMPACTS SOCIAL

IMPACTS ENVIRONMENTAL

IMPACTS A change in trade policy will alter the incentive structures and opportunities in the markets affected by the measure of trade liberalisation specified in the scenario. A rules change, for example, alters the market conditions for producers and consumers, and the new structure of incentives and market opportunities will induce a change in the economic behaviour of enterprises (producers) and households (consumers). Figure 1 illustrates, in its simplest form, the causal chain approach which is used in SIA to assess significant linkages and final impacts on the sustainable development indicators. It does not convey the full complexity of the linkages between each stage in the causal chain, nor does it convey the cross-linkages between the social, economic and environmental impacts. Further, the direct and indirect impacts from individual measures may have cumulative impacts, which need to be considered in the appraisal of the trade agreement as a whole. The ‘routes’ through which these cause-effect relationships operate may be numerous and complex.


• The direction of changes to base-line conditions; • The nature, order of magnitude, geographic extent, duration and reversibility of

changes; • The regulatory and institutional capacity to implement mitigation and enhancement

measures. Two scenarios are used in assessing the potential impact of the trade negotiations on sustainable development:

• Base scenario: no change in the current negotiated trade measures affecting EU and Mercosur trade, including no agreement on the trade liberalisation measures being discussed within the WTO Doha Development Agenda negotiations. The baseline scenario assumes, therefore, a continuation of existing trends in trade flows and current levels of tariff and non-tariff measures.

• Further liberalisation scenario: this represents the strongest probable implementation of the trade negotiations., including economic modelling of full tariff removal. Negotiating options for the actual trade agreement cover a range of intermediate scenarios, involving different degrees of liberalisation for each type of product or service, differing for each form of trade measure.

The main focus of the SIA is on the potential impacts in the regional groups that are party to the trade negotiations. However, the SIA will also provide information on potential impacts at the individual country level, where it appears that a particular country may be disproportionately affected (positively or negatively), or where countries are likely to respond in different ways, e.g. depending on their competitive position. Equally, social and environmental impacts may vary significantly at the country or intra-country level. The SIA methodology allows for the assessment of possible preventative, mitigation or enhancement measures, subsequent to the assessment of potential impacts. These measures can be categorised as follows:

• Trade-related measures, which can be integrated into the trade agreement • International and regional measures to improve the policy environment and strengthen

national regulatory capacity • National sectoral policy measures to remedy or regulate market imperfections • National policy measures to mitigate adjustment costs.

Consultation is a key part of the SIA methodology. Consultation is a source of evidence for the assessment of impacts and also contributes to good governance in terms of accountability and transparency with stakeholders. The SIA methodological framework needs to to adapted and modified to meet the particular conditions and requirements of the trade negotiations that are being assessed. In the case of the EU –Mercosur Trade SIA, the assessment of economic impacts was based the quantitative results obtained from an integrated CGE model.2 2 The EU-Mercosur CGE model is described in Annex 1.


1.3 The EU-Mercosur Trade Association Agreement The European Union has long established cultural, political and economic links with countries in Latin America and has, ever since the 1960’s, launched a series of political and trade initiatives as well as cooperation agreements with countries in the region. Furthermore, the EU has sought to support newly established democracies and has favoured the strengthening of regional integration schemes. One year after the establishment of Mercosur in 1992, the European Commission signed an Inter-institutional Agreement with Mercosur to provide technical and institutional support to the fledging structures of Mercosur (Giordano, 2003). A major step towards the beginning of official trade negotiations occurred in December 1995. On the same day, when Mercosur officially converted itself from a free trade area to a customs union, EU and Mercosur signed the EU-Mercosur Interregional Framework for Cooperation Agreement. The agreement was based on three pillars: political dialogue, cooperation and trade issues. Its objective was to create a framework for negotiations on an Interregional Association Agreement which should include full liberalization of trade in goods and services in conformity with WTO rules, enhanced form of co-operation and strengthened political dialogue. Negotiations for an EU-Mercosur Association Agreement were launched at the Rio Summit, in June 1999 and cover the full range of trade-related areas: trade in goods and services; sanitary and phytosanitary measures; the liberalization of capital movements; opening up government procurement markets for goods, services, and public works; competition policies; intellectual property rights; and dispute settlement (IADB, 2006). The trade chapter negotiations are governed by three main principles (EC, 2006b): (1) A region to region approach, which constitutes the basis of discussions on all

regulatory areas; (2) The agreement should be comprehensive and balanced, going beyond the respective

obligations in WTO. No sector should be excluded, while taking account of product sensitivities;

(3) The agreement should constitute a single undertaking, implemented by the parties as an indivisible whole.

The EU – Mercosur Bi-regional Negotiation comity (BNC) is the main forum for negotiation, and its work is complemented by other institutional mechanisms such as the sub-committee on Cooperation and three Technical groups on trade. The first round was held in April, 2000. Since than, seventeen negotiation rounds have taken place. By the time of the thirteenth round in May 2004 there was agreement on the whole text of the cooperation chapter. Cooperation is to cover a wide range of topics, including standards, services, investment, energy, transport, science and technology, customs, competition, agriculture, and fisheries (IADB, 2006). During that ministerial meeting substantial progress was made also with the trade chapters which allowed both parties to realistically envisage conclusion of negotiations by October 2004. In that month, however, a trade negotiators’ meeting at ministerial level decided that the offers on the table were insufficiently ambitious, especially in agricultural and service sectors, and negotiations entered something of an impasse. Following a number of technical contacts in 2005 to discuss the ways to re-engage the process, both sides exchanged in early 2006 non-papers with proposals for further negotiations. They also regularly met, for instance at the EU-Mercosur Ministerial meeting in Vienna, Austria, in May 2006, and during a trade coordinators’ meeting in Rio, Brazil, in


November 2006. In conclusion, since 2004, discussions have continued mostly at the technical level, but no new negotiating offers have been exchanged and the discussions are currently at a standstill. The EU and Mercosur negotiators will take stock of the negotiations at the EU-Latin America Summit that will take place in April 2008 in Lima, Peru. Both sides, however, agree that concluding EU-Mercosur Association Agreement negotiations is very difficult, if not undesirable, before the outcomes of the Doha Round are known. Nevertheless, there is a continued interest in both parties in reaching agreement on the trade negotiations. The EU’s recently published trade strategy (EC, 2006a) identifies Mercosur as one of the priority areas for Europe’s regional trade negotiations, based on the size of the Mercosur market and the potential for stimulating inter-regional trade flows by removing market access obstacles. 1.4 The EU-Mercosur Trade SIA Programme As part of its commitment to ensuring that its policy choices are consistent with the overarching objective of sustainable development, the European Commission has since 1999 been engaged in an ongoing programme of Sustainability Impact Assessment (SIA) studies of all EU trade negotiations. Within this programme, DG Trade has commissioned a Trade SIA for the current negotiations for a trade agreement between the EU and the Mercosur trade area composed of Argentina, Brazil, Paraguay and Uruguay. The objective of the EU-Mercosur SIA programme is to assess how the trade aspects of the Association Agreement could affect sustainable development in the EU and the partner regions.The SIA programme will assess the potential economic, social and environmental impacts of the proposed agreement in Mercosur and EU countries, and propose measures for avoiding, preventing or mitigating adverse impacts and enhancing beneficial ones. There are two phases to the EU-Mersosur Trade SIA programme. Phase 1, which was completed in 2007, comprised of a Preliminary Overall SIA and three sector reports covering agriculture, automobiles and forests.3 Phase 2 will be carried out in 2008 with a completion date in November 2008. There are three components of the SIA to be undertaken in this second and final phase of the EU-Mercosur SIA programme: a Final Overview SIA; a sectoral study for Trade Facilitation; and a sectoral study for Financial Services. The Final Overview SIA will update the Preliminary Overview SIA that was completed during the first phase of the programme, and draw this together with the sectoral studies for Trade Facilitation, Financial Services, Agriculture, Automobiles and Forests. The Final Overview will make suggestions, based on the existing regulatory frameworks and domestic policies of the countries under review, on complementary measures that might be introduced to address the negative impacts and maximise the positive impact of further liberalisation and changes in rule-making. The Final Overview SIA will also provide proposals for the ongoing monitoring of key sustainability indicators affected by trade liberalisation and for ex-post evaluation of the Final Overview SIA Report. Finally, the Overview SIA will provide an evaluation of the Trade SIA methodology and identify areas for further development and refinement in future Trade SIAs.

3 The Phase 1 reports are available on the project website (www.sia-trade.org) and the DG Trade website


As in the case of the Overview SIA, the sector studies will provide an overview of the current trade situation in each sector, and an analysis of the expected significant economic, social and environmental impacts resulting from trade liberalisation and/or rules changes. The sector reports will propose preventive as well as flanking or other measures that would prove effective in tackling any adverse impacts of liberalisation and/or in promoting its positive impacts in these two sectors. A team of experienced local experts will be involved in the preparation of the sector studies, and will undertake detailed case studies, the results of which will be incorporated into the case studies. There will be three reporting stages for Phase 2: Inception Reports; Mid-Term Reports and Final Reports. The Inception and Mid Term Reports describe the current progress in carrying out the studies and contain proposals of the further development of the subsequent stages. The Final Report will contain the final results and recommendations. The Reports will give particular attention to the need for transparency in the presentation of the analysis, and will include all references and sources of evidence used in the assessment of potential impacts to facilitate full understanding of the results of the studies. Consultation with key stakeholders is an integral part of the Trade SIA methodology and there will be an opportunity for key stakeholders both in Mercosur and Europe to provide input into the negotiations by engaging in consultations on the results in the reports. Engagement with stakeholders in the Mercosur countries is of particular importance, and for this purpose a regional Consultation on the Inception Report was held on 20-21 May 2008 in Montevideo, Uruguay.4 The consultation process will also play an important role in formulating the possible flanking measures that can be taken to prevent and/or reduce any negative impacts, and enhance the positive impacts, resulting from trade liberalisation. The flanking measure proposals will be presented in the Final Reports. 1.5 Structure and Content of the Mid Term Final Overview Trade SIA

The Terms of Reference require the Final Overview Trade SIA to:

(1) Provide an overall assessment of the potential impact on sustainability of the trade aspects for an Association Agreement between the European Communities and Mercosur

(2) Allow for the cross-sectoral and cumulative impacts likely to result from the implementation of the trade aspects of the Association Agreement between the European Communities and Mercosur as a whole.

(3) Build on the update of the overall preliminary Trade SIA EU-Mercosur and the sectoral studies that were undertaken under specific agreement 1 of the Framework Contract, and identify the generic issues and lessons that can be drawn form these earlier studies.

(4) Draw together the results of the earlier studies and complement this with further analysis in order to provide an assessment of the impacts on sustainability of the Association Agreement between the European Communities and Mercosur.

(5) On this basis, identify, as far as possible in quantitative terms, the likely impacts on the three key areas of sustainability – economic, social and environmental development –of the different aspects of the proposed EU-Mercosur trade agreement.

4 The outcomes of the Consultation Meeting with Mercosur stakeholders on the Phase 1 Final Report and Phase 2 Inception Report, are given in Part F of this Report.


(6) On the basis of identified impacts, propose preventive, mitigation and enhancement measures, and policy recommendations in different areas of public policy, including trade policy.

(7) Identify the generic issues (potential sustainability impacts and policy options for optimising outcomes) which can inform negotiators and policy-makers.

(8) Evaluate the Trade SIA methodology and identify areas for further development and refinement in future Trade SIAs.

(9) Provide proposals for the ongoing monitoring of key sustainability indicators affected by trade liberalisation and for ex-post evaluation of the final overview Trade SIA EUMercosur.

(10) Contribute to enhancing the dialogue concerning the final overview Trade SIA EU Mercosur with interested stakeholders, inside and outside of the EU.

(11) Produce an SIA-Trade Newsletter and distribute in electronic and paper format. (12) Contribute to the development of a credible international network of Trade SIA

experts in other countries and within other international organisations, particularly in relation to Mercosur.

The deliverables of the Mid Term Report are to present the work that has been undertaken on the project so far and to describe the implementation of the methodology and provide information on consultation and communication activities. The focus of the Mid Term Final Overview Report is on outputs (1) to (5) above.In addition the report provides information on the ongoing process of consultation and dialogue on Trade SIA matters (Task (10) above. The Mid Term Report builds on the Phase 1 Preliminary Overview Report by:in the following ways:

Assessment of the priority issues that were identified at the conclusion of Phase 1 for more detailed consideration in Phase 2.

Assessment of cross cutting issues that were identified in the Phase 1 Preliminary Overview and Phase 1 sectoral studies for Agriculture, Automobiles and Forest.

Priority and Cross Cutting Issues The identification of priority areas was based on the likely significance of the sustainability impacts as assessed in the Phase 1 report. Consideration was given to economic, environmental and social impacts, both positive and negative. The methodology for identifying priority areas for the Phase 2 studies involved combining information from the following sources:

• the expected sustainability outcomes based on their relative importance from an economic, social and environmental perspective5

• the direction of changes to base-line conditions; • the nature, order of magnitude, geographic extent, duration and reversibility of

changes; • the extent of existing economic, social and environmental stress in affected areas; • the extent to which each sector may be impacted on by the EU - Mercosur trade

negotiations6 • consultations with civil society and the European Commission7

5 Based on the findings of the Phase 1 reports 6 The Phase 1 reports provide tabular indicators of the significant of the expected social, economic and environmental impacts of trade liberalisation on a sector by sector basis.


2. BASELINE CONDITIONS FOR EU MERCOSUR TRADE AND INVESTMENT FLOWS

2.1 Introduction The SIA methodology provides for the estimation of two scenarios: a baseline scenario (often referred to as ‘do nothing’ or ‘business as usual’) and a further liberalisation scenario. Impacts are estimated as the difference in the outcomes expected with the baseline scenario and the further liberalisation scenario. The further liberalisation scenario is specified in greater detail in the assessment sections of the report. This section specifies describes the baseline in terms of current situation and expected future trends in trade and investment flows. 2.2 Trade Flows In recent years Mercosur’s trade flows recorded record levels for both exports and imports and a positive trade balance. In 2006, the most recent year for which full year data are available, Mercosur’s total exports and imports stood at $190 billion and $135 billion, respectively. This represented a 16% increase from the previous year with regards to exports and 23% increase of imports. 2006 was, however, the first year for the past 6 years that the trade balance has decrease but still remains large at $60 billion. This is attributed to an increased import demand as GDP growth of the Mercosur in 2006 was almost 5%. An analysis of Mercosur countries’ trade flows with external partners (Table 3) shows that the EU is Mercosur’s largest trade partner but trade growth dynamism is much greater with other partners especially from South America and the Asia and Pacific Region. These changes in composition of Mercosur’s exports reflect the steep GDP growth rate of Latin American and Asian Partners, whereas the demand from most traditional markets such as European Union and NAFTA has developed more slowly than the rest of the world. Although EU’s share of Mercosur’s extra-bloc exports has declined over the last decade, European Union remains Mercosur’s main trading partner, accounting for nearly 25% of total exports in 2006, followed by the NAFTA, and in particular the USA which represents 20% of exports. In terms of Mercosur’s imports. EU remains the largest sole exporter to the region but as in the case of export, import show greater dynamism with countries with Latin America and Asia and the Pacific. As the result the share of EU imports in Mercosur’s total imports have declined from 34% in 1998 to 24% in 2006. In 2006, there was a 4% increase in the share of Mercosur imports coming from the Asia and the Pacific as that region became the main supplier of exports to Mercosur. This can be attributed to an incremental leap in imports coming from China as demand for imports coming from this country increased by 40% over the previous year (INTAL, 2007).


Table 3: Mercosur’s Extra Block Trade (Import and Export) Exports 1998 1999 2000 2001 2002 2003 2004 2005 2006 Asia & Pacific* 16.5 16.5 15.7 16.5 17.7 20.3 19.2 19.6 19.4 EU25 33.3 33.0 30.6 28.0 26.9 27.1 26.6 24.4 24.6 LAC (exc. Mercosur and Mexico) 15.8 13.8 14.9 15.3 14.4 13.3 14.7 16.0 17.4

MENA 6.0 5.4 4.8 6.0 6.1 5.7 6.3 6.0 6.4 NAFTA 22.8 26.3 29.1 28.3 28.7 27.1 26.5 25.4 23.3 Non EU Europe and CIS 3.4 3.2 2.9 3.6 3.6 4.0 4.0 4.9 5.4 Sub Saharan Africa 2.2 2.0 1.9 2.4 2.7 2.4 2.8 3.6 3.5 Imports 1998 1999 2000 2001 2002 2003 2004 2005 2006 Asia & Pacific 18.8 17.7 20.1 20.4 20.5 23.0 24.3 26.9 30.9 EU 35.5 36.1 30.9 31.9 32.4 30.5 28.2 27.4 24.4 LAC (exc. Mercosur and Mexico) 6.6 6.9 7.9 6.7 6.4 6.3 6.6 7.5 8.6

MENA 2.5 3.2 4.4 3.8 4.8 5.2 6.0 6.1 5.2 NAFTA 31.6 30.7 30.6 29.9 28.3 26.0 24.3 23.4 21.8 Non EU Europe and CIS 3.2 3.2 3.6 3.7 4.5 5.3 5.1 4.3 3.9 Sub Saharan Africa 1.8 2.1 2.5 3.6 3.1 3.7 5.5 4.3 5.2

Source: Comtrade; *- Excludes Middle East and Commonwealth of Independent States The EU-Mercosur trade relations are characterized by sharp asymmetries. Although the EU continues to be a strategic trade partner for the Mercosur economies, the Southern Cone countries exports constitute only 2.4 % of EU imports and 1.7 of EU imports in 2006. As in the case of Mercosur’s total trade, Mercosur trade with the EU has reached record levels in the past years (Figure 2). In 2006, bilateral trade was $66.3 billion, with exports being $39.5 billion, up by 14.9% from 2005 and imports were $26.7 billion, up by 13.1% from the previous year. Historically, Mercosur economies have experience trade deficits with the EU. This trend has, however, been reversed in 2002, since when Mercosur has had increasing trade surpluses with the EU. In 2006, this surplus exceeded $12 billion. Much of this trade surplus is accounted for by agricultural sector trade. In 2006, Mercosur’s agricultural exports to the EU were worth $19.5 billion and imports amounted to only $1.05 billion. In contrast, Mercosur’s exports of manufactured goods were nearly $13 billion with imports of manufactured goods from Europe amounting to $24.4 billion.


Table 5: Composition of Mercosur exports, 2000–2006 (%)

Agricultural & Food

Crude Materials

Material Fuels Oils Chemicals Manufactures

2000 2006 2000 2006 2000 2006 2000 2006 2000 2006 2000 2006 World 23.9 23.7 13.0 14.7 6.6 9.2 2.6 2.8 6.6 6.9 45.1 40.2 Asia & Pacific 22.6 20.8 30.7 39.6 1.0 8.8 11.5 7.6 4.6 3.3 29.6 20.0 EU25 37.7 35.8 22.0 21.8 0.5 3.6 0.7 2.4 3.8 5.0 34.7 31.2 LAC* 15.5 13.6 3.7 3.0 18.3 15.8 3.0 2.4 12.2 11.3 47.1 53.8 MENA 57.0 57.4 12.4 11.9 0.7 0.3 16.2 9.0 1.3 0.8 12.5 20.6 NAFTA 11.6 11.0 6.5 6.5 7.9 11.0 0.3 0.3 5.0 7.5 66.9 61.8 Europe & CIS 43.0 62.8 20.2 11.8 0.0 0.1 2.7 2.2 2.9 1.9 28.9 15.1 SSA 37.8 36.7 5.3 2.8 2.1 13.2 6.9 5.1 8.2 5.9 37.4 36.3

Source: Comtrade; *- Excludes Middle East and Commonwealth of Independent States; ** - excludes Mexico and Mercosur Mercosur’s export portfolio is fairly diversified, but with wide variation across countries. More than 50% of Brazil’s exports are composed of industrial goods, but this percentage decreases to 14.6% for Paraguay. Crude materials and fuels account for 34% of Paraguay’s exports, while this sector only represents 11.6% of Uruguay sales to the world. Agricultural raw materials and food account for 48.4% of Uruguay’s exports, 42.9% for Argentina, 34% for Paraguay and 22.7% for Brazil.9 In 2006, Mercosur’s imports from the EU consisted mostly of Machinery and Manufactured Goods with 68.5% of total imports and of Chemicals & Pharmaceuticals with 24.8% of total imports (Table 6). Together these two categories comprised 93.3% of Mercosur’s total imports from EU. This pattern is fairly constant over time and is similar to the one with NAFTA or the Asia and the Pacific Region. Table 6: Composition of Mercosur imports, 2000–2006 (%)

Agricultural & Food

Crude Materials

Material Fuels Oils Chemicals

& Pharmac. Manufactures

2000 2006 2000 2006 2000 2006 2000 2006 2000 2006 2000 2006 World 6.0 3.8 3.1 3.7 11.7 15.4 0.3 0.3 17.7 17.7 60.9 58.9 Asia & Pacific* 1.0 0.7 1.9 2.1 5.5 8.0 0.3 0.3 9.8 9.5 81.5 79.4 EU25 3.0 2.4 1.3 1.4 2.5 2.3 0.4 0.6 22.0 24.8 70.5 68.5 LAC** 16.6 8.7 8.1 16.4 34.7 32.6 0.3 0.1 9.3 8.6 30.9 33.6 MENA 0.4 0.7 1.3 2.0 92.6 88.5 0.3 0.0 4.3 7.5 1.1 1.4 NAFTA 1.7 1.0 2.9 2.9 2.7 6.8 0.1 0.0 23.6 27.3 69.0 61.8 Europe & CIS 6.4 5.3 2.3 1.5 9.7 9.9 0.5 0.0 50.1 49.2 31.0 34.2 SSA 3.4 0.9 7.4 1.4 74.2 89.8 0.0 0.0 4.2 1.7 10.8 6.2

Source: Comtrade; *- Excludes Middle East and Commonwealth of Independent States; ** - excludes Mexico and Mercosur 9 Source INTAL, 2005: Data for 2004


Mercosur countries are major producers and net-exporters of agro-food products. In 2003, Brazil ranked third in the top-10 list of agro-exporters and Argentina ranked seventh. Both countries are also the second and third EU providers of agricultural products, behind the US. The agricultural sector is a key component of Mercosur economies. In all the member states, agriculture accounts for more than 10% of GDP. Mercosur exports of agricultural products are diversified. Table 7 shows that the most important products exported by Mercosur are: soybeans and soy products, bovine and poultry meats and preparations, sugar, fruits juices, coffee, corn, wheat, tobacco, fruits and vegetables (fresh and prepared). Table 7: Value and destination of Mercosur agricultural exports (2004) World

($USm)Share of Mercosur total agricultural exports (%)

Asia (%)

EU 15 (%)

Mercosur (%)

North America (%)

Other (%)

Beverages/Spirits 824 1.8 27 23 8 20 22 Bovine Meat/Preparations 4343 9.3 14 35 2 17 32 Coffee 1759 3.8 12 56 2 20 10 Corn 1825 3.9 42 19 3 0 36 Dairy products/Bird’s eggs/natural honey

1014 2.2 12 16 10 9 53

Poultry meat/preparation 2875 6.2 58 7 8 6 21 Soybeans/soya products 18665 40 49 24 0 1 25 Sugar 2707 5.8 1 1 80 1 17 Swine meat/preparation 745 1.6 44 37 3 1 15 Tobacco 1666 3.6 33 2 1 7 58 Vegetables/fruits (fresh and preparation)

1456 3.1 15 4 7 0 74

Fruit juices 1657 3.5 23 33 4 16 24 Wheat 1613 3.5 2 44 21 16 17 Other agricultural products 5565 11.9 11 63 0 20 5 TOTAL AGRICULTURE 46714 100 Source: COMTRADE 2.3 Investment Flows 2006 marked a significant shift in the pattern of FDI in Mercosur economies. Due to record levels of outward FDI, for the first time Mercosur saw a positive net balance of foreign investments which accounted to $5.1 billion (Table 8). The increase in outward FDI in recent years is largely attributable to a small number of large transactions originating in particular sectors and enterprises in Brazil. In 2006, significant transactions included the acquisition of the Canadian mining company Inco by the Brazilian firm CVRD which itself accounted for $16.7 billion of the $28.2 billion of total Brazilian investments abroad. Furthermore it should be stressed that Argentina and Uruguay have, in recent years, become two of the main destinations of Brazilian FDI flows (INTAL, 2008).


Sweden -11.7* 57.2 -110.5 41.6 UK 1994.2** 1315.6 678.6 C*** Source: Eurostat; * - Excludes Paraguay; **- Excludes Uruguay and Paraguay; ***- Confidential (undisclosed)

Looking at the composition of EU’s FDI to Mercosur indicates that it is located in areas as diverse as telecoms, energy, financial services, the automotive industry, the agro industry and the retailing sector. The concentration of FDI in services is particularly strong in the Mercosur region. In Brazil, between 1997 and 2000, over 81 percent of all FDI inflows were to the services sector. A large part of these investments were made by European firms, and in particular, Spanish investors. However, with the deterioration in the global economic situation and the corporate credit retrenchment, this pattern changed: in the early years of the new decade, less than 60 percent of FDI inflows were undertaken in services, while the share of FDI in manufacturing rose to 35 percent in the same period. In fact by 2005, net EU’s FDI in manufacturing were $2.9 billion and $2.75 billion in services. The share of FDI in other areas of economic activity is negligible. In agricultural and fishing net EU’s FDI in Mercosur was only 4 million and in extraction of petroleum and gas the net FDI was actually negative and stood at - $98 million.


3. AGRICULTURE SECTOR 3.1 Introduction A sectoral SIA for agriculture was carried out in Phase 1 in parallel with the Overall SIA. The results of the agriculture study are reported here, together with the analysis for four of the priority issues identified for more detailed assessment in Phase 2. These issues are: rural livelihoods and gender; bio-fuels; animal welfare and food standards and safety. 3.2 Negotiations in the Agricultural Sector The agriculture sector is one of the sources of the current stalemate in EU – Mercosur negotiations. The EU is a net importer of agricultural products from Mercosur, which has a clear comparative advantage in exporting low priced agricultural products to the EU market. The main points of divergence between the two parties are related to market access. (Kutas, 2005). Mercosur requests faster and more comprehensive tariff reduction and higher in-quota quantities as it wishes to increases production and exports to the EU. Table 10 shows the last official agriculture sector liberalization offer proposed by the EU, in September 2004. The EU offered full tariff reduction on 60% of EU agricultural tariff lines implemented over a 10 year period. 31% of the tariff lines would be liberalized immediately after the signing of the agreement, however the majority of products included in this category already enjoy duty free access to the EU market. Progressive liberalization is foreseen for about 29% of the tariff lines, with implementation periods of 4, 7, and 10 years, corresponding to categories B, C, and D, respectively. A high proportion of fruit, plants and food preparation products are included in the last category. The remaining 40% of the agricultural tariff will, either be excluded from the agreement (Category E – 20% of agricultural tariff lines), or a scheme of preferential TRQ will be imposed or extended. The excluded products include sugar, live animals, wines, some fresh and prepared fruits and vegetables and diary products. Table 10: Latest EU agricultural offer – September 2004 Number of tariff

lines % of tariff line

Category A Category B (full liberalization after 4 years) Category C (full liberalization after 7 years) Category D (full liberalization after 10 years) Tariff Rate Quotas Preferential Tariff (between 20%-25%) Preferential Tariff (between 20%-25%) Category E (excluded from the Agreement)

665 121 188 311 231 106 94 429

31 6 9 14 11 5 4 20

Source: Kutas, 2005 Divergent proposals on the quantities of TRQ are some of the biggest obstacles in the successful closure of the agriculture chapter in the Interregional Association Agreement. Mercosur requests enhancement of quotas offered for selected products, implementation of quotas in the first year of the agreement, elimination of in-quota tariffs and a reduction of over-quota tariffs. The EU has proposed a gradual implementation of TRQ over a 10 year period.


3.3 Modelling Results for Agriculture11 The results of the CGE modelling that was undertaken for the EU Mercosur SIA indicate that liberalisation would globally increase agricultural and food output in the Mercosur region, while output would decrease in the EU. The estimates are for full liberalisation. Lesser degrees of liberalisation, including the introduction or revision of tariff rate quotas, would have smaller effects in the same direction. Within the EU, the EU 15 will be relatively more affected by liberalization of agriculture and food products. The projected output decrease for full liberalisation is highest for food products (-5.1% for the EU15 and -2.7% for the EU10). Grain output is projected to decrease in the EU 15 by 4.4% and in the EU 10 by 1.5%. The effects for animal products are estimated as -3.5 % (EU15) and -1% (EU10). It should be noted that in the EU, a high proportion of grains are fed to cattle. This is less the case in Mercosur where grass and grass forage currently form a higher proportion of beef cattle diets. An increase in animal product imports to the EU, and a corresponding fall in domestic livestock production, will therefore see a significant fall in EU demand for grains fed to livestock. This is likely to account for the projected decrease of grains output in the EU, as well as an increase of wheat imports from Mercosur. The consequences on crops estimated by the model are different: the EU15 output is projected to increase slightly (by 0.2%) and decrease for the EU10 by 0.4%. The main EU exports to Mercosur, wines, spirits, malt and olive oil, are produced from crops in this category. This result tends to indicate that expansion of those products will compensate a cut in sugar beet production. Mercosur agriculture and food output are expected to increase through liberalization. The model indicates that production in Brazil and Paraguay would increase particularly for animal products, with respectively 31.9% and 36.6% for full liberalization. Food products would develop strongly in Paraguay (72.9%) and Brazil (46.6%), while Uruguay would increase its food products output by 17.1%. Grains would develop more equally in the four countries, although the increase in Brazil is projected to be twice that in Uruguay (respectively 15.1% and 8.6%). It should be noted that any significant rise in chicken production in the Mercosur states would increase demand for grains, particularly wheat, in these countries. Changes in output for crops are projected to be less than 2% for Brazil, Argentina and Uruguay, and even negative (-7.8%) for Paraguay. These modelling results are surprising, as sugar is in this category, and Brazilian sugar could be expected to develop after liberalisation through better access to the EU market. The results of the modelling for export quantities indicate that Mercosur countries would increase their exports of food products to the EU, with a high percentage of growth, EU exports would fall for the EU10, with limited gains for EU15 exports. The modelling results for animal products, which indicate a decrease in exports of living animals and raw milk from Mercosur to the EU, need to be treated with caution: animal products, under the definition of GTAP database, are only traded in a very limited way, and so exports are small and are strongly dependent on factors other than tariffs, such as sanitary measures.

11 The full set of CGE modelling results for agriculture are given in the Phase 1 Preliminary Overview Report.


Based on the model, food exports would expand, due primarily to increased output in the food processing sector. Changes in output would be reduced for less than full liberalisation however, a significant increase is expected. According to the modelling results, the largest change in export quantity in processed foods would come from Paraguay and Brazil, followed by Uruguay and Argentina. Under full liberalisation, employment will follow the same trend as output. The model projects a considerable increase output in animal products in Brazil (37.5%) and Paraguay (43%), and this is likely to occur mainly in poultry farming and cattle breeding. Employment in the grains sector is estimated to grow up to 10% to 20% for full liberalisation, varying between countries. This may be the result of increasing wheat production for export to the EU, and increasing maize production for animal feeding. Employment in the food industry, here under the category of food products, will increase mainly in Brazil and Paraguay, clearly linked to the expansion of food products output and exports. With the EU, employment in the agricultural and food sector is expected to decrease in the short-run. Employment is likely to decrease in all agricultural sectors, and particularly in the EU 15. Employment in animal products is likely to fall as a result of increased meat imports from Mercosur. The expansion of food product imports from Mercosur will lead to a contraction of food processing within the EU, and thus declines in employment. Subsequent to the completion of the Phase 1 CGE modelling for the agriculture sector, the draft results of a 6th FP policy support project on ‘Analysis of the competitiveness of Mercosur’s key agro-food sectors, comparison of policies and the ex ante impacts of EU-Mercosur trade liberalisation’ were published.12 The project aims to provide the necessary data, parameters and to expand the necessary tools for a comprehensive impact assessment of free trade agreements between the EU and Mercosur countries. Ten principal agri-sectors were pre-selectedFas foci for the research i.e. wheat, rice, maize, soybean, orange (juice), apples, cane sugar, beef,chicken meat, and milk products. The Mercosur agri-sector analyses complement the trade impact assessments in such a way as to analyze the Mercosur region capacity to respond to future increased export opportunities, as a consequence of trade liberalization policy scenarios. In order to assess the possible impact of a free trade agreement between the Mercosur countries and the EU, the CAPRI (Common Agricultural Policy Regionalised Impact) modelling system is used. CAPRI covers interactions on agricultural markets with a focus onEU agriculture by linking non-linear mathematical programming models for about 250 regionscovering the whole of EU25, Norway, Bulgaria and Romania with a global market model foragricultural products. The analysis of the potential impact of different trade liberalization scenarios between the Mercosur countries (MS) (Argentina, Brazil, Paraguay and Uruguay, as well as the associated member Bolivia) and the EU, is made in the context that the Mercosur region is currently undergoing what amounts to a technology-induced productivity and supply boom. This situation led to the decision to attempt to“hedge” the baseline 2013 projections, allowing for several technological scenarios. To accomplish this task, a dynamic simulation model - SIGMA (for details, see at:http://www.inta.gov.ar/ies/docs/otrosdoc/resyabst/mercosur_baseline.htm), was used to estimate three baseline supply figures for the relevant MS-EU trade-sensitive commodities. Three baseline scenarios were defined: conservative, optimistic and dynamic. Parameters assumed to determine the adoption path of currently available production technology by farmers were assigned different values for each one of those scenarios, so as to simulate (in 12 The project is being carried out by a consortium of 13 Latin American and European research partners, coordinated by CIRAD.


the same order they are listed)increasingly favourable conditions for the adoption process to move forward (for a more detailed specification of the mathematical model and the parameters definitions used in the study, see http://www.inta.gov.ar/ies/docs/otrosdoc/resyabst/mercosur_baseline.htm). CAPRI model runs to simulate the effects of trade policy shocks (four scenarios) were implemented for two of the defined baseline scenarios; conservative (B1) and dynamic (B2). The quantitative results of the analysis highlight that, even though all trade liberalization alternatives offer gains over the base line scenario, these gains, however, are dwarfed by the overall impact of the technological variables. Policies aimed to promote technology adoption and optimization of resource use, have a greater impact on agricultural income, even under the conservative baseline. EU producers lose some of their profits across all scenarios due to decreasing prices induced by import pressure. In percentage terms this is not more than – 6% at the most. The impacts of the analysed scenarios on net production in the EU are quite small. Large absolute changes only appear for the product group ‘cereals’. Total European demand, at the same time, also shows only limited changes. Generally, the analysed scenarios have only a minor effect on domestic production and demand structure, while the effects on trade positions are much stronger. To take advantage of emerging opportunities the studies also identify a number of restrictions that need to be confronted. Overall, infrastructure and logistical capacities appear as a common weakness across all agri-chains and countries, but better quality, traceability and inspection systems, including the availability of well trained human resources for their implementation, a more proactive technology development and innovation promotion policies –particularly in regards to public and private investment levels – and a more stable and transparent trade, including protection and export promotion, and fiscal and financial support policy environments, also appear as factors in need of improvement to assure the sustainability of the agri-chains’ competitiveness. Environmental management issues appear as a factor in some cases but they do not seem to be critical. Studies show important improvement in this area as local production is more integrated into the world trade system (for a detailed discussion of the nine agri-chains studies see www.eumercopol.org ). The main findings of the study are: (1) The commonly held belief that Mercosur agricultural exports constitute a major threat for the EU farm sector and hence the EU’s strong position on sensitive products in the negotiations, has in fact proven to be a non-issue since the study’s findings mostly demonstrate relatively low impacts on key EU parameters. (2) Mercosur technology advances (and rapid adoption) in the agri-sectors have proven to be far more important to bi-regional trade impacts than the trade liberalization policy scenarios. (3) The new knowledge of the relatively lesser impacts from trade policy scenarios may influence the positions on agriculture versus industry offers between the 2 regions, as the relative cost-benefit ratios of present proposals may not totally reflect what each region would actually gain or lose from their implementation. The modelling results are used as one of the main evidence inputs for the assessment of economic, environmental and social impacts. The next sections present the results of the assessment for Mersosur and for the EU.


3.4 Animal Welfare The principal concern relating to animal welfare is that while a government can legitimately set standards of production in its own territory, any standards set which relate to methods of production rather than to the characteristics of the product, and which have the effect of discriminating against imports, will violate the normal requirements of the GATT. Trade liberalisation could therefore lead to increased competition in domestic markets from countries with lower animal welfare standards than in the importing country. It is a priority of the European Commission to build internationally a common understanding and implementation of animal welfare standards as foreseen in the 2006-2010 Community Action Plan on the Protection and Welfare of Animals. In April 2008, DG Trade and DG SANCO held a joint conference with Eurogroup on Animals, RSPCA, CIWF and WSPA to share experience on inclusion of farm animal welfare in trade and identify ways to promote further the adoption of farm animal welfare policies.13 During the Mercosur negotiations in 2004-05, the Commission insisted on including animal welfare in the scope of the agreement with the aim of cooperating in standards.14 Animal welfare groups in the EU has expressed particular concerns relating to trade in eggs and derived products (dried and pasteurised), where the traded products are produced in battery cages. EU Directive 74/1999 has imposed a phasing out of conventional battery cages in the Eu by 2012. The Agriculture SIA indicated that trade liberalisation would result in increased EU imports of poultry and related products from Mercosur. While the proportion of chicken and eggs produced in Mercosur using battery cages remains to be investigated, it is reasonable to assume that a significant proportion of the increased exports to the EU market will have been produced under battery cage conditions. If the Commission requires that the Directive be met in Mercosur, there will be significant adjustment costs for Mercosur producers. The assistance that might be given to Mercosur producers by the EC, and the phasing-in period that might be allowed, will be examined in the Final SIA Report as part of the flanking measure proposals. Animal welfare concerns are often linked with consumer health and environment concerns.15 In its regional trade negotiations, for example with Chile and Canada), the EC has included cooperation on animal welfare in the negotiations on SPS issues. 3.5 Food Standards and Safety As regards the handling of consumer protection in the negotiation of an EU-Mercosur agreement, the Commission is committed to ensure that imported products meet at least equivalent standards to those applied to EU products. Based on the parameters put forward by the Commission at the EU Mercosur technical meeting in December 2004, the EU included sanitaty and phytosanitary standards as one of five issues that was needed in Mercosur to guarantee free circulation to EU operators or products of EU origin. Specifically, the Commission called for a bi-regional approach on SPS matters, and proposed the following minimum requirements to achieve this objective: (1) integration/harmonisation of SPS

13 See www.animalwelfareandtrade.com 14 Letter from Director General for Trade to RSPCA, dated 8th February 2007. 15 It is generally assumed that there are positive (win-win) outcomes between animal welfare and human health. However, there are instances of trade offs (win-lose) between animal welfare and human health (and the environment) (Passille and Rushen, 2005)


legislation and procedures for EU commodities imported into Mercosur (2) institutional provision (3) administrative capacity. In response to the paper entitled ‘elements for a possible agreement’ submitted by Mercosur at the march 2006 EU-Mercosur meeting, the EU stated that it was committed to efforts to find solutions that reflect the interest of both parties. In particular, the EU is seeking intra-Mercosur harmonisation of internal SPS measures, but is willing to discuss transitional and practical arrangements to address the difficulties of Mercosur integration. Mercosur exports to the EU are subject to various EU food product regulations. Table 13 lists some of the EU regulations for food imports. Table 13: EU Regulations on Food Products Council Directive 2000/29/EC of 8 May 2000 on protective measures against the introduction into the Community of organisms harmful to plants or plant products and against their spread within the Community Regulation 396/2005 of the European Parliament and of the Council of 23 February 2005 on maximum residue levels of pesticides in products of plant and animal origin. Commission Directive 2002/63/EC of 11 July 2002 establishing Community methods of sampling for the official control of pesticide residues in and on products of plant and animal origin Regulation 178/2002 of the European Parliament and of the Council of 28 January 2002 on food safety, which establishes traceability for food products The Phase 1 Agriculture SIA predicted a significant increase in EU imports of beef and poultry from Mercosur as a result of trade liberalisation. Both products are subject to EU SPS regulations. 3.6 SIA Findings for Agriculture Mercosur Economic Impacts Output is expected to rise significantly for the agricultural sector as a whole, with little adverse impact from reduced barriers to EU imports. Mercosur production is particularly competitive for meat, cereals, sugar, ethanol and fruits, for which exports to the EU are expected to increase. Production in Mercosur is expected to expand in these sectors, allowing the development of agriculture and of the food industry. Exports of soya products to the EU may fall in response to a fall in EU beef and chicken production. The CETM model projections for full liberalisation indicate a rise in output for grains of the order of 10% for all the Mercosur countries. For animal products, which include cattle rearing, the projected increase is significant in Argentina and Uruguay at around 4%, and considerably higher in Brazil and Paraguay at over 30%. Larger increases in production are projected for meat and other processed foods, of nearly 50% in Brazil and over 70% in Paraguay. These modelling estimates are for full liberalisation rather than the more limited agreement likely to be reached, and are strongly dependent on the assumptions made in the model. Agricultural output in Mercosur has been growing rapidly in recent years, with increasing exports to the EU and other countries. Therefore, the sector is already highly competitive and is in the process of responding to market opportunities that already exist. The


model results give an indication of the possible magnitude of the effects that could occur over the ten year period in which an EU-Mercosur trade agreement would come into effect. Employment in agriculture is expected to rise approximately in proportion to the output changes, as indicated by the modelling results. The model assumes fixed total employment, with the increase in agriculture coming from a decline in other sectors. In practice most of the increase is expected to come from the rural informal sector and the rural unemployed. This will apply mostly to satisfy demands for additional employment in agricultural production and the processing industry (sugar or ethanol for instance), with a smaller increase in urban areas for other processing and transport (including harbour services for the increased exports). In Brazil and Paraguay, where the percentage increase in output is greatest, the recorded level of rural unemployment is below the national average, reflecting the existing trend of rising production and its demand for extra labour. The additional output due to EU-Mercosur liberalisation will encourage a further decrease in unemployment. In Argentina and Uruguay, for example, rural unemployment is considerably higher than the national average. The additional demand for agricultural labour in these countries may help to address this problem. As noted in the case study for ethanol, these effects may change in the longer term through increased incentives for mechanisation, resulting in higher skill levels and lower agricultural employment. In the shorter term, increased employment in large scale production may be countered by loss of livelihoods for small scale farmers. The effect of the EU-Mercosur agreement would be an incremental addition to existing pressures in this direction. The expected increase in agricultural output will stimulate additional investment in the sector. This is expected to include new infrastructure and machinery as well as the acquisition of land. Total fixed capital for the agricultural sector should increase. Social Impacts To the extent that the increased employment in the sector comes from the pool of unemployed, it will have a beneficial impact on rural poverty, which is particularly high in Paraguay and Brazil. There may however be an adverse effect associated with the need for additional land. Land tenure is weak in many areas, particularly in Paraguay, where the overwhelming majority of peasants have no formal land titles. Informal farmers are likely to be displaced by the expansion of commercial farming. Depending on the labour productivity of new commercial activities, the number of employment opportunities may not be sufficient for the number of people displaced, and the standard of living provided by formal employment may be lower than in informal farming. In Brazil in particular, additional land for agricultural production is expected come from forest clearance, resulting in the loss of livelihoods for indigenous people. For expanding production of sugar cane for ethanol, some of these potentially adverse impacts may be countered by the introduction of a certification scheme for ethanol imports into the EU. The case study for beef has identified a potentially serious concern. A small part of the employment in cattle raising is forced labour. The Brazilian government is endeavouring to combat the problem, but the trade agreement could exacerbate it. Without effective mitigation the number of forced labourers would increase, without any improvement in wages or working conditions above those of the existing workforce, and a significant decrease for the people affected. The case study also identifies a potential increase in disputes over land tenure, with further adverse impacts on poverty for small scale farmers who lose their land.


It is therefore concluded that liberalisation offers potential for a reduction in rural poverty throughout the region, but that there could instead be significant adverse effects in some areas in the absence of strengthened regulation. Improved export performance should in principle help to strengthen Mercosur economies overall, which would help enable increased public finance and higher health expenditure. This is particularly the case in Paraguay, where the modelling results indicate a significant increase in overall welfare. In the other Mercosur countries, the static welfare gains are too small to be significant in this respect. Dynamic effects offer greater potential in all the countries, but this depends strongly on other aspects of government policy that interact with trade liberalisation. Similar considerations apply to education, with potential for both positive and negative effects. Expansion of production will lead to an increase of total farm income, but not necessarily to a reduction of income inequalities in the farm sector. Increased incentives for mechanisation may in the long term lead to higher skill levels in the sector and hence to reduced inequalities for those in employment. This would however be associated with a decline in agricultural employment. The overall impact would depend on increasing the quantity and quality of employment in other sectors. In the absence of structural changes leading to higher skill levels overall, a decrease in inequality typically requires redistributive public policies. The effects on poverty discussed above may, in the absence of effective mitigation, have significant adverse impacts on equity. Competition between farmers for new arable lands is expected to increase land prices, and also land conflicts in areas where land tenure is weak. Small scale farmers could be the losers of that process, including women. Adverse gender impacts may arise through the loss of traditional livelihoods and limited opportunities for women in the formal sector. Working conditions have to be watched with scrutiny. Forced labour in Brazil is already a problem in the bovine sector. Although the government is working to combat it, liberalisation could amplify this problem. The problems for sugar cane production are smaller, but could be significant. Sugarcane production for ethanol is expected to develop in new regions where land is available, but where workers are not organised in trade-unions and may have difficulty in obtaining good working conditions. A certification scheme for EU ethanol imports, with appropriate social as well as environmental criteria, could help to address this. More generally, agricultural export development on its own is not expected to reduce structural income inequalities in Mercosur. Environmental Impacts Agricultural production is expected to rise significantly in all the Mercosur countries, placing pressure on both land and water. The modelling results indicate a significant rise in grain production in all the countries, with a large increase in meat production in Brazil and Paraguay. The animal products sector also rises significantly in Argentina and Uruguay. As discussed in the case studies for ethanol and beef, there are potentially significant adverse effects from both intensification and expansion. In Argentina the projected increase in beef production is relatively small. Production is likely to be intensified, with less available land than in Brazil. Significant adverse impacts on water resources are expected to be restricted mainly to the semi-arid central area where water is scarce.


In Brazil the expansion of beef production is expected to have a direct impact on deforestation, while the expansion of sugarcane would have an indirect spillover effect by taking land from products which would move into forested areas. For sugarcane, certification of EU ethanol imports could help to address the problem. For beef and other products the expansion would add to existing long term pressures on forests which need to be addressed by a stronger regulatory regime. Other potential impacts which may occur from increased production unless adequately regulated, include flooding, especially on the plains such as the Pampas (arising from disruption of soil hydrology), and soil erosion from cultivation of steep slopes. In many of the areas where agricultural production would increase, such as the Cerrado, conversion of these lands to arable cropping or intensive grassland management would require application of agrochemicals, artificial fertiliser and irrigation, both of which would have impacts on soil and water quality. Some adverse pollution impacts may occur in this and other areas where production increases, which may be locally significant in the absence of effective regulation. The use of agrochemicals potentially affects both water and soil pollution. An increase in poultry meat production could also have an impact on water contamination, depending on production methods. Effective regulation will be required in order to avoid locally significant impacts of this nature. If certificates aimed at ensuring the sustainability of production are in place, there is a significantly reduced risk of adverse impacts from increased production; such certificates should be monitored and possibly revised to ensure the best positive impact on the environment.16 Large areas of the Mercosur region are of global environmental significance, particularly the Amazon and Cerrado. Global attention is, understandably, focussed on the threats to the Amazon rainforest resulting from increased trade. The most sensitive regions lie within the Mercosur region and although timber logging has been the major driver for deforestation in the Amazon, subsequent conversion of land to soya bean production has ongoing impacts on biodiversity and enforces more permanent changes to soils and hydrology. The Brazilian Cerrado is South America’s largest, and one of the world’s most biologically rich, areas of savannah. Conversion to monoculture crop production (particularly soya beans) and intensification of beef production is reducing the area of natural and semi-natural habitat. At present, there remain large areas of relatively undisturbed Cerrado where conversion to soya bean production or cattle ranching would significantly reduce biodiversity. The region includes extensive areas of wetland at the Deltas of the Orinoco, Parana and Tigre rivers. Conversion to plantation forestry is the main threat to biodiversity in these areas.In other areas such as the Pampas of Argentina, Uruguay and southern Brazil, and the Brazilian sertão, centuries of extensive agriculture, particularly cattle ranching, have already replaced the climax natural vegetation with more open grassland. Conversion of grassland to soya bean and cereal production, particularly on the fertile soils of the Pampas, has a negative impact, particularly on areas of Pampas, that are otherwise rich in diverse vegetation. The last ten years have seen the conversion of the majority of soya bean production to Genetically Modified (GM) varieties. Fears have been expressed about the impact that the transfer of novel genes from GM crops could have to natural organisms and systems. Perhaps

16 ETL 2006.


because the soya bean is not closely related to any South American plant, these fears have not yet been realised. Any conversion of pristine habitats and natural resources to agricultural production, whether it be cattle ranching, sugar cane plantations or arable cropping, would have significant negative impacts. The increased intensification of the most agriculturally areas, such as the Parana plain and the Pampas, is likely to have fewer negative impacts but, in common with any such intensification of land use, issues of pollution, both diffuse and point source, and reductions in soil quality, would need to be addressed. In relation to natural resource stocks, the projected expansion of beef production and sugarcane are both expected to have adverse impacts on deforestation in the Brazilian Amazon. This will also have adverse impacts on biodiversity. In the case of sugarcane, a certification system for EU ethanol imports could be an important mitigating measure. The beef case study also identifies a potential adverse impact on biodiversity through production development in the Cerrado, where intensification is expected to lead to the cultivation of more natural pasture in seeded grasslands. Stronger measures of public control will be necessary in both regions to avoid potentially significant adverse impacts. There is still room to expand production onto seeded grasslands, and thus avoid additional degradation of natural ecosystems. Process Impacts The proposed trade agreement is judged to be highly consistent with principle 12 of the Rio Declaration, in promoting a supportive and open international economic system. There are however potential conflicts with the Rio principles of reducing and eliminating unsustainable patterns of consumption (principle 8) and enhancing technology transfer (principle 9). Except in these areas, the scenario is judged to be relatively neutral in respect of sustainable development principles. In relation to consumption and production patterns, the scenario aims to accelerate economic growth in both the EU and Mercosur. To the extent to which it achieves this goal, it will add to the underlying processes which drive increasing consumption and associated wastes. Stronger environmental regulation will therefore be needed, to achieve a sustainable balance between economic growth and environmental degradation. The EU-Mercosur trade liberalisation scenario adds incrementally to this general need. In relation to technology transfer, the scenario encourages a movement of capital into low added value agricultural production and out of higher added value industrial production. While some aspects of agricultural production have a high technology content, the overall effect may be to inhibit technology transfer rather than enhance it. EU-Mercosur agricultural liberalisation is judged to be neutral in its influence on institutional capacity for strategic sustainable development planning. The potential sustainability impacts in Mercosur agriculture are summarised in Table 11.


Legend: beneficial greater significant impact, adverse greater significant impact, beneficial lesser significant impact, adverse lesser significant impact, beneficial and adverse impacts likely to be experienced according to context (may be lesser or greater as above), - non-significant impact compared with the base situation. Greater and lesser significance are defined by the SIA methodology as: lesser significant impact – marginally significant to the negotiation decision, and if negative, a potential candidate for mitigation greater significant impact – significant to the negotiation decision, and if negative, merits serious consideration for mitigation. European Union Economic Impacts Increased imports from the Mercosur region will compete with domestic products, reducing prices to EU producers and processors, and consumers. This impact is likely to be greatest at the lower end of the commodity market. An additional outcome of reduced tariffs could be both regions improve their balance of trade, leading to welfare gains for both regions as the EU will improve both its non-agricultural trade with Mercosur, as well as total agriculture and food trade.17 Increased imports from Mercosur to the EU would increase pressure on EU producers, primarily in the area of chicken and sugar production, leading to higher differentiation of these markets within the EU. Further impacts expected include increased imports of processed foods and ethanol from Mercosur sugarcane. Lower tariff rates could also lead to a reduction in deadweight losses, which would prove particularly beneficial for economies engaging in their own reforms—such as the new accession countries.18 Competition is likely to increase for sugarcane and chicken, with EU producers having greater potential for securing differentiated markets for domestically produced beef and fruit. While EU chicken producers would benefit from lower wheat prices (for feed) arising from greater imports, this is unlikely to offset the competitive advantage (particularly lower labour costs) of chicken producers in the Mercosur region. A decline in EU chicken production would therefore reduce demand for grain production, particularly wheat, resulting in lower domestic prices. The market for apples and pears is already segmented by the different seasons of production (southern and northern hemisphere) but improving storage techniques is prolonging the seasons, thus increasing competition. The EU Biofuels Strategy19 seeks to increase consumption of transport fuels produced from renewable feed stocks, reducing consumption of fossil fuels. While the EU targets for biofuels present an opportunity for EU producers, it is widely anticipated that a significant component of these targets will be met, at least initially, by imports from overseas, including Mercosur. Although the overall effect for EU agricultural production is adverse, liberalisation of the Mercosur market would be beneficial for some EU products such as wine, olive oil and spirits. Reduced trade barriers will allow some firms to expand their markets, leading consumers in Mercosur to gain better access to improved foreign varieties of goods such as wine, olive oil and spirits All these products are likely to enter at the top of the consumer market. If this is associated with stronger protection of geographical indications, European wine producers are expected to gain further market share in Mercosur.

17 Laborde & Ramos, 2006 18 Francois et al, 2005 19 February 2006, implementing the EU Biofuels Directive of May 2003.


The agricultural sector in the EU remains a key source of employment in rural areas, and particularly in Poland, Italy, Spain, France and Hungry, which combined account for nearly two-thirds of the total EU agricultural labour force. Accompanying the decline in agriculture within the EU is a reduction in agricultural employment, particularly for the new member states. EU employment in the farm and agricultural processing sectors will follow the output changes, and again may be significant in local areas. This may be in part offset, however, by increased geographical differentiation of production, thus creating jobs in food processing sectors producing higher value products. Employment in primary commodity production is likely to fall, particularly in the areas of economically marginal production such as the uplands and mountainous regions where production is least competitive. These agriculturally marginal areas are those most likely to receive rural development support from the CAP for economic adaptation and the maintenance of high nature value areas which will tend to reduce the impact of trade competition. Opportunities for re-employment would be lower in the EU-10 compared to the EU-15. The CETM model results suggest that the EU-15 will be somewhat more affected than the EU-10, but qualitative considerations suggest that some of the new member states are more vulnerable for some of the affected products. In Europe as a whole, domestic markets are likely to react by providing increased opportunities for employment in the food processing sectors, producing higher value products sold with strong geographical indications. This will present opportunities for increased employment in food and drink processing and distribution. The overall effect on agricultural employment in the EU-15 is expected to be a small addition to the long term trend towards lower agricultural employment. For the new member states, employment opportunities associated with accession will be somewhat reduced by greater competition from Mercosur. The increased exposure of EU agriculture to competition from Mercosur may adversely affect investment in the agriculture sector. Some processing facilities for products such as beef and sugar may suffer from closures and a decrease in capital stock. A reduction in agricultural investment in the EU itself would be partially compensated by investment in products benefiting from greater exports (wine, olive oil and spirits), but the overall effect of the trade agreement is expected to be a transfer of investment out of European agriculture into more competitive economic sectors. The overall effect for the EU economy as a whole is expected to be beneficial. Social Impacts The overall impacts of the Agreement on social welfare will be mostly adverse, particularly for countries specialising in meat and cereal production. Likewise, the accession countries are expected to feel short term impacts on rural incomes and unemployment. The economic impacts on employment will have corresponding social effects, with a possibility of short term adverse effects on poverty in localised areas. In the new member states, and to some extent in the EU-15, existing problems of unemployment and poverty could increase in the short term, depending on social policies at the national level. The additional difficulties could be significant in accession countries where social policies have been dismantled and new systems are not yet fully in place. Imports from Mercosur will continue to comply with EU sanitary and phytosanitary standards (SPS), and no adverse health impact is expected from increased imports. Concerns that have


been raised regarding plant diseases and animal welfare are discussed below in relation to environmental quality. The adverse employment effects are likely to be felt by the least competitive farmers and processing facilities. Some rural areas will be negatively affected, and small farms may be more affected than large ones. As already noted, producers involved in undifferentiated commodity production and in agriculturally marginal areas will be most affected, increasing geographic disequilibrium. More competitive and entrepreneurial farmers will be in a stronger position to decrease their production costs, while less competitive ones will experience greater difficulties. Income inequalities among EU farmers could therefore increase in the short term. Rural development support to maintain traditional agricultural systems, cultural landscapes and natural value, and to encourage diversification into new non-agricultural activities, would reduce negative impacts. The longer term impact on income distribution is not expected to be significant. No significant gender impacts are anticipated. Environmental Impacts Impacts on the stocks of water and soil will depend on the changes to agricultural production systems. Reductions in the intensity of production or complete agricultural abandonment, which is likely to occur in the agriculturally marginal areas (for instance uplands and mountainous regions) will decrease pressure on natural resources. In these areas, water supplies and quality could be ameliorated and soil erosion decline. On the other hand, the increased competition from Mercosur imports may stimulate higher intensity of production, which could place greater demand on ground and river water and on soils. The EU Water Framework Directive and the EU Action Plan for Soils will both result in policy measures to address threats to water and soils. The overall impact of the trade agreement is expected to be less agricultural production in the EU, and decreased pressure on water supply, with a beneficial effect in those areas where the resource is scarce. Loss of competitiveness may encourage greater intensity of production in order to increase yield, but the overall effect on soil and water resources is expected to be small and beneficial. The factors outlined above on natural resource stock also apply to environmental quality. Policy interventions through Pillar II of the CAP (particularly the agri-environment programmes) will seek to address any threats to environmental quality. The quality of water may improve in some areas through reduced use of agrochemicals, although in others there may be adverse pollution impacts associated with a decline in livestock farming and an increase in use of chemical fertilisers. The overall effect is not expected to be significant. Concerns have been expressed that increased imports of Mercosur produce may increase the likelihood of plant diseases being introduced, particularly for citrus fruits20. EU phytosanitary standards have been designed to prevent impacts of this nature. The EC maintains regular surveillance of exporting countries’ compliance with these standards, and so it is not anticipated that the EU-Mercosur trade agreement would entail a significant increase in risk. Concerns have also been expressed in respect of animal welfare, in that standards which relate to methods of production rather than to the characteristics of a product are not permissible under normal WTO requirements. Imports from Mercosur countries would be produced under their own standards rather than EU standards. It has been suggested that EU producers could

20 EUCOFEL (2007)


become uncompetitive, through the higher costs of producing to high standards21, or that there would be an economic incentive for the EU to relax its animal welfare standards22. During the WTO negotiations the EU has proposed that compensation should be permissible for the additional costs of meeting legal standards23. Any such arrangement in the EU-Mercosur agreement would be a matter for negotiation, and would need to be WTO-compliant. For the potential impact on climate change, the case study for ethanol concludes that increased imports of sugarcane ethanol from Mercosur will have a significantly beneficial impact on greenhouse gas emissions. For beef production, the case study indicates that the combined impact in EU and Mercosur on greenhouse gas emissions will be neutral, except for the adverse effect of increased international transport and a small increase in overall production. For other agricultural products the impact of higher production in Mercosur and lower production in the EU is also expected to be neutral. The modelling results support this. For full liberalisation of all goods and services they indicate that the production changes would reduce CO2 emissions in the EU and Mercosur combined (including Venezuela) by less than 0.1%. This does not include emissions of methane, ammonia and nitrogen oxides, which are significant for cattle raising and other agricultural activities. Here too it is expected that an increase in Mercosur will be approximately cancelled by a corresponding decrease in the EU. An additional factor not allowed for is the effect of forest clearance on carbon sequestration. However, a greater impact on climate change is expected to come from the increase in carbon emissions arising from increased international transport. Increased competitive pressure on EU agriculture, particularly on beef, chicken and cereal production, will tend to increase the specialisation of production systems, reducing diversity of habitats. Agriculture specialization is expected to increase, with a concentration of production in some sectors, and a possible small decline in agricultural biodiversity. Agricultural abandonment could also reduce biodiversity of ‘semi-natural’ habitats such as hay meadows, but will provide opportunities for recolonisation of ‘climax’ vegetation. On the other hand a move to less intensive production systems (such as organic) could increase biodiversity. Once again, policy interventions such as the CAP agri-environment schemes will be available to reduce negative impacts. The overall fall in EU agricultural output is expected to result in an overall impact on biodiversity in the EU that is small but beneficial. Process Impacts The agricultural component of the proposed EU-Mercosur trade agreement is judged to be highly consistent with principle 12 of the Rio Declaration, in promoting a supportive and open international economic system. There is however a potential conflict with Rio principle 8, for reducing and eliminating unsustainable patterns of consumption. Except in this area, the scenario is judged to be relatively neutral for the EU in respect of sustainable development principles.

21 van Horne and Bondt (2003) 22 CIWF (2000), EAW (2000) 23 CEC (2003)


Greenhouse gas emissions

Global Benefit from Mercosur ethanol. Smaller adverse transport effects

Certification of biofuel production

Biodiversity All, mixed effects, benficial overall

Specialisation, abandonment.

Policy interventions in CAP reforms

Process SD principles Positive for

international cooperation, otherwise neutral except for increased consumption

Acceleration of underlying processes

Global environmental regulation and support for Mercosur regulation

-

SD strategies Neutral impact - - Legend: beneficial greater significant impact, adverse greater significant impact, beneficial lesser significant impact, adverse lesser significant impact, beneficial and adverse impacts likely to be experienced according to context (may be lesser or greater as above), - non-significant impact compared with the base situation.


4. MANUFACTURING SECTOR 4.1 Introduction The Phase 1 preliminary Overview provided an assessment of the potential impacts of the further trade liberalisation scenario on the manufacturing sector. Phase 1 also included a sector level SIA for the automobile sector. The results of both Phase 1 studies are included in the Phase 2 Final Overview. The industrialisation process in Mercosur countries was for many years promoted by protectionist import substitution industrialisation (ISI) strategies. However, with the adoption of liberalisation policies in the late 1980s and 1990s, the tools for pursuing industrial development strategic objectives shifted from control and ownership to market regulation and development. Trade policy is seen as one of the key policy instruments for industrial development. The manufacturing sector now accounts for a significant share of GDP in each of the Mercosur countries (Table 14). Table 14: Manufacturing Value Added (% of GDP)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Argentina 19 19 20 19 18 18 17 22 24 24 Brazil 24 23 20 17 17 17 14 13 12 11 Paraguay 15 15 15 15 14 13 14 14 14 14 Uruguay 19 19 18 18 16 16 15 16 18 21

Source:World Bank Development Indicators Manufactures also account for a significant proportion of Mercosur exports and imports. Brazil has the highest share of manufactures in total exports at almost 70 percent; Argentina (51 percent), Uruguay (44 percent) and Paraguay (24 percent) have lower share of manufactures in exports (Table 15). In contrast, imports of manufactures dominate total imports in all four countries (Table 16). Table 15: Share of Non Agricultural Exports in Total Exports (%) 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005Argentina 50 48 51 49 50 56 55 54 51 51 53 Brazil 68 67 66 68 68 73 70 70 68 69 71 Paraguay 55 42 28 26 29 34 30 24 22 24 Uruguay 54 52 50 48 48 52 54 49 46 44

Source: UN COMTRADE Table 16: Share of Non Agricultural Imports in Total Imports (%) 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005Argentina 93 94 94 94 94 94 93 94 95 97 96 Brazil 88 88 90 89 91 92 93 92 92 94 94 Paraguay 81 79 80 78 82 82 85 87 91


Uruguay 88 88 88 88 88 87 87 84 85 89 Source: UN COMTRADE 4.2 Negotiations in the Manufacturing Sector Existing levels of protection in Mercosur on manufactures are on average around 12% (Table 17), although there are sizeable variations in the AVE level of protection on specific products and sub-sectors. The average tariff rate imposed by the EU on Mercosur exports is 5%. These sub-sectoral variations in protection levels are found in the external tariff and non-tariff barriers applied to trade with the EU, and in the barriers to trade which are imposed on intra-Mercosur trade flows. Table 17: EU and Mercosur Tariff Structure by sector: 2003 (all figures in percentage)

Country Sector Simple Average Tariff

Effectively Applied Tariff*

Number of Tariff Peaks

Maximum Tariff Rate

Total 6.17 10.2 665 230 Agriculture 8.99 17.9 640 230 RawMat

EU tariffs applied on Mercosur Exports

erials

0.98 0.98 0 5

Textiles 10.59 17.2 17 29 Manufacture 4.72 5.14 6 27 Total 11.16 12.25 195 55 ARaw Materials

Mercosur tariffs applied on EU exports

griculture 12.41 11.0 3 55 1.11 1.11 0 6

Manufacture 11.35 13.8 192 35 Textiles 16.24 18.92 0 25

Source: Trains, MAcMap data for 2001 from MAcMap The Effectively Applied Tariff is an ad valorum equivalent of applied border protection that includes information on tariffs, special and mixed tariffs, quotas, tariff rate quotas and preferential rates

There are sectoral imbalances with regards to export composition with over 50% of Mercosur exports in ‘food and raw agricultural products’, whereas EU exports are concentrated on manufactured goods. These sharp asymmetries give rise to significant differences in negotiation positions. Successful completion of negotiations on non-agricultural market access will be heavily dependent on the progress in negotiations on agricultural issues. Furthermore, the EU calls for free circulation of goods within the two blocks which imposes a series of challenges for the consolidation of Mercosur’s regional integration (Rios and Doctor, 2004). The offers on trade liberalization in manufactured goods, from both the EU and Mercosur, have included over 90% of tariff lines. The main conflicting issues were: tariff liberalization timetables, the inclusion/exclusion of some sensitive sectors, degree of special and differential treatment, the extent of reciprocity, protection for infant industries and a possibility of applying drawbacks and safeguard. The inclusion of these trade restriction mechanisms in the bilateral agreement is opposed by the EU side.


The EU offered immediate tariff reduction on 58% of Mercosur exports (which have already been liberalized as a result of the multilateral negotiations), 35% at ten years, 1.2% through fixed preferences and 5% thought quotas (in the latter two it included many agricultural products and foodstuffs) (INTAL, 2006). The Mercosur proposal offered immediate liberalization of European imports 11% of EU exports and on 61.3% at 10 year, with preferences and quotas for another 18% of goods. 10% of imports from the EU would be left out of the agreement (INTAL, 2006). In the case of specific industries, the EU expected Mercosur to make a significant improvement in its offer especially on industrialized good such as footwear, textiles, vehicle parts and ferrous and non-ferrous metals. Mercosur, on its part, insisted on adoption of a system of quotas for imports of products from the industrial sector such: automobiles, and vehicle parts, wines, information technology and telecommunication products and capital goods (INTAL, 2005). Furthermore, the EU proposal anticipated the possibility that some sectors – pharmaceutical, steel, construction equipment, agricultural machinery, furniture, toys would have tariffs eliminated immediately on both sides. Mercosur rejected this on the grounds that many of these sectors are considered sensitive, especially for Brazil (INTAL, 2005). 4.3 Modelling Results for Manufacturing Sector The results of the EU Mercosur CGE model indicate that liberalisation would reduce the output of manufacturing output in Mercosur (Table 18). The estimates are for full liberalisation. Lesser degrees of liberalisation, including the introduction or revision of tariff rate quotas, would have smaller effects in the same direction. .The estimates in Table 18 show the change in output relative to the sector’s output level in the base scenario equilibrium for Mercosur. Table 19 show the changes predicted by the CETM for industrial sectors in the EU 15 and EU10. Table 18: Static Equilibrium Changes in Industrial Sector Output, Mercosur (percentage change in sector output)

Argentina Brazil Paraguay UruguayCETM modelTextiles and Clothing -1.4 -6.5 -27.8 -15.7Wood, Pulp, Paper -1.8 -5.0 -21.3 -7.8Chemicals -0.1 -5.1 -20.1 -5.4Metals -3.7 -14.0 -19.1 -13.8Motor Vehicles -9.7 -29.1 -66.4 -41.6Transport Equipment 4.0 -17.6 -63.0 -35.7Machinery -15.3 -24.3 -57.8 -38.0Source: CETM Model Table 19: Static Equilibrium Changes in Industrial Sector Output, EU (% change in sector output)

EU 15 EU 10 Textiles and Clothing

0.9 0.2

Wood, Pulp, Paper 0.1 0.0 Chemicals 0.4 0.2 Metals 0.7 0.6 Motor Vehicles 1.8 0.7


Transport Equipment

0.1 1.0

Machinery 1.4 0.8 Source: CETM Model The results of the modelling also indicate that Mercosur countries as a group would reduce their exports of manufactured products to the EU (Table 20). However, the changes in Argentina are positive, in contrast to the other three Mercosur countries. In absolute value terms, the largest declines are in machinery and motor vehicles. Table 20: Change in Exports, Mercosur (value of exports)

Argentina Brazil Paraguay Uruguay Venezuela MERCOSUR Textiles and Clothing 125 -244 -51 -88 30 -229 Wood, Pulp, Paper 42 -456 -32 -17 15 -449 Chemicals 143 -378 -14 -36 410 124 Metals 215 -448 -8 -18 515 256 Motor Vehicles 8 -866 -35 77 -816 Transport Equipment 31 -411 -4 5 -380 Machinery -33 -1.436 -15 -33 106 -1.412

Source: CETM Model The CETM results are broadly similar to the results of other modelling studies of EU –Mercosur trade liberalisation in showing a decline in manufacturing sector output in Mercosur and a small increase in the EU.24 The CGE model results for employment follow those for output, with employment predicted to decline in manufacturing (Table 21). Under the full liberalisation scenario, the implications of production shifting in response to changes in comparative advantage induced by trade liberalisation would be a s shift of labour out of manufacturing and into agriculture and food processing activities.25 Table 22 shows the predicted changes in the EU. Table 21: Changes in Employment, Mercosur (%) (Full Liberalisation scenario) Argentina Brazil Paraguay Uruguay Venezuela Textiles and clothing -1.6 -6.1 -27.3 -15.7 -0.1 Wood, pulp, paper -1.9 -4.8 -20.9 -7.9 0.0 Chemicals -0.3 -4.5 -19.8 -5.5 2.1 Metals -3.8 -13.6 -18.0 -13.8 3.4 Motor vehicles -9.9 -28.6 -66.4 -41.6 0.2 Transport equipment 3.9 -17.2 -63.0 -35.7 2.0 Machinery -15.4 -23.9 -57.3 -38.0 3.1

24 These other modelling results were discussed in the Phase 1 Mid Term Report. 25 (The figures in Table 5.15 show the percentage change in employment in the sector: the industry changes in employment have a smaller percentage impact on the total level of employment).


Table 22: Changes in Employment, EU (%) (Full Liberalisation scenario)

EU 15 EU 10 Textiles and Clothing 0.9 0.3 Wood, Pulp, Paper 0.1 0.1 Chemicals 0.4 0.2 Metals 0.7 0.6 Motor Vehicles 1.8 0.7 Transport Equipment 0.1 1.0 Machinery 1.4 0.8

4.4 SIA Findings for Manufacturing Mercosur Economic Impacts The modelling results are consistent in showing a general decline in manufacturing in Mercosur following trade liberalisation. The results of CGE modelling give an indication of the changes in economic incentives that result from trade liberalisation. If it is allowed that resources move smoothly and instantaneously in response to these new comparative advantage ‘signals’, then the predicted changes in output occur. In the real world, however, an industry’s response to trade liberalisation will be influenced by the effect which trade liberalisation has on longer term productivity growth and investment, and by corporate strategic planning decisions. Trade opening can induce greater competitiveness and export performance on the part of domestic manufacturing firms, allowing them to adjust positively to the new market incentives and opportunities. However, a necessary condition for this positive adjustment process to occur is a phased process of liberalisation which gives the affected industries time to adapt. The costs of adjustment associated with trade liberalisation are likely to be lower if adjustment is spread over time.26 The optimal sequencing of trade liberalisation is to begin with the elimination of quantitative restrictions by conversion into tariffs, followed by a phased reduction of tariffs. European FDI accounts for a significant share of total FDI in the manufacturing sector in Mercosur. The main determinants of FDI inflows are the investment climate within the Mercosur countries and the potential for growth in the domestic and export markets. In the early 2000’s European FDI diversified into the services sector in response to domestic market opportunities, but more recently, has switched back to investing in those parts of manufacturing where there is potential of export growth, such as automobiles. The inflow of FDI can also contribute to productivity growth and economic growth, with the potential for economy level spill over externalities from the industry in which the investment is made. To the extent that investors continue to have confidence in Mercosur as a stable investment environment with potential for market expansion, the potential negative impact of trade liberalisation on manufacturing sectors will be moderated. But for other sectors which are unable to compete internationally as import substitutes in the domestic market or as exports, trade liberalisation will accelerate the underlying process of sectoral decline.

26 Winters, 2000


The short term impact of trade liberalisation on the manufacturing sector in Mercosur is expected to be significant and negative in the short term, but the adverse impact will be less in the longer term as industry adjusts to the new competitiveness pressures induced by greater openness. The results for the CGE model are based on a fixed capital stock, which is redeployed across sectors in accordance with the static output changes that occur as a result of trade liberalisation. However, in a dynamic context, trade liberalisation may have a positive impact on investment behaviour, and particularly on the investment decisions of foreign investors. Multinationals will tend to invest in sectors with the most promising growth potential and will pick the companies in the host country which are likely to be the most productive. Trade liberalisation is unlikely, therefore, to have any significant adverse impact on the inflow of FDI in the manufacturing sector in the short term. Over time, however, it may have an impact on the sub-sector allocation of new investment. The removal of protective barriers will make investment in import substitution production less attractive, while at the same time increasing the attractiveness of those activities which have the potential to compete internationally and expand production for export markets. The long term gains that investment may have on economic growth would be dependent on technological development and the dynamics of both foreign and domestic firms.27. The CETM predicts percentage changes in sectoral employment similar to those for output. The model follows the standard computable general equilibrium modelling approach and assumes that total employment is fixed at the national or regional level. Workers from a declining sector are able to immediately find work in an expanding sector, hence, the model allows only for the evaluation of inter-industry shifts in employment.28 Transitional and persistent unemployment effects due to labour market constraints and the associated adjustment costs are not generally evaluated within a CGE modelling framework. In other words, CGE models tend to remain silent on employment effects such as moves into or out of disguised unemployment in very low productivity, informal sectors, from or into formal employment in higher productivity, modern sectors within a country/region, or the migration of jobs from one country to another as a consequence of trade liberalisation.29, 30. For each of the Mercosur countries the model predicts a negative overall impact on employment in the manufacturing sector, reflecting the predicted structural shift from industrial to agricultural based production which occurs following trade liberalisation. Although this will be compensated by a rise in employment in other sectors, a time lag can be expected between declining employment in one area and a rise in another. Given the rigidities in the labour market and the high level of official unemployment in the urban sector in Mercosur countries31, the overall employment effects of trade liberalisation during the period of adjustment are expected to be negative, and may be significant if the pace of liberalisation is faster than can be accommodated by the markets. The long term impact on industrial employment will be similar to that for output. However, the pressure to maintain cost competitiveness in international markets may accelerate the adoption of less labour intensive technology, with negative consequences for employment, 27 Ozler, Yilmaz and Taymaz (2004) 28 Changes in relative wages are used to maintain overall level of employment (and unemployment) constant. 29 Ackerman, 2005 30 The short term adjustment costs in employment may be significant, particularly if they are concentrated in particular sub-sectors and/or regions. Recent work by the OECD has considered ways in which governments can assist workers displaced by trade to re-integrate into the labour market (OECD, 2005). 31 14% in Argentina, 12% in Brazil, 10% in Paraguay, 13% in Uruguay. Official figures on employment in developing countries typically understate the level of labour un- and under- employment.


particularly for unskilled labour. In contract, trade liberalisation which extends to labour may increase the employment opportunities for skilled labour, for example engineers, who are displaced as a result of sector level adjustments to trade liberalisation. Social Impacts CGE models by design are not particularly well suited for poverty analysis due to their lack of disaggregated information at the household level and their inability to distinguish between poor and non-poor individual households. The CETM model gives estimates of the static equilibrium effects on skilled and unskilled real wages in each of the Mercosur countries. A significant rise in unskilled wages is projected for Paraguay. The effect in the other countries is small, including a small decrease in skilled wages in Argentina (potentially offset by trade facilitation measures). These changes are derived on the assumption that overall employment remains constant. If we allow for the decline in manufacturing employment during the adjustment period and the likelihood that, during this period of adjustment, many of the displaced workers will join the pool of urban unemployed, then any gain in wages by those remaining in employment is likely to be offset by the fall in income for the now-unemployed. Many urban households in Mercosur countries are on or below nationally recognized poverty levels. The impact of industrial trade liberalization on poverty within the manufacturing sector during the adjustment period is expected, therefore, to be adverse, although the negative impact on household incomes of manufacturing sector labour could be partly offset by any reduction in prices of consumption goods resulting from trade liberalization.32 Longer term impacts may be more beneficial, if trade liberalization raises investment and the long run economic growth path and subsequent increases in incomes of poor households.33 From the perspective of national poverty levels, the impact of trade liberalization is more difficult to predict. The direct fiscal impact of the removal of tariff barriers to imports of industrial goods would be to reduce government revenue, if this is not mitigated by levying the same amount of income by other means34. Table 23 indicates the potential magnitude of the effect for industrial and agricultural tariffs combined. About three quarters of the total can be expected to come from industrial liberalisation35. A reduction in social expenditure could then be expected. Depending on the types of alternative taxes that are chosen, further social impacts would occur, if the incidence of their effects differed from those of the import tax which they replace. The short term impact of industrial trade liberalisation on expenditure in health and education might also be negative. Longer term impacts will depend on the ability of the industrial sector to respond positively to increased competition. Table 23: Tariff Revenue Effects, millions of dollars

Base revenue

New revenue

Change

Argentina 1.984 1.044 -940 Brazil 5.609 3.185 -2.424 Paraguay 151 164 13 Uruguay 246 129 -117

32 Barraud and Calfat (2006) estimate that trade liberalisation in Argentina will lower poverty levels, by reducing the prices of consumption goods and increasing the demand for labour in non traded sectors such as construction. 33 However, economic growth is not a sufficient condition for poverty reduction. 34 If trade liberalisation proceeds by substituting tariffs for non-tariff barriers there may be a positive revenue impact in the initial phases of trade liberalisation. 35 Kowalski P (2005)


Source: Model results A study by the IMF indicates that trade liberalisation has typically been associated with a marked decline in trade tax revenue. 36 In middle income countries revenues as a share of GDP fell by about a third, while in low income countries the decline was over 40 percent. Many middle income countries have responded by raising revenue from other sources to leave total tax revenues broadly unchanged, but in low income countries total revenues declined in parallel with the falling trade tax revenues. The report also notes that the revenue concerns may be exacerbated by short term expenditure pressures that can arise from liberalisation, such as increased social outlays for displaced workers. The IMF study advocates the use of domestic consumption taxes, notably VAT, to offset the anticipated loss. If the system is appropriately designed, consumer prices can be left almost unchanged, so that distributional impacts are minimised, and potentially avoided altogether through appropriate adjustment of income tax, enabled by an anticipated rise in incomes. The study reports Tunisia, Malawi, Uganda, Senegal and Jordan as examples of where tax reforms have been used successfully to replace lost tariff revenues, in contrast with many other cases where reforms have not been undertaken, revenues have fallen, and government expenditure has had to be cut. In Jordan and Senegal IMF funding programmes had explicitly linked trade reform with domestic tax changes. In addition to the potential impacts on employment and poverty discussed above, industrial liberalisation may have impacts on gender equity. These are considered unlikely to be significant for the industrial sector as a whole, although there may be significant differential impacts at the sub-sector level, where female employment may be concentrated. Trade liberalisation has in general tended to lead to increasing feminisation of the workforce, with effects on gender equality that have not been clear cut37. Reforms which draw more women into the labour force can coincide with persistent gender segmentation in labour markets, and specific policies are often needed in order to achieve greater gender equality. The short to medium term effects for EU-Mercosur liberalisation may differ from the more general case, with an overall movement out of industrial employment and into agriculture. Although some significant effects may occur for particular industries, the overall gender impact is expected to be relatively neutral. Environmental Impacts Production levels are expected to rise for processed food, particularly in Paraguay and Brazil, and decline in most other manufacturing sectors. The principal biodiversity effects will occur through any consequent changes in pollution (primarily of water) and water consumption, which may have knock-on effects through pollution of aquifers or a fall in groundwater levels. Water resources are relatively abundant in the Mercosur countries, and impacts from consumption changes are unlikely to be significant. The effect on water pollution may be significant in local species-rich areas if existing pollution levels are high, and regulation is weak. The overall effect of the production changes is expected to be beneficial but small, with a possibility of localised effects that are adverse, but also small. The overall impact on

36 IMF (2005) 37 UNRISD (2005)


biodiversity of industrial liberalisation in Mercosur countries is therefore expected to be non-significant. Impacts will occur for both air pollution and water pollution as a result of the production changes. In Mercosur countries these are expected to be beneficial overall as a result of the overall fall in manufacturing production, but with the possibility of localised adverse effects from the increase in production of processed foods. These could be significant if regulatory regimes are weak or are unable to respond (Box 3). The potential for adverse effects is particularly high in Paraguay and to a lesser extent Brazil. Any reduction in intra-Mercosur shipments of industrial goods will contribute to the overall improvement in environmental quality. Little effect on greenhouse gas emissions and climate change is expected from the production changes, as these consist primarily of movements of production between the EU and Mercosur and also other countries. A quantitative estimate of the effect is given in Section 5. A significant adverse effect may however arise from the increase in international transport. For full liberalisation of agriculture as well as manufactured goods, this could amount to an increase in global CO2 emissions of about 0.15%. Box 1: Industrial Pollution and Regulation In terms of the impact of industry on the environment, there is evidence that pollution has increased with the increased privatisation, reduced participation of the government in the productive sector, and the liberalisation of capital and trade flows (Young, 2003). A detailed analysis of the contribution of different sectors in Brazil to overall air pollution points to the complexity of the pollution haven debate and the country-specific terms of production and trade, as well as the importance of the regulatory structure and reach of the government in monitoring and controlling sector-specific pollution levels. While large industry, such as the automotive and paper sectors, are subject to greater regulation and are more highly visible in Brazil, small-scale industries are among the most polluting in the country-by sector. Based on the number of employees, small-scale industries in the wood production, leather products and metal production far exceed large-scale contributors (Jayaraman, Lanjouw, 2004). Small-scale industries may not only be more difficult to monitor and thus their full contribution to overall scales of pollution unknown, they also have fewer opportunities to incorporate new technology into production due to cost; monitoring their compliance is more difficult; disposing of waste properly may be more expensive, and there is often reduced awareness to potentially harmful effects of pollution among small-scale producers (Jayaraman and Lanjouw, 2004). The overall effect of industrial liberalisation on water resources in Mercosur countries will be beneficial, because of the overall decline in industrial production. Water resource pressures tend to be low in the region, and so any localised adverse effects are not expected to be significant. Similar effects are expected for industrial energy consumption. As assessed in the economic model, energy consumption may fall slightly overall through a change in energy mix. A larger decline in the industrial sector will be countered by an increase for other sectors. In the longer term, improvements in production technology can be expected to include reduced intensity of energy consumption and water use. Reduced energy consumption in production will partially counter increased consumption in international transport. However, except perhaps in particular areas where industrial use is a major factor and environmental


European Union

Economic Impacts The CGE model predictions for EU manufacturing show modest gains in output and exports. The more significant gains to the EU from trade liberalisation in manufacturing are likely to be linked to the investment flows to Mercosur. There has been significant levels of EU investment in the manufacturing sector in Mercosur and the EU is now the largest investor in the Mercosur region. The majority of European FDI is directed to Brazil. In 2001, the FDI stock of the EU in Brazil amounted to US$ 74,508 millions and to US$ 50,397 in Argentina (Table 25). Spain is the EU member with the largest stock of FDI in Mercosur, followed by France, the Netherlands, the United Kingdom, Italy, Germany and Portugal. EU investment is located in areas as diverse as telecoms, energy, financial services, the automotive industry, the agro-industry and the retailing sector. Table 25: EU FDI Stock in Latin America, 2001

(Outward stock, Millions Euros)

Latin Americaa

Argentina Brazil Chile Columbia Mexico Venezuela

European Union (%)

194738 50397 74508 15064 5902 25945 7493

100 26 38 8 3 13 4 France 19504 5553 8389 698 262 1556 1647 Germany 17829 2336 7481 537 505 5102 966 Netherlands 12296 1646 5223 899 -533 2630 1075 United Kingdom 16963 3622 4508 2947 2085 2283 666 Italy 9117 3147 4648 91 60 387 229 Portugal 8515 96 8185 16 0 88 5 Otherb 110514 33997 36074 9876 3522 13900 2905

aEurostat Balance-of-Payments (BOP) Economic Zone of Latin America includes: Argentina, Bolivia, Brazil, Chile, Columbia, Costa Rica, Cuba, Ecuador, El Salvador, Guatemala, Honduras, Mexico Nicaragua, Panama, Paraguay, Peru, Uruguay and Venezuela b“Other” has been computed as the difference between the estimated EU aggregate and the sum of the selected declaring countries. Note: Data on Spanish assets in Latin America are not separately available: it can be assumed they account for a significant part of “Other”. Source: Amann and Vodusek, 2004 The concentration of FDI in services is particularly strong in the Mercosur region. In Brazil, between 1997 and 2000, over 81 percent of all FDI inflows were to the services sector. A large part of these investments were made by European firms, and in particular, Spanish investors. However, with the deterioration in the global economic situation and the corporate credit retrenchment, this pattern changed: in the early years of the new decade, less than 60 percent of FDI inflows were undertaken in services, while the share of FDI in manufacturing rose to 35 percent in the same period.. This shift in the composition of European investment in Mercosur in part reflected the influence of devaluations on foreign investment decisions. For the services sector, devaluation had adverse repercussions for foreign firms serving the domestic market. On the other hand, devaluation increased the international competitiveness of manufacturing, and foreign firms in Brazil and Argentina responded by increasing their exports—particularly to the rest of Latin America.


5. SERVICES SECTOR 5.1 Introduction The performance of the services sector is an important contributor to economic growth. The availability of efficient financial services, for example, has been shown to be a key input to economic advancement.38 Infrastructural services are also an essential factor for rapid economic growth. 39 Environmental services are increasingly important in managing environmental outcomes of economic growth. Similarly, the competitiveness of firms in open economies is determined in part by access to low-cost and high-quality telecommunications, transport and distribution services, and financial intermediation. Regional trade agreements increasingly include negotiations on services.40 The EU ahs adopted a GATS approach to services liberalisation in its regional and bilateral trade negotiations.41 In principle, GATS covers all commercial tradable services, with the exception of some aspects of air transport such as traffic rights, and services supplied under government authority. The WTO Secretariat has drawn up a list of twelve groups of service sectors, which is used in the negotiation of commitments by most WTO member countries42. These are:

o business (including professional and computer) services o communication services o construction and related engineering services o distribution services o educational services o environmental services o financial (insurance and banking) services o health-related and social services o tourism and travel-related services o recreational, cultural and sporting services o transport services o other services not included elsewhere.

The share of services in GDP and employment rises as per capita incomes increase. Table 27 shows that the share of services in GDP in the EU15 has risen steadily since 1995 to over 70% in 2004. The share of services in Mercosur increased between 1995 and the beginning of the new decade, but decline after 2001, reflecting the financial and macroeconomic volatility experienced in the region in this period. Table 27: Mercosur services value added (% of GDP) Country\Year 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Mercosur 58.2 60.0 60.3 60.5 63.1 63.3 60.6 56.9 53.6 53.0 Argentina 65.8 65.1 64.8 65.3 66.9 66.9 68.1 56.8 54.3 54.0 Brazil 54.3 62.3 62.4 62.8 65.3 64.7 53.9 53.3 50.0 49.6 Paraguay 49.3 48.2 48.9 48.8 52.1 53.5 51.1 51.3 48.5 48.5 Uruguay 63.6 64.5 65.0 65.3 68.3 68.1 69.2 66.1 61.8 60.0 EU15 67.8 68.4 68.8 68.9 68.9 69.5 69.6 70.1 70.8 71.3

38 See Jalilian and Kirkpatrick (2005). 39 World Bank (2004); Jalilian, Kirkpatrick, Parker (2006) 40 Roy and Marchetti (2006) 41 As opposed to a NAFTA approach which is based on a negative list scheduling modality. 42 WTO (1999)


Source: World Development Indicators (Edition: April 2006); World trade in services has grown more rapidly than merchandise trade. The same pattern has occurred in the EU and Mercosur. Over the period 2000-2005, EU 25 services exports grew by 11% per annum, while those of Mercosur grew at 8% per annum. In 2005, the total value of services exports was $1233 bn., compared to $3988bn merchandise exports.43 For Mercosur, services exports were $23bn in 2005, compared to merchandise exports of $163bn.(Table 28). Table 28: Value of Merchandise and Services Trade in 2005 (billion dollars) Merchandise

Exports Merchandise Imports

Services Exports

Services Imports

EU 25

3988

4120

1233

1119

Mercosur 4

163

113

23

31

Source: WTO 2006 Mercosur is a net importer of services, and runs a traditional deficit in the service accounts. The deficit, in Brazil, for instance was US$7.2 billion in 2001 although by 2004 it has shrunk to US$5.1 billion. The MERCOSUR Council approved the Montevideo Protocol on Trade in Services at the end of 1997. It entered into force in 2005 after having been ratified by Argentina, Brazil and Uruguay. The protocol aimed at total liberalization of trade in services in Mercosur over a 10 year period44. The obligations on market access and national treatment do not apply to sectors, sub-sectors, activities or measures not inscribed in the lists of specific commitments. The Protocol of Montevideo follows the GATS model in that a Member may adopt or maintain quotas to services providers, economic needs tests, limitations on foreign investments and on the participation of foreign capital in a company. Nonetheless, the validity of these measures is conditioned on their inscription in the Member’s schedule

45s of

pecific commitments.

Wholesale and Retail Trade, Hotels and Restaurants is the single largest subsector 5.6%).

s The composition of the services sector in Mercosur shows some variation between countries (Table 29). In Brazil, Finance, Insurance, Real Estate and Business Services is the largest services sub sector contributing 42% of total services sector output. In Argentina and Uruguay, the Finance, Insurance, Real Estate and Business Services subsector is again the largest subsector, contributing 34% and 44% respectively, to total services sector output. In Paraguay,(4

43 WTO, 2006 44 INTAL, 2005 45 WTO, 2004


Table 29: Service Sub-Sectors in Mercosur as % of Total Service Sector (excludes community, social and personal services)

Source: Calculated by the authors with data from ECLAC Statistical Yearbook for Latin America and the Caribbean, 2006

1995 2000 2002 2003 2004 2005 Argentina

Electricity, Gas and Water Services 4.1 4.6 5.5 5.5 5.3 5.1

Construction 9.7 9.2 6.7 8.4 9.9 10.7 Wholesale and retail Trade, Hotels, Bars and Restaurants,

32.6 30.5 28.7 29.9 30.6 30.3

Transport, storage and communication 15.5 16.8 18.0 18.2 18.8 19.6 Finance, Insurance, Real Estate and Business Services

38.1 38.9 41.1 38.0 35.4 34.3

Brazil Electricity, Gas and Water Services 7.3 8.0 7.6 7.8 7.8 7.9

Construction 21.0 20.8 19.5 18.6 18.7 18.5

Wholesale and retail Trade, Hotels, Bars and Restaurants,

18.7 16.9 16.6 16.4 16.9 17.0

Transport, storage and communication 11.4 12.5 13.8 14.1 13.9 13.8

Finance, Insurance, Real Estate and Business Services

41.5 41.8 42.6 43.1 42.6 42.7

Paraguay Electricity, Gas and Water Services 5.2 5.7 5.9 6.0 5.9 5.8 Construction 14.2 11.4 10.3 11.4 11.1 11.2 Wholesale and retail Trade, Hotels, Bars and Restaurants,

48.1 45.3 44.8 45.8 45.9 45.6


19.8 20.5 21.0 19.4 18.8 18.7

Uruguay Electricity, Gas and Water Services 6.3 6.8 7.6 7.3 7.1 7.3 Construction 11.1 9.8 7.7 7.5 7.6 7.7 Wholesale and retail Trade, Hotels, Bars and Restaurants,

24.7 22.1 17.9 18.4 21.1 22.7


43.4 46.2 51.6 50.6 47.1 44.0

The lowering of barriers to trade in services can contribute significant static efficiency gains in terms of allowing foreign suppliers to provide lower cost services to the domestic market. Increased openness to international trade in services also offers large potential benefits through dynamic effects on overall economic performance. Services liberalisation can also deliver significant gains in terms of sustainable development and poverty reduction, by raising investment in basic infrastructure and improving the quality of the services delivered.46

46 Adlung 2007



5.2 Negotiations in Service Sector The service sector is the EU’s main offensive interest within the EU-Mercosur bilateral negotiations. The EU is the main exporter of services in the world with export value at US$ 823 billion. The competitiveness of EU in services is greater than that of Mercosur along almost the entire range of sectors. The EU-Mercosur bilateral negotiation on reciprocal liberalization of trade in services began when the EU presented, in July 2001, the first draft of the proposal on Services Chapters (Pena, 2005). By 2003, both parties had agreed on the methods and modalities of the agreement. The objective of the agreement was to achieve a ‘comprehensive and balanced level of liberalization in service with substantial sectoral coverage that strengthens transparency between stakeholders and is in concordance with the existing GATS commitments’. Both parties have adopted GATS commitments as a starting point for bilateral discussions, hence only service liberalization that goes beyond the existing GATS framework would constitute preferential access at the bilateral level. Table 30 compares GATS commitments of EU and Mercosur with those offered in the framework of bilateral negotiations. The latest proposals on services sector liberalization do not include a significant number of GATS-plus sectors. The EU offered liberalization of 20 sub-sectors that were not included in initial offer presented at the WTO.

Table 30: Comparison of specific commitments in different Service Liberalization scenarios

Argentina Brazil Paraguay Uruguay EU Sector UR Doha M/EU UR Doha M/EU UR Doha M/EU UR Doha M/EU UR Doha M/EU1. BUSINESS SERVICE

16 16 25 10 19 20 0 1 7 14 19 30 43 43 43

Professional Service 4 4 7 4 5 6 1 1 11 11 10 10 Computer Related S. 5 5 5 1 1 5 5 1 5 5 5 Research and Development Serv.

3 3 3

Real Estate Serv. 1 1 2 2 2 Rental/Leasing Serv. 3 3 4 4 5 Other Business Serv 7 7 13 6 14 13 5 5 10 18 18 19 20 2. COMMUNICATION S.

15* 15* 15* 1 1 9 13 1 1 13 12* 14* 14*

3. CONSTRUCTION AND RELATED ENGENEERING

4 4 5 4 5 5 5 5 5 5

4. DISTRIBUTION SERV.

3 3 3 3 4 4 3 4 4 4 4

5. EDUCATIONAL SERV.

1 4 4 5

6. ENVIRONMENTAL S.

1 4 4 4 4* 7* 7*

7. FINANCIAL SERVICES

20 20 21 11* 11* 35* 5 5 10 3* 3* 26* 22 22 22

8. HEALTH RELATED AND SOCIAL SERVICES

1 3 3 4

9.TOURSIM & RELATED S.

3 3 4 1 3 3 3 3 3 3 3 3 3 4

10. RECREATION 1 1 1 1 1 1 4 4 4



AND CULTURE RELATED S. 11. TRANSPORT SERV.

10 5* 5* 12* 3 1 1 10 11 20 35

12. OTHER SERVICES nes

4 4 4

SECTORAL COVEREGE

61 61 85 35 49 93 5 9 45 23 28 96 119 133 153

UR: Uruguay Round Doha: Initial offers presented in Doha Negotiations M/EU: offers presented at the bilateral process Aware that the countries did not undertake their commitments according to the classification of W/120, thus comparison can not be made between commitments of various countries. Source:Pena,2005 2005

Of these sectors 15 belong to the transport service sectors and the rest are spread out among health services, tourism services, educational and business services. All of these sector offers have been undertaken with limitations (Pena, 2005). Mercosur’s offer in the service sector has incorporated more ‘new’ sectors compared with GATS commitments but given the fact that there is no free provision of services between Mercosur member countries this offer is less attractive that it would have been with the free circulation of services in place (Pena, 2005). Argentina offered a limited number of additional subsectors corresponding to professional services, environmental services, tourism services, greater coverage of construction services, the establishment, without limitation of insurance companies and commitments for news agency services and air transport services. Brazil, in addition to Uruguay Round commitments, has offered some new services in professional sector, environmental services, telecommunication, financial services and transport services. The offer presented by Paraguay contains a significant amount of ‘new’ service subsectors. These belong to business services, distribution services, computer services, environmental services and tourism services. Finally, Uruguay has presented a broad offer in relation to coverage with 10 sectors at bilateral negotiations as opposed to 6 at Doha (Pena, 2005).47 In terms of conflicting areas in service liberalization, there were particular differences in maritime, financial and telecommunication, investment, government procurement. The EU requested agreement to take part in maritime transport, and to take part in tenders for government procurement. With regards to the last point, Mercosur only accepted to grant this facility to companies that were already installed in the region (INTAL, 2004). Furthermore, the EU requested the possibility of selling cross-border service without the need for the company to be established in the country in which it would be providing the service. The EU also argued for the inclusion of ‘profession services’ in the agreement, which would allow the transfer of skilled labour from Europe to the affiliates of European companies located in Mercosur. The EU also focused on sectors considered sensitive by Mercosur, such as mining (including the extraction of oil and gas), financial services, telecommunications, environmental services (including water and sewage) cabotage and fisheries (INTAL, 2004). 5.3 Modelling Results for Services Sector CGE modelling of services liberalisation faces a number of challenges. Many of the barriers to trade in services are hard to quantify and this increases the unreliability of the resulting estimates of the effects of trade liberalisation. Also, the debates about liberalisation in services concentrate on rule changes, such as the removal of particular regulations, rather than the lowering of trade barriers by a given percentage. A further complication is that the impacts of a particular measure extend beyond the trade effects and can have significant impacts on domestic policy and national autonomy. Modelling studies are not well suited to take into account the highly differentiated nature of services and the linkages to domestic regulatory policy. The nature of liberalisation in services is fundamentally different to liberalisation in goods. In the latter case, the discussion centres on changes in the level of effective trade barriers expressed in quantitative terms. In the case of services, liberalisation is mainly about qualitative measures, such as regulation changes, which have to converted to quantitative equivalents in order to be modelled. Second, most services are consumed at the

47 Summarizing the proposals, Pena (2005) argues that the value of the Mercosur offer is concentrated in the value of the Brazilian contribution, especially in telecommunications and financial services. The Brazilian offer, however, presents significant shortcomings due to the fact that liberalization in the telecommunication sector is still conditioned by principles and disciplines that would be negotiated for the sector whereas financial sector liberalization is subject to (discretional) presidential authorization.

SIA of Mercosur Negotiations – Trade Facilitation Mid-Term Report page 55

point of production, which means that trade in services is closely linked to movement of capital and labour.48 The CETM modelling results for EU Mercosur trade liberalisation predicted that services trade liberalisation would account for about 8% of the real income gains in Mercosur.49 The estimates of the gains from services liberalisation are large because protection levels are high in the services sector, and services make up a growing share of trade. However, the overall gain in economic welfare is associated with significant changes within the services sector output as shown in Table 31, with a decline predicted for financial services and business services in all Mercosur countries. The retail and wholesale services sector is also projected to be adversely affected by trade liberalisation in Argentina and Paraguay.50. Table 31: Changes in Services Output, Mercosur (percentage change) Argentina Brazil Paraguay Uruguay Wholesale, Retail -0.4 0.7 -2.7 0.7Communications 1.1 -0.2 1.3 -2.5Transport Services 0.8 0.7 0.1 -3.2Finance -2.1 -1.4 -23.1 -0.6Business Services -1.0 -1.2 -12.5 -2.0Other Services 0.2 0.3 1.5 0.7Source: Model simulations For the EU, the gains from services trade liberalisation will accrue mainly from improved market access for the export of services. For the Mercosur countries the gains will accrue mainly from the efficiency and competitiveness gains in the domestic market that result from increased imports of services.51 However, trade liberalisation does not in itself create a competitive domestic market and the anticipated welfare gains may not occur where the domestic market is highly imperfect or monopolistic. Furthermore, the premature exposure of domestic infant industries may result in the displacement of domestic suppliers by foreign providers. The sequencing of domestic reforms such as privatisation or regulation prior to trade liberalisation then becomes a critical issue in determining the magnitude of the gains from services liberalisation in sectors such as financial, distributional and environmental services. It cannot be assumed, however, that these potential gains will be realised simply by the opening up of services markets. The main concern of foreign private investors in determining the scale of their involvement in foreign markets is the quality of governance, including the predictability of the regulatory environment and the general business environment.52 In addition, the benefits from foreign entry will depend on the domestic market conditions and effectiveness of public institutions and policy. For example, if private involvement in sectors previously entirely in the public sector occurs without creating conditions of effective competition, the economic efficiency gains from trade liberalisation will not be forthcoming (Parker and Kirkpatrick 2005; Mattoo, 2005). Similarly, if increased entry into the financial

48 Stiglitz and Charlton (2006) 49 Mode 1 only was covered in the model estimates 50The large fall in domestic output projected for finance and business services in Paraguay is associated with a larger increase in static economic welfare than in the other Mercosur countries. 51 There may be increased exports in certain sectors, such as construction, where Mercosur firms have established a comparative advantage. Exports of services personnel under mode 4 is another area of potential export growth. 52 IMF (2003); Kirkpatrick et al (2006a: 2006b)


services sector is not accompanied by adequate prudential supervision, the result may be increased systemic risk ( Brownbridge and Kirkpatrick, 2002). The impact of services liberalisation has raised concerns as to the potential adverse social impact, particularly in the areas of utilities services which have historically been delivered by the public sector. Private sector involvement may result in increased prices (to ensure financial viability) or a concentration of investment and provision in areas of high population or income. As a result, if policies to ensure universal service at affordable prices are not put in place as part of the regulatory framework, the access of the poor to essential services may not improve.53 The concentration of FDI in services is particularly strong in the Mercosur region. In Brazil, between 1997 and 2000, over 81 percent of all FDI inflows were to the services sector. A large part of these investments were made by European firms, and in particular, Spanish investors. However, with the deterioration in the global economic situation and the corporate credit retrenchment, this pattern changed: in the early years of the new decade, less than 60 percent of FDI inflows were undertaken in services, while the share of FDI in manufacturing rose to 35 percent in the same period (Amann and Vodusek, 2004). This shift in the composition of European investment in Mercosur in part reflected the influence of devaluations on foreign investment decisions. For the services sector, devaluation had adverse repercussions for foreign firms serving the domestic market. Liberalisation within the EU-Mercosur agreement is expected to lead greater competition from EU providers in Mercosur, particularly in banking, insurance, telecommunications, computer and related services, distribution services, environmental services and construction and engineering services. Exports of services from Mercosur to the EU are less significant although there is potential for growth, particularly in mode 4 (movement of people) professional labour54. Trade liberalisation in services often raises issues of national economic and social policy and concerns about policy autonomy. Where domestic regulatory capacity is weak, the over-rapid liberalisation of services can give rise to adverse effects. Financial sector liberalisation has been linked to increased financial instability; utility sector liberalisation has sometimes been accompanied by increased market concentration and higher prices for consumers; liberalisation of environmental services has raised issues of national regulatory capacity and autonomy55; and liberalisation of distribution services has been associated with job losses and social unrest56.The challenge for policymakers is to liberalise trade in a manner consistent with other public policy objectives. 5.4 Business and Professional Services Introduction Removing barriers to trade in services in a particular sector is likely to lead to lower prices, improved quality, and greater variety. Greater foreign participation and increased competition together imply a larger scale of activity, and hence greater scope for generating growth-enhancing effects. Even without scale effects, the import of foreign factors that characterizes services sector liberalization could still have positive effects because they are likely to bring

53 Kirkpatrick et al (2006); Kirkpatrick and Parker (2005) 54 Valladao and Guerrieri (2006) 55 George, Kirkpatrick and Scrieciu (2006) 56 WTO (2002)


technology with them. Econometric evidence confirms that openness in services influences long run growth performance57. Business and Professional Services have become integral part of liberalization of international trade in services as these services have been increasingly important as a share of GDP for both developed and developing countries and as a share of total trade in services. According to the OECD business and professional services collectively have been growing at around 10% per year with overall turnover for 1999 close to USD 1.5 trillion. In OECD countries alone, they have been estimated to create employment for at least 11 million persons OECD (1999). This overall strong performance is driven by several factors: the general shift towards services in the economy, the rise of the knowledge based economy, the need for greater flexibility within firms, specialisation and increased division of labour in many areas, outsourcing by established firms, and the trend towards smaller production units and firms. Governments influence the demand for business services by promoting private sector investment in intangibles such as R&D and business organisation, and by supporting the supply of these services through a range of intermediary agencies. Lesher and Nordas (2006) has highlighted that many EU economies have experienced a rapid increase in the share of business services in GDP, demonstrating that business services now represent one of the most dynamic sectors in many economies. In Denmark and Germany, business services share of GDP more than doubled in Denmark (from 3.5% in 1970 to 7.3% in 2003) and more than tripled in Germany (from 3.7% to 11.9%)1. Data available from 1980s show that the GDP share tripled for Austria and approximately doubled for Finland and France between 1980 and 2002-2003. The business services share of GDP in the most recent year available, 2002 or 2003, varies from about 3% in Greece to 12.7% in France. Business and Professional Services are also an important part of the Mercosur Economies. For example, in Brazil, Business and Professional Services have been the most important component of the large expansion of trade in services. The driving component of the increase in export of services was miscellaneous business, professional, and technical services, expanding from $3.9 billion in 2000 to over $7.5 billion in 2006. There has also been a sharp increase in the share of ‘Miscellaneous Business, Professional, and Technical services’ in total service exports. Figure 1 reveals that in 1995 the larges categories in Brazil’s export of services were ‘Transportation’ (43.5) percent followed by ‘Miscellaneous Business, Professional, and Technical services’ (19.3 percent). This order has reversed already in 2000 and by 2006 ‘Miscellaneous Business, Professional, and Technical services’ occupied the largest share (42.3 percent) of total service exports followed by ‘Travel’ (24.3 percent) and ‘Transportation Services’ (19.3).

57 OECD (2004) gives an overview of recent evidence on the effects of liberalization of trade in services.


other business services category (74) represents services such as advertising, architectural, engineering, legal, accounting and business management services, among others. We adopt this definition, however given that a bulk of our descriptive statistics is aggregated according to Eurostat’s and IMF’s Balance of Payment statistics we choose categories most closely corresponding to the above definition. Global demand for business and professional services, especially specialised services, is very high as every organization — whether public or private, for-profit or non-profit, large or microenterprise has support functions that are critical to its survival and competitiveness but that are not their core mandate or competency. Examples include accounting (in non-accounting firms), training (in non-training institutions), market research (in non-market research firms), and computer services (in non-IT firms). No organization, no matter what its size, can operate for long without functions like these as they improve the management and productivity of the enterprise (OECD, 2004). Professional services are of particular importance for economic development, in terms of both their contribution to the building up of infrastructure (engineering, architecture), and the creation of an investment and business friendly environment (legal and accounting services). Granting market access for these services can be important for attracting FDI and for promoting the transfer of knowledge (OECD, 2004). Furthermore, the convergence of computing and lower-cost international telecommunications has turned data into a commodity that can be moved around the globe instantaneously. The processing of a range of non-core service functions, including routine administration tasks, customer service and technical support is increasingly gravitating to places where it can be performed most efficiently (OECD, 2004). In this regard, the importance of electronic supply of services for developing countries emerges strongly. Out-sourcing and back office services, covering computer and related, business, professional and financial services are key areas of export interest for developing countries. ICT has created real opportunities for many developing countries by dramatically reducing the cost of transportation, and thus enhancing their comparative advantages. The relatively low cost of highly skilled labour and improvements in telecommunications means that this is clearly an area for potential future growth (OECD, 2004). EU – Mercosur Trade in Business and Professional Services58 EU is the largest exporter of services in the world. It is strongly competitive on almost the entire range of service sub-sectors including business and professional services. Also Mercosur, and in particular Brazil and Argentina, have strong and competitive business and professional services sectors as exports of such services have increased rapidly in recent years. A bulk of this export growth was, however, directed towards other Latin American countries rather than EU. EU – Mercosur trade in Services has risen in the past years from euro 10 billion in 2004 to 14.5 billion in 2006 (Table 34). The EU has a positive trade balance in services trade which has risen from euro 400 million in 2004 to euro 1.37 billion in 2006. Brazil accounts for 65% of EU exports and 70% of imports from the EU with Argentina comprising of 30% of exports and 25% of imports. 58 Please note all figures in this section are obtained from Eurostat and are quoted in euros. Average yearly Euro/US Dollar exchange rate is as follows: 2004 – 1.244, 2005 – 1.244, 2006 – 1.256.


Table 34: EU – Mercosur Trade in Services 2004-06 2004* 2005* 2006 Country Credit Debit Net Credit Debit Net Credit Debit Net Argentina 1264 1184 79 1605 1449 156 2394 1652 742

Brazil 3723 3455 268 4580 4019 561 5162 4609 551 Uruguay 252 207 45 293 203 90 294 228 66 Paraguay n/a n/a n/a n/a n/a n/a 59 48 12 Mercosur 5239 4846 392 6478 5671 807 7909 6537 1371

*excluding Paraguay; Source: Eurostat Trade in ‘Miscellaneous Business, Professional and Technical’ services is an important category of EU-Mercosur total trade in services as in comprises 25% of EU imports from Mercosur and 10% of exports. EU – Mercosur exports and imports are almost equal to each other with exports accounting to euro 1.351 billon and imports equal euro 1.344 billion (Table 35). The pattern of trade in this category differs from that of total services as there are many sub-categories in which EU has a negative trade balance in 2006. These sub-categories include ‘Advertising, Market Research & Pooling’, ‘Research and Development’ and ‘Services, between affiliated enterprises, nie’. In categories such as, ‘Architectural, Engineering & other Technical Services’ the EU exports exceed those from Mercosur. The industry with highest trade volume (excluding services between affiliated enterprises and other miscellaneous business services) is ‘Legal, Accounting, Management Consulting, and Public Relations Services’ where trade accounts to nearly euro 300 million and trade is nearly balanced between the two regions. Table 35: EU – Mercosur Trade in ‘Other Business Services’ by sub-category (2006)

Credit Debit Net

i) Other business services 1007.6 1663.7 -656.2 a) Merchanting and other trade-related services -519.5 306.5 -826

i) Merchanting -639.3 2.5 -641.7 ii) Other trade-related services 119.9 304.1 -184.2

b) Operational leasing 173.6 12.3 161.4 c) Misc. business, prof. & tech. serv. 1351.4 1344 7.5

i) Legal, acc., man., cons. & pub. rel. 152.4 145.7 6.7 ii) Adv., market research & polling 30.2 63 -32.8 iii) Research and development 80.4 154.9 -74.5 iv) Architectural, engin. & other tech. 206.5 95.9 110.6 v) Agric., mining & on-site processing 276.7 2.8 273.9 vi) Other 372.8 256.7 116.1 vii) Serv. Between affiliated enter., nie 232.6 622.9 -390.3

Source: Eurostat The aggregate figures for EU-Mercsour business service trade mask significant differences in pattern of trade between individual Southern Cone members and EU. Argentina has a trade surplus in ‘Miscellaneous Business, Professional, and Technical’ services amounting to nearly euro 100 million. This surplus originates mostly in ‘Advertising, Market Research & Pooling’, ‘Legal, Accounting, Management Consulting, and Public Relations’ and ‘Research and Development’ services (Table 36). On the contrary Brazil has a trade deficit in ‘Miscellaneous Business, Professional and Technical’ services accounting to euro 122


million. This deficit is mostly a result of a negative trade balance in Architectural, engineering. & other technical services and Agricultural mining and on-site processing services (Table 37). Given the size of Uruguayan economy trade in Business and Professional Services between EU and Uruguay is much smaller than the other two partners and accounts to a little over euros 90 million. Uruguay has a sizable trade surplus in the sector which accounts to euro 22 million. This surplus is the result of Uruguay’s a positive trade balance in ‘Advertising, Market Research & Pooling’, ‘Legal, Accounting, Management Consulting’ and especially in Other Miscellaneous Business Services which account for 75% of the surplus. Table 36: EU – Argentina Trade in ‘Other Business Services’ by sub-category (2006)

Credit Debit Net i) Other business services 307 340.2 -33.3

a) Merchanting and other trade- related services 75.2 44.1 31.1

i) Merchanting 63.5 0.4 63.1 ii) Other trade-related services 10.8 43.7 -32.9

b) Operational leasing 36.1 5.2 30.9 c) Misc. business, prof. & tech. serv. 194.5 290.8 -96.3

i) Legal, acc., man., cons. & pub. rel. 24.3 33.4 -9.1 ii) Adv., market research & polling 10.3 13.7 -3.4 iii) Research and development 6.5 57.3 -50.9 iv) Architectural, engin. & other tech. 35.4 13.3 22.1 v) Agric., mining & on-site processing 7.2 0.6 6.6 vi) Other 52.6 86.6 -34 vii) Serv. between affiliated enter., nie 58.2 82.9 -24.8

Table 37: EU – Brazil by category Trade in ‘Other Business Services’ (2006)

Credit Debit Net i) Other business services 629 1 237 -608

a) Merchanting and other trade-related services -626 237 -864 i) Merchanting -722 2 -724 ii) Other trade-related services 97 235 -139

b) Operational leasing 139 7 131 c) Misc. business, prof. & tech. serv. 1 116 994 122

i) Legal, acc., man., cons. & pub. rel. 118 100 18 ii) Adv., market research & polling 20 45 -25 iii) Research and development 73 95 -22 iv) Architectural, engin. & other tech. 161 78 83 v) Agric., mining & on-site processing 270 2 267 vi) Other 306 139 167 vii) Serv. Between affiliated enter., nie 169 532 -363


Table 38: EU – Uruguay Trade in ‘Other Business Services’ by sub-category (2006)

Credit Debit Net i) Other business services 67 79.7 -12.4

a) Merchanting and other trade-related services 30.2 23 7.2 i) Merchanting 19 0 19 ii) Other trade-related services 11.2 22.9 -11.7

b) Operational leasing 0.1 0 0.1 c) Misc. business, prof. & tech. serv. 36.2 56.6 -20.4

i) Legal, acc., man., cons. & pub. rel. 8.2 11.5 -3.3 ii) Adv., market research & polling 0 3.2 -3.2 iii) Research and development 0.4 1.4 1.1 iv) Architectural, engine. & other tech. 8.8 4.7 4.1 v) Agric., mining & on-site processing 0.1 0.3 -0.2 vi) Other 14 30 -16.1 vii) Serv. between affiliated enter., nie 3.6 3.4 0.2

Source: Eurostat (for tables 2,3,4) Moving to the analysis of EU-Mercosur trade in ‘Computer and Informational Services’, the EU has a significant trade surplus which has risen from euro 126 million in 2004 to 195.8 million in 2006. Also total trade in ‘Computer and Informational Services’ has risen significantly in the past years from euro 228 million to euro 384 million in 2006. Table 39: EU – Mercosur Trade in ‘Computer and Informational Services’ by sub-category (2006) 2004 2005 2006

Debit Credit Net Debit Credit Net Debit Credit Net Argentina 34.5 2.6 31.9 65.2 7.3 57.9 52.7 16.8 35.8

Brazil 140.2 46.9 93.3 178.2 52.8 125.4 233.8 75.8 158 Uruguay 1.1 1 0 0.2 3.1 -3 0.4 2.1 -1.7 Mercosur 177.4 51.1 126.3 249.3 65.3 183.9 290.7 94.9 195.8

Source: Eurostat Barriers to trade in Business and Professional Services in Mercosur Many studies have shown that in services regardless of the sector under analysis and the methodology used, on average, developing countries have more restrictive barriers than developed countries (Dihel and Shepherd, 2005). Mercosur economies have a moderate level of protection in business services but higher that the one prevailing in the EU. It is expected that liberalization in the secor will trigger positive welfare effects. Box 2 highlights hypothetical short and long term effects of removing barriers in business and professional services. Box 2: Hypothetical Effect of Removing Barriers Short Term Effects – the first potential effect of removal of barriers may liberalize markets with an increase in cross-border demand and/or a free up cross border supply. The effect of such liberalization will be to increase competition. A symptom of lack of competition may be a large differential in prices between what appear to be similar markets.


A recent European Commision (2001) survey on barriers to trade in business services in the EU has concluded that the main obstacles for free flow of services with the union are as follows: (1) imposition of national technical standards; (2) inability to practice without a licence from professional body, or lack of mutual recognition of professional qualitications; (3) requirements to have a specific legal form, or difficulties with administrative regulation in setting up locally; (4) dealing with legal systems of another country generally, including the absence of transparency in regulationand their implemantiaon. Furthermore, the restrictions on forming multi-disciplinary professional service firms are also seen as an important barrier developing corporate structures in the sector. Such professional sevices barriers are particularly important in Accounting, Auditing, Tax Service and Engineering Related Consultancies. (EC, 2006). It is important to mention that the above obstacles are even more sever for firms ouside of the Union. Mercosur’s offer in the service sector liberalization under the EU-Mercosur Association Agreement has included some ‘new’ sectors compared with GATS commitments but given the fact that there is no free provision of services between Mercosur member countries this offer is less attractive that it would have been with the free circulation of services in place (Pena, 2005). In the last comprehensive proposal on services, of September 2004, Argentina has included 9 ‘new’sectors, Brazil included 1 ‘new’ sector, Uruguay 11 and, finally, Paraguay 6. The EU on the contrary has not offered any new elements in business and professional services other than the 43 commitments made under the GATS. Despite that, many limitations for free circulation of trade in business and professional services remain in Mercosur economies. In Brazil, Article 22 of the Constitution gives the Union the exclusive power to legislate on the practice of professions. Although for some professions registration requirements on Federal or Regional Councils is mandatory, this does not apply to all professions. The authorities note that no professions are reserved for nationals, but that foreigners must meet certain requirements established by law to exercise in Brazil (WTO, 2005). For accounting, auditing, and bookkeeping, commercial presence is bound only if a foreign supplier cedes its name to Brazilian professionals, to constitute and exercise full participation in a new legal person within Brazil. Participation of non-residents in legal persons controlled by Brazilian nationals is not allowed. Also, Brazil's Schedule refers to special registration requirements for accountants who wish to audit such companies as financial institutions and savings and loans associations, and Brazilian accounting and auditing standards must be followed. For architectural and various engineering services, commercial presence depends on foreign service suppliers joining Brazilian service suppliers in a specific type of legal entity (consórcio), where the Brazilian partner must maintain the leadership. For example, foreign participation in production of advertising services is limited to one third of the footage of advertising films; larger participation is conditional on the use of Brazilian nationals and domestic production-house facilities (WTO, 2005). In Argentina Under Decree No. 2293/92, the freedom to exercise a profession is subject only to the requirement of a single registration, where appropriate. However, those professions whose exercise could place the health, safety, rights, property or education of the population directly at risk are regulated by the State. Twenty-four professions have been declared to be of public interest and must be periodically accredited by the National Evaluation and University Accreditation Commission (CONEAU). These include medicine, pharmacy, biochemistry, veterinary science, architecture, dentistry and psychology, together with 18 engineering specialties. According to the authorities, there are no professions reserved for Argentine nationals (WTO, 2006).


Under Law No. 24.521, for foreign diplomas (whether awarded to Argentine nationals or to foreigners) to be recognized in Argentina and authorize the exercise of a professional activity they must have been revalidated by a National University. (WTO, 2006). To practice as a lawyer it is necessary to have a national law diploma awarded by a public or private university or by a foreign university. In this latter case, the diploma must have academic validity under a bilateral treaty or have been revalidated by a national university. In all cases, to practise as a lawyer it is necessary to obtain professional authorization through enrolment in the Register of the Colegio Legal de Abogados (Law Association) of the corresponding jurisdiction. Access to the Argentine market for foreign-trained accountants depends on revalidation of the professional diploma, professional accreditation and registration in Argentina. Foreign accountancy firms may set up and offer services in Argentina. Balance sheets must be certified by a public accountant whose signature must be attested by the professional economics council of its jurisdiction (WTO, 2006). Uruguay has no general regulations on the exercise of professions. In Uruguay, the professions are regulated through approval of the study programmes followed in order to obtain a qualification and compliance with a number of legal standards that to a greater or lesser extent control the exercise of specific professions. The revalidation of professional qualifications from abroad is governed by the Regulation on the Revalidation and Recognition of Qualifications, Academic Grades and Foreign Study Certificates. Academic grades, professional qualifications and study certificates issued by foreign institutions may be revalidated or recognized by the Central Administrative Council of the University of the Republic, subject to certain conditions (WTO, 2006). With regards to Legal services only those with valid qualifications allowing them to exercise the legal profession in Uruguay may offer legal services there; access to the Uruguayan market by foreign lawyers requires recognition of their professional qualifications and registration in Uruguay. Qualifications may be revalidated. Foreign lawyers authorized to exercise their profession in their country of origin but whose qualifications have not been revalidated in Uruguay may set up a consultancy or an association of consultants in foreign law in Uruguay (WTO, 2004). Similar situation occurs in accountancy services. Only accountants with a valid qualification from a Uruguayan university or a revalidated qualification are entitled to exercise in Uruguay. Access to the Uruguayan market for accountants trained abroad requires professional accreditation, revalidation of their professional qualifications and registration in Uruguay. Foreign accounting firms may become established and offer services in Uruguay. Law No. 12.802 provides that balances must be certified by a chartered accountant and must be in accordance with international accounting rules (WTO, 2004). Liberalization Business and Professional Service under ‘Mode 4’ Mode 4, covering the movement of people (‘natural persons’) is a contentious area, since labour market regulation and wider national immigration controls place inevitable constraints on this form of liberalisation. The GATS agreement makes clear that it does not apply to ‘natural persons seeking access to the employment market’59, and that commitments need apply only to temporary stay. Most of the scheduled commitments made by developed countries apply only to ‘intra-corporate transferees’ or highly qualified personnel and

59 WTO (1994)


business visitors, with some progress on contractual services suppliers. Developing countries have argued for access to providers of low-skilled and labour intensive services. There is signifincant scope to improve the liberalization of business and professional services to include Mode 4 delivery. In particular, in the area of independent foreign service suppliers (the movement of individuals who are unrelated to commercial presence), Spain and Italy (but not only) offer significant opportunity for skilled and semi-skilled workers from Mercosur to export their labour temporarily. At the same time many EU-based multinational would prefer greater freedom to locate key personnel in Mercosur countries. Greater allowance for contract-based supply could pave the way for temporary access by the individual (and typically higher-skilled) service supplier. This could also provide a means of addressing the temporary admission of teams of less skilled workers, such as those engaged in construction or environmental services (Pena, 2005). Econometric studies confirm the liberalization of Mode 4 delivery, and in particular for lower skilled labour brings significant positive welfare effects for both recipient and origin country (Walasley and Winters, 2003) Furthermore, the area of mutual recognition and its contribution to the liberalization of trade in professional services could usefully complement greater liberalization of Mode 4 trade (Pena, 2005). As these agreements tend to be more flexible among smaller set of participats, the EU-Mercosur Assosiation FTA should provide for a possibility of only selected countries from both EU and Mercosur to part take in such agreement. 5.5 Environmental Services Introduction Environmental goods and services (EGS) play an essential role in sustainable development and in achieving specific targets set out in the United Nations Millennium Declaration. For developing countries the gains from liberalization of EGS sector are in improved environmental conditions and resource management at home, and in strengthened capacity to comply with environmental requirements abroad. Furthermore, in the long run such liberalization might reduction of air and water pollution, improved resource efficiency and safer disposal of solid wastes. Developed countries in turn will be looking for gains in terms of market access. At the Fourth World Trade Organization (WTO) Ministerial Conference in Doha in November 2001, WTO Members agreed to negotiations on “the reduction or, as appropriate, elimination of tariff and non-tariff barriers to environmental goods and services” (EGS). However, “Environmental goods” were not further defined in the declaration as there is no well-defined “environmental goods sector”. Rather, environmental goods are found in a wide range of industrial and trade classification nomenclatures. OECD, 2005 notes that “This business is less a sector than an agglomeration of providers of many types of goods, services and technologies that are usually integrated into production processes and are often hard to tease out as separate items.” Furthermore, many goods used for environmental protection and resource management have other uses: for example, pumps can be used in a wastewater treatment facility or in industrial uses not related to environmental remediation. Other goods may be considered “good for the environment” by virtue of their relative (as opposed to absolute) performance; as almost all goods and technologies have substitutes that are cleaner or more efficient, the resulting definition might be extremely broad (OECD, 2005). The Organization for Economic Co-operation and Development (OECD) and Eurostat have taken the lead in defining and classifying the environmental industry for analytical purposes


as: “activities which produce goods and services to measure, prevent, limit, minimize or correct environmental damage to water, air and soil, as well as problems related to waste, noise and ecosystems”. The definition serves as a basis for an indicative list that extends across all environmental media. It includes goods and services “which provide environmental protection in different domains: water, solid waste, air, soil, noise, natural resources, and miscellaneous services” (OECD, 2001) and classifies those under three broad rubrics: pollution management, cleaner technologies and products, and resource management (Vikhlyaev, 2003). This list included in the appendix serves basis for the statistical analysis in this section. Cleaner technologies and products, and resource management groups belong to the environmentally preferable products (EPP) category which include industrial and consumer goods not primarily used for environmental purposes but whose production, end-use and/or disposal have positive environmental characteristics relative to similar substitute goods60. Pollution management group belongs to established environmental technologies (EET) which include manufactured goods and chemicals used directly in the provision of environmental services61. It is instructive to note that a number of categories within the resources management group and cleaner technologies group (and, to a lesser extent, pollution management) lack corresponding disaggregated sub-sector HS codes, highlighting the inherent difficulty defining the EGS sector. The EGS market The total environmental market size is estimated at US$ 628 billion in environment industry (figure for 2004). In relative terms, this is not as big as the steel or agriculture markets, but roughly the same size as the pharmaceuticals and information technology markets (Hight, 2007).. The industry is dominated by developed countries. Europe, US and Japan together account for 82% of the global environmental market in 2004 have many of the largest environmental firms in the world, and concentrate global exports of environmental equipment, technology and services. The largest environmental sub-sector is solid waste management with $128.2 billion, followed by water utilities with market size of $96 billion. Other large sub-sector include air pollution control and clean energy and power (Hight, 2007). While the global environmental industry is estimated to have been growing fast during the last years, saturation has slowed market growth in the developed countries and therefore most of the future demand growth is expected to occur in developing countries and countries in transition (UNCTAD, 2003). The European Union, the United States and Japan have considerable surpluses in trade. The European Union is the biggest exporter the United States and Canada form the biggest market for European Union products and services. In 2003 global exports of EG reached approximately USD369 billion, of which USD295 billion (79.9 percent) originated in developed countries and USD74 billion (20.1 percent) in developing countries (Hamwey, 2005). This proves that the export of EG is highly dominated by the industrialised world. Although exports of EPP are balanced between developed and developing countries, its participation within global EG exports is small; whereas EET exports reached USD333 billion in 2003 (90.2 percent), EPP reached USD36 billion (9.8 percent). This shows that EET clearly dominate the trade in EG. However, EET exports represent approximately 4 percent of world exports, are smaller than textiles trade, correspond

60 Examples of EEP include items such as chlorine-free paper, energy efficient office machines, clean production and energy technologies, natural fibre clothing, packaging or floor covering materials. 61 Examples of EET include goods, and systems comprised thereof, used to provide an environmental service such as wastewater treatment, solid waste management, air pollution. control, etc.


to a third the size of chemicals trade and to a tenth of trade in machinery and transport (Bora and Teh, 2004). Markets in developed countries are mature: they are highly competitive, with a sophisticated customer base, and experience slow or negative growth in many segments. Conversely, markets in developing countries represent compelling environmental and resource management needs associated with population growth, urbanization and material-intensive patterns of economic activity. The usual sequence of evolving priorities is: water delivery, wastewater treatment, air pollution control, solid waste disposal, hazardous waste management, and remediation (UNCTAD, 2003). The environmental industry is characterized by a few dominant multinationals operating in the water and wastewater management sectors, and a large number of small- and medium-sized firms in solid waste management. Water and wastewaste services tend to be natural monopolies and, given their importance to human health, the environment and social policies, are influenced heavily by the public authorities. They are mostly provided through monopolistic structures, public or private, with the public sector being the traditional main supplier. Competition in these sectors takes place for markets, rather than in markets. These services are highly subsidized in many developing countries, but also in some developed countries (Vikhlyaev, 2003). EU and Mercosur Environmental Goods and Services Sector Markets The estimated total turnover of eco-industries in the EU-25 is $283 billon (€227 billion), of which $267.5 billion (€214 billion) corresponds to the EU-15 area. In constant prices, the turnover of the EGS grew around 7% between 1999 and 2004 (for the EU-15 area). The total turnover in 2004 can be split into $181 billion (€ 144.9 billion) for pollution management activities (64% of the total) and $102billion (€ 81.8 billion) for resource management activities (36% of the total). The goods and services provided by eco-industries represent approximately 2.2% of GDP in the EU-25 area. The largest national markets for eco-industries are France and Germany which taken together account for 49% of total turnover in 2004. The three following countries (UK, Italy and the Netherlands) represent together another 24% of the EU-25 total expenditures. The 10 new member states represent only 5.7% of total turnover, of which half for Poland alone (PwC, 2006). The environmental market size in Mercour is only a fraction of the European one. In 2004 Brazil’s EGS market accounted to $6.6 billion and the Argentinean one to $2.2 billion. The growth rate of the sector in Brazil in 2004 was 11.1% in Brazil and 10.0% in Argentina. In Mercosur as in other developing countries the environmental market is expected to grow equally fast in subsequent years, particularly in areas such as water and wastewater treatment, waste management, air pollution control and environmental monitoring and instrumentation (Industry Canada, 2003). Mercosur economies are net importers of Environmental Goods (Table 41). The trade deficit has been, however, halved in recent years from $1.17 billion in 2002 to just $570 million in 2007. Both exports and imports have risen steeply in the past five years. In 2002, export accounted to just over $2.3 billion and imports were $3.5 billion whereas in 2007 exports were $5.7 billion and imports were nearly $6.3 billion.


Table 41: Mercosur Total Exports, Imports and Trade Balance in Environmental Goods

-2

-1

0

1

2

3

4

5

6

7

8

2002 2003 2004 2005 2006 2007

Mercosur Exports Mercosur Imports Trade Balance

Source: COMTRADE Although the Mercosur region as a whole, and all of its countries on their own, are net importers of environmental goods, there are a few products for which Mercosur countries have a trade surplus. According to UNCTAD (2003), in 2000 Brazil and Argentina were net exporters of machinery, mechanical appliances, and their parts, with a surplus of approximately USD700 million for the former and USD42 million for the latter. Other important environmental products for which Mercosur has a trade surplus are, of course, ethanol for which Brazil is the largest producer in the world as well as chemical compounds, like anhydrous ammonia and calcium hydrogen-orthophosphate and plastic films and measuring apparatuses. Moving to the analysis of EPP exports of Mercosur these are concentrated in residues and waste from the food industries and to wool, whereas Argentina and Brazil dominated the export market for residues and waste from the food industries, Argentina and Uruguay dominated South American exports of wool (Claro et. al , 2005). Brazil is the main market for both environmental goods and services in Mercosur. The Brazilian-German Chamber of Industry and Commerce estimated foreign investment in environmental technology in Brazil at USD 3 billion in 2002. The main product areas were equipment, engineering and consulting services, and instrumentation associated with pollution control and clean-up. The group forecast market growth of around 7% a year. The Chamber estimated the market breakdown as follows in 2003: air-pollution control, USD 230 million; water and wastewater treatment, USD 1.6 billion; and solid waste treatment, USD 1.2 billion. The investment in the industry over 1999-2004 is estimated at USD 10-15 billion and projected that the total would reach USD 42 billion by 2010 (OECD, 2007b). . EU – Mercosur Trade in Environmental Goods Mercosur – EU trade in environmental goods has increased in recent years and currently accounts for nearly $4.5 billion (Table 42). In the years from 2002 to 2007 EU’s export of EGs to Mercosur have risen from slightly above $1 billion to nearly $3 billion whereas imports have risen from $500 million to 1.5 billion. These figures suggest that Mercosur’s trade deficit in environmental goods has witnessed a steady increase from $800 million in 2002 to nearly $1.5 billion in 2007 and highlight the strong competitiveness of the sector in the European Union (Table 43).


Table 42: EU – Trade of Environmental Goods

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

2002 2003 2004 2005 2006 2007

EU exports to MercosurMercosur Exports to EUTotal Trade

Source: COMTRADE Table 43: EU-Mercosur Trade Balance in Environmental Goods

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

2002 2003 2004 2005 2006 2007

Source: COMTRADE Brazil is the main recipient of EU export in the sector and account to 79.4 per cent of Mercosur’s imports. Argentina account for over 17% of Mercour’s imports whereas Uruguay and Paraguay together accounting for the remaining 3%. From this perspective it is Brazil’s offer of liberalization of environmental goods that is the key in successful conclusion of negotiations in the sector (Table 44).


custom procedures, regulation on payment, inadequacy of intellectual property protection, and government procedures. Summary It is often argued that trade and service liberalization in EGS would enhance the mutual supportiveness of trade and the environment, suggesting a potential for “win-win” outcomes. These gains however are not immediate and require effective support policies and capacity to benefit from improved market conditions. Developed countries expect greater access to emerging environmental markets for their export-oriented industries. According to UNCTAD (2003), potential gains for developing countries include: (a) easier access to environmentally sound technology and know-how as liberalization implies more environmentally sound options are available at lower price; (b) economic, environmental and developmental benefits resulting from improved resource management and environmental conditions; (c) new export opportunities in certain EGS sectors; and (d) enhanced capacity to comply with environmental requirements in international markets. Employment could also benefit, as developing countries posses significant human capital in areas related o provision of certain EGS. There are also several concerns about the effects of liberalization on developing countries. Potential negative effects are: (a) increased competition for the local environmental sector companies; (b) reduced policy space available to the government with regards to environmental policy; (c) reduction in tariff revenue. As Yu (2007) points out, ‘developing economies should only liberalise trade in environmental goods in the context of a strategic sustainable development policy’. For example, the benefits of reducing trade barriers on wind turbines and biofuels in South American and Asian countries may well only be obtained if such reduction is combined with domestic policies and regulations on renewable energy (Alavi, 2007). The absence of such domestic policy and political definitions might be crucial, as it prevents the articulation of clear and effective national negotiating strategies (Yu, 2007). As previously noted domestic markets for EET in developing countries tend to be dominated by small and medium sized enterprises (SMEs), with the exception of water and wastewater industry where large private multinationals dominate approximately half the global market. As SMEs are a factor of income distribution and creation of employment, the impact of EET liberalisation on these firms needs to be carefully considered (Claro et. al , 2005). On the one hand, SMEs might benefit from cheaper imported technology needed to comply with domestic environmental regulations. Liberalization of trade in environmental services is more difficult to negotiate within the context of EU-Mercosur Association Agreement. The main way to trade environmental services is through commercial presence (mode 3) and the temporary movement of natural persons (mode 4), given the need for highly specialized professionals in many of these services. Therefore the main obstacles to trade have to do with restrictions on foreign direct investment and the participation of foreign service suppliers in domestic industries. Commercially meaningful liberalization of environmental infrastructure services requires market access in environmental support services such as construction, engineering, legal, consulting, etc., where mode 4 is an increasingly relevant factor (Vikhlyaev, 2003). As a recent OECD document acknowledges (OECD, 2005), liberalising trade in environmental services, particularly services that require long-term investments in plant and equipment, may require new regulatory tools, including those relating to pricing and service


standards. This is particularly necessary in the case of environmental services, as they involve a wide range of services and a large number of measures can potentially affect access to them. Identifying and removing barriers to commercial presence (Mode 3) and movement of natural persons (Mode 4) are clearly key to achieving the full benefits of liberalisation in this area. 5.6 SIA Findings for Services The Phase 1 Final Preliminary Overview provided a SIA screening and scoping of the potential impact of trade liberalisation of each of the main services sub-sectors. The results of this assessment are summarised below. The Phase 1 findings indicated the need for a more detailed assessment of several of the services sub-sectors, namely, financial services, business services and environmental services. Sections 5.5 and 5.6 below give the findings for business and environmental services. Financial services are examined in the separate sector study.. Mercosur Economic impacts As indicated by the model results the overall impact on static economic welfare of the services component of the EU- Mercosur agreement is likely to be positive. Much greater long term gains are available provided that the opening of services markets is complemented by domestic regulatory reform. These gains can, in turn, make a significant contribution to investment and economic growth. However, the implementation of appropriate and effective regulation would entail both costs and time, which Mercosur governments will have to weigh against the emerging benefits in a carefully phased programme of reforms. The exposure of Mercosur’s services industries to foreign entry and competition can be expected to encourage investment in establishing a commercial presence on the part of foreign firms, particularly from EU companies. However, the recent downturn in private foreign investment in the infrastructure sector in Latin America, including the Mercosur countries, has highlighted the importance of regulatory and contractual credibility for foreign investment decision-makers. Domestic investment in services provision may also increase over time, as local firms establish an export capacity in services sector activities. There are a growing number of Mercosur service companies that have themselves acquired technological and services capacities. This may come from participating in joint ventures in their own countries, but in some cases, including Brazil, the export capacity is based mainly on indigenous knowledge and experience (Zarrilli, 2003). In Mercosur countries there will be negative adjustment effects on employment in the short-run, as sectors become more efficient and productive. Impacts are expected to be small overall, and restricted to service sub-sectors such as distribution. In comparison with similar changes associated with privatisation and other domestic reforms, impacts from services liberalisation are not likely to be more than minor in significance. The long term effects on employment in Mercosur are expected to be positive. Most of the anticipated employment changes arise through increases in productivity, which are likely to be associated with a beneficial long term effect on wage levels. Social impacts


The increase in investment in infrastructure services provision, such as water and sanitation, and electricity has the potential for improving the access of the poor to essential services.62This will require an effective regulatory institutional structure which can ensure that the services provided to the poor are affordable and accessible. There is a substantial body of empirical evidence showing that improvements in the quality of basic infrastructure services has a positive impact on the health of the poor63. Trade liberalisation may contribute to this, provided that the new investment in infrastructure results in improved quality, affordability and accessibility for the poor. Liberalisation of environmental services may have significant social and health impacts, depending on the nature of associated reforms. Potential efficiency improvements may have significant beneficial effects, but adverse effects can occur for poorer social groups if the reforms are not accompanied by effective regulation and government subsidies. There are no significant impacts on equity attributed to services liberalisation. Environmental impacts No significant impacts on biodiversity have been identified.. Services liberalisation is expected to help increase the use of environmentally efficient management techniques and technologies, and add to the pressures on government to improve environmental regulation and enforcement. This will provide a fairly small addition to the promotion of such techniques by international agencies. Liberalisation of distribution services is expected to lead to goods being sourced from a wider area, with consequent adverse impacts on local pollution and climate change associated with increased transport. Changes in packaging techniques may have adverse impacts on waste generation, requiring stronger regulation to encourage recycling. Greater use of environmentally efficient management techniques and technologies will tend to reduce pressures on consumption of water and other resources. The impact is not expected to be significant in relation to other effects in this area. Process Indicators Some of the service sectors affected, particularly telecommunications, can have important beneficial influences on processes of economic and social transformation. Liberalisation will also help to enable stronger environmental management. Increased transport associated with distribution services liberalisation will additionally add to climate change pressures. The effects in terms of sustainable development principles are all are beneficial or neutral, except for the principle of reducing and eliminating unsustainable patterns of production and consumption (Principle 8). The effects on sustainable development strategies will be similar to those for industrial products. These are all relatively neutral in that they neither add to nor detract from Mercosur countries’ capacity to implement effective sustainable development strategies. 62 Kirkpatrick, Parker and Figuera (2007) 63 Clarke et al (2004), Kirkpatrick and Parker (2005, 2006)


6. RULES BASED MEASURES 6.1 Investment Introduction The negotiations on the EU Mercosur trade agreement include a number of areas relating to domestic regulatory rules.64 Liberalisation in these areas is seen as complementing the traditional market access measures by providing an ‘enabling environment’ for the expansion of international trade and investment flows. The inclusion of investment in trade negotiations is intended to minimise the conditions and regulations on foreign investors entering and operating in the host countries, to improve the transparency and consistency of the regulations that are applied to foreign investors, and to grant them national treatment. An investment agreement can include a number of different provisions, depending on the objectives of the agreement.65 This would typically involve the removal of performance requirements and the adoption of a range of investor rights. The underlying premise in favour of an investment agreement is that it will increase the flow of foreign investment. In addition, by improving investor protection and confidence, domestic investment may be stimulated. Proponents of investment agreements argue, therefore, that the improvement of the investment ‘climate’ and the liberalisation of investment would be of mutual benefit to both parties in the trade agreement.66 However, the inclusion of investment provisions in trade agreements has been contentious since investment provisions affect domestic policy space with possible implications for the domestic economy. An investment agreement can combine elements of these approaches simultaneously. In the case of the EU – Mercosur negotiations, discussions on an investment agreement have focused on the improvement of the investment environment and a progressive liberalisation of investment, complemented by appropriate domestic regulations.67 There is an extensive literature on investment agreements, particularly in the context of developing countries. There are opposing theoretical arguments on investment provisions. Proponents argue that the inclusion of investment provisions within trade agreements will increase FDI, by fostering an enabling environment and strengthening the credibility and security of government commitments to investors. Opponents are sceptical of the influence of investment provisions on the inflow of FDI, or are concerned about the potential loss of control over domestic policy space (UNCTAD, 2006) The empirical evidence on the economic impact of investment provisions in regional trade agreements is generally positive. Dee and Gali (2003) find that FDI responds positively to the non-trade provisions within RTAs. Similarly, Te Velde and Bezemer (2006) find that regions with more investment provisions provide US and UK investors with positive signals about how different regions will treat them. Furthermore, the type of regional grouping matters for attracting FDI (i.e. whether or not the RTA includes certain trade and investment provisions). The OECD (2006) finds that investment provisions in RTAs are positively associated with

64 The main areas for negotiation are the so-called ‘Singapore issues’, namely, investment, trade facilitation and public procurement. 65 Te Velde and Fahnbulleh, (2006) identify the following areas that can be covered in an investment agreement: Investment promotion and cooperation, liberalisation and market access, and investment protection. 66 The following paragraphs are taken from Te Velde and Fahnbulleh (2006) 67 EU FTAs have in general, been concerned with investment cooperation, promotion and to some extent liberalisation, rather than investment protection


both trade and investment flows, and that they matter more for FDI flows than trade flows. The impact with investment provisions have on the inflow of FDI depend on the quality of domestic institutions, such as the rule of law and governance. 68 Foreign Investment Regime in Mercosur The provisions in an investment agreement would depend in part on existing commitments on investment. Investment promotion measures may already be included as part of trade facilitation measures and may also form part of an agreed aid for trade programme of flanking measures. With respect to investment liberalisation, the provisions within the FTA will need to take into account any existing commitments in GATS services sectors. It would also need to take account of any TRIMS commitments. With respect to investment protection, the legal implications of the RTA investment agreement would need to take into account any existing international commitments on investment protection. The foreign investment regimes have been significantly liberalized in the last 15 years, in each member of Mercosur, and are now considered to be conducive to attracting large foreign investments. In Brazil, constitutional amendments passed in 1995 eliminated the distinction between foreign and national capital. Constitutional Law now mandates the same legal treatment for national capital, and foreign capital invested in the country, under the same circumstances, and prohibits all forms of discrimination not explicitly foreseen in the Law.69 As a consequence, the Federal Government does not grant special incentives to foreign investment, other than those available to investment in general, and foreign direct investment (FDI) is accorded, in general, national treatment. However, restrictions to foreign investment apply in a number of areas. These include mining of mineral resources as well as exploitation, refining or transportation of hydrocarbons which remains under a state monopoly. Direct or indirect investment in health care in Brazil is closed to foreign enterprises. Investment in highway and road transport is limited to no more than 20-25% of the capital stock with voting rights. Commercial presence of foreign entities or individuals is restricted in financial services as the installation of new financial institutions is subject to case-by-case approval.70 Also in Argentina foreign companies can invest without prior approval, on the same conditions as investors domiciled in Argentina, and have the right to repatriate their investments and transfer their profits abroad at any time. However, until late 2006 the repatriation of direct investments as a result of the sale or definitive disposal of the investment is subject to the prior approval of the Central Bank of the Argentine Republic insofar as it exceeds US$2 million per month71. Under certain conditions, direct investments are subject to the 30 per cent deposit. Further, in 2003, a new law on the preservation of cultural property and assets was adopted. This imposed a 30 per cent cap on the participation of foreign enterprises in the ownership of communications media and limited their voting rights to 30 per cent72. In Uruguay, the Investment Law prescribes that the investment regime shall not discriminate between foreign investors established in Uruguay and Uruguayan investors. There are, however, some restrictions concerning market access.73 For example, foreign investment is

68 There is the possibility of reverse causation, where investment agreements have a positive impact on the quality of domestic institutions, thereby increasing FDI. 69 WTO, 2004 70 opt. cit. 71 WTO, 2007 72 opt. cit. 73 WTO, 2006


specifically prohibited in the following sectors: the operation of radio and television stations; cabotage and domestic transport of passengers by sea or air; fishing within an area of 12 nautical miles; and ownership of more than 49 per cent of the shares in railway companies. In general, foreign investors may engage in any type of activity on the same terms as Uruguayan investors. Foreign investors are eligible for the same incentives as Uruguayan investors. As in the case of other Mercosur’s members Paraguay's foreign investment regime is relatively open. There are no restrictions on foreign investment and private investment in general, other than in sectors reserved for the State. There are no prohibitions on Paraguayan investment outflows or restrictions on conversion or transfer of foreign currency. Private-sector participation is restricted in areas reserved for the State, such as some specialized telecommunications services. 74 The Colonia and Buenos Aires Protocols codify common rules on investment for Mercosur’s member and non-member countries, respectively. These protocols, however, make no progress in disciplining investment incentives and still await ratification by some members75. 6.2 SIA Findings for Investment Mercosur Economic Impacts European investment in the Mercosur region is already very substantial and an investment agreement is expected to confirm investor confidence in the region. Given the substantial inflow of FDI to the services sector, the impact of an investment agreement may be muted. However, if an agreement resulted in the relaxation or removal of sectoral restrictions, there could be a proportionately larger increase in European investment into these sectors. An investment agreement will also act as a signal to non- EU investors. The additional inflow of FDI that can be attributed to the agreement is unlikely to be significant, but any agreement can be expected to stabilise the long term flow of FDI. Over time, the inflow of new FDI is expected to contribute to economic growth. An investment agreement is expected to have positive impact on foreign direct investment and may also increase domestic investment. The increase in growth resulting from FDI inflows is expected to have a positive long term impact on employment Social Impacts In the long run, the increase in real income attributable to higher FDI inflows may have a indirect trickle down effect on poverty. The inflow of FDI into the basic utilities sector is also likely to contribute to poverty reduction, provided that domestic regulatory offices are able to regulate for accessibility and affordability criteria in the delivery of services by private utility operators.76

74 WTO, 2005 75 Bouzas, Da Motta Veiga and Torrent (2002)

76 See, Kirkpatick and Parker 2007


exporters.79 To achieve this, the EU aims to negotiate access to procurement markets through its bilateral trade agreements and free trade agreements (FTAs), by encouraging third countries to negotiate substantial commitments with the EU. Government procurement has been an integral part of the ‘second wave’ of regionalism which has been characterised by a ‘deepening’ of these agreements to include ‘behind the border’ regulatory issues including investment, technical barriers, and trade facilitation. The European Commission’s recent Communication on trade policy states that: ‘Free Trade Agreements (FTAs), if approached with care, can build on WTO and other international rules by going further and faster in promoting openness and integration, by tackling issues which are not ready for multilateral discussion and by preparing the ground for the next level of multilateral liberalisation. Many key issues, including investment, public procurement, competition, other regulatory issues and IPR enforcement, which remain outside the WTO at this time can be addressed through FTAs.’ EC, 2006:8). With regards to public procurement the EU Communicating highlights that: ‘Public procurement is an area of significant untapped potential for EU exporters. EU companies are world leaders in areas such as transport equipment, public works and utilities. But they face discriminatory practices in almost all our trading partners, which effectively close off exporting opportunities. This is probably the biggest trade sector remaining sheltered from multilateral disciplines. An examination of the areas of EU economic interests where the government procurement is most prevalent reveals that sectors such as ‘construction work’ and ‘Architectural, construction, legal, accounting and business services’ account for over 45% of the total number of government tenders (Table 48). These areas coincide with EU’s main ‘offensive interests’ in the area of government procurement as the EU is world leader in the export of services as well as sectors such as construction, pharmaceuticals, public utilities, transport equipment. Table 48. EU Tenders announced in selected economic areas Economic

Area Description Tenders (share of total no of tenders)

CPV 24 Chemicals, chemical products and man-made fibres. 3.4%

CPV 29 Machinery, equipment, appliances, apparatus and associated products.

3.5%

CPV 30

Office and computing machinery, equipment and supplies.

5.1%

CPV 33 Medical and laboratory devices, optical and precision devices, pharmaceuticals and related medical consumables

8.1%

CPV 34

Motor vehicles, trailers and vehicle parts. 3.6%

CPV 45

Construction work. 20.0%

CPV 50 Repair and maintenance services of motor vehicles and associated equipment.

3.7%

CPV 74

Architectural, construction, legal, accounting and business services.

15.6%

CPV 90 Sewage services. 3.2% Total 66.3%

79 http://ec.europa.eu/trade/issues/sectoral/gov_proc/index_en htm


The Government Procurement Market Estimates of the size of public procurement by state bodies in goods and service for a sample of 106 developed and developing countries find that for the OECD countries the total value of government procurement market is estimated at USD 4 733 billion and for the non-OECD countries it is estimated at USD 816 billion .80 The role of government procurement of goods and services typically accounts for 10-15 per cent of GDP for developing countries and around 20 per cent of GDP for developed countries.

In the EU, the procurement market is worth 1600 bn Euro. or over 16% of GDP.81 In Mercosur, in 2004, the size of the government procurement at national level accounted to $1.4 billion in Argentina and $3.5 billion in Brazil. 82 This market is significantly smaller in Uruguay and Paraguay due to their smaller size but still accounts for a significant part of the total government expenditure.

Government procurement legislation in Mercosur countries gives preference to local suppliers. In Argentina the Compre Nacional [Buy Argentine] programme was reintroduced in 2001 in favour of domestic industry for the procurement and contracting of goods, works and services by public organizations, with a maximum of 10 per cent domestic preference in the case of goods.83 This provision was subsequently repealed by Law No. 25.551, (Compre Trabajo Argentino) [Buy Argentine Labour], which established a system of preferences for goods of domestic origin, defined as those produced or extracted in Argentina, provided the cost of the raw materials, imports or nationalized imported materials did not exceed 40 per cent of the gross production value. There are also ‘Buy provincial’ and ‘Buy municipal’ programmes.84

In Brazil, under the Law No. 8,666 all procurement of goods, words and services must be tendered except in cases listed in Article 24 of the law. This law has effectively established no discrimination between companies incorporated under Brazilian law as the determining factors in selecting suppliers are the lowest price or best technical offer. However, in order to qualify for government contracts, suppliers must be legally established or represented in Brazil. Foreign firms without operations in Brazil and involved in international tenders need legal representation in the country or to be associated with a Brazilian firm (at least 51% Brazilian capital participation and operational control). Under the Law number 10,176 of 2001, the Federal Public administration should give preferences to the information technology goods and related services developed in Brazil.85 In Uruguay Decree No. 194/997 provides that government procurement should be through a public bidding procedure open to any Uruguayan or foreign supplier, although preferences are given to Uruguayan suppliers. State and semi-public enterprises give preference to Uruguayan over foreign products provided that they equal the foreign product in terms of quality and suitability. This requirement allows Uruguayan bidders to be awarded contracts even if their bids are 10 per cent higher than the foreign bid. In order to encourage the participation of foreign suppliers, invitations to tender are published abroad through

80 OECD, 2003 81 EC (2004) 82 WTO (2004) 83 WTO (2007) 84 opt. cit. 85 WTO (2004)


Uruguay's diplomatic missions, but this is not a legal requirement.86 When awarding contracts for public works, preference is given to those which guarantee the most utilization of domestic raw materials and labour; for the purposes of evaluating such a preference, the general terms and specifications require bidders to give an estimate of the percentages of Uruguayan labour and materials comprised in the price offered. For foreign suppliers, preference is given to those which offer to purchase and use Uruguayan products.87 In Paraguay the Law on Government Procurement (LGP) No 2,051 of January 2003 establishes the statuary provisions governing all public procurement in Paraguay. The LGP classifies public tendering as either local or international. The former is limited exclusively to natural or legal persons domiciled in Paraguay, while the latter is open to participation by natural or legal persons, whether or not they are domiciled in Paraguay. International tenders are used only in one of the following cases: (i) where required by an international treaty; (ii) where stipulated in agreements with international organizations; (iii) where, following investigation by the UOC, no Paraguayan suppliers are found to supply goods and services of the quality required or where the price of such goods or services is not "suitable"; or (iv) where no proposal has been submitted in a local tendering procedure.88 In the past few years Mercosur has undertaken initiatives liberalize government procurement market within its member states. In December 2004 the Common Market Council (CMC) approved the Protocol on Government Procurement with CMC Decision 27/04. The objective of this instrument was to gradually extend non-discriminatory treatment in the procurements made by public entities to the suppliers and providers established inside Mercosur. Finally, it is important to note that none of the Mercosur member states is a party to the WTO Plurilateral Agreement on Government Procurement. The Potential Benefits and Costs The 2006 Communication focuses on the global competitiveness gains to Europe from improved access to foreign public procurement markets. In an earlier Communication on government procurement, the Commission emphasized that increasing the scope and transparency government procurement can:89

• Increase competition to make bidders more efficient and stimulate innovation • Achieve better value for money and lower budget expenditure • Promote partnership between national and foreign bidders • Fight bribery and corruption in the public sector

There are two potential sources of benefit from liberalisation of government procurement (Evenett, 2003). First, as a result of the transparency requirements the government will be required to demonstrate better value for money in its contracting and purchases. More generally, greater transparency will contribute to improved governance. Estimates of the economic impact of improvement transparency and accountability suggest significant savings in the reduction of economic rents and corruption. Hockman (1998) estimates that competitive tendering and outsourcing could produce savings of about 20% without comprising quality. It is estimated that the introduction of the Internal Market reforms in the EU significantly improved the performance of public procurement markets over the past decade. Public procurement directives have effectively increased transparency and resulted in 86 WTO (2006) 87 opt. cit. 88 WTO, 2005 89 EC, 2002a


an estimated saving of 30% or more in public finances, despite the fact that direct cross border procurements remain low. Second, exports could expand as a result of purchases of goods and services by governments in the partner countries.. A significant share of government procurement is in services, where foreign supply would require the movement of people across national boundaries. The scope of negotiations on trade liberalisation in government procurement therefore is not without relevance to issues relating to domestic policy towards foreign direct investment, joint ventures and foreign mergers and acquisitions of domestic firms. However, negotiations on government procurement properly speaking are only concerned with the right for a company to participate in a procurement, and thus do not include in themselves the liberalisation of cross border movement of services and labour flows. Developing countries have in the past consistently opposed the inclusion of government procurement in the WTO negotiation agenda on the grounds that the scope of the issues is unclear and that they lack the technical and institutional capacity to comply with international tendering procedures. However, that position has more recently begun to shift, possibly in recognition of that fact that every country in the world already has some rules governing public expenditure, and also on account of the potential benefits in terms of governance and money saved which enhanced transparency may generate. A number of developing countries have therefore engaged in negotiations on transparency, if not also coverage. Resistance to GPA compliance may also be based on more fundamental concerns about the potential damaging effects on the development process. Procurement policies may be part of an industrial policy or an instrument to attain social objectives (e.g., support for small and medium sized enterprises, minority-owned businesses, disadvantaged ethnic groups, or certain geographic regions) through set-asides and preference policies.90 In addition, a government’s ability to procure from firms of its own choice can be an instrument for macroeconomic management.91 There is the concern that premature or over-rapid opening of government procurement markets will allow large foreign firms to drive out local firms before increasing prices, similar to predatory dumping. However, there is also growing awareness that it may be possible to address these issues within a procurement chapter, to the mutual satisfaction of all Parties involved. Furthermore, most developing countries are unlikely to gain a significant share of the government procurement market in the developed country partner’s market. Many developing countries’ competitive advantage continues to lie in the provision of labour intensive services. However, as emerging economies increasingly diversify, their exporting interests grow more varied. Developing countries can compete in the supply of goods, for example, office furniture and equipment, textile products required in hospitals, shoes, tyres and other rubber products required by defence and other public organisations, but the lack of information on tender invitations and of the expertise required in filing the tenders can prevent producers from developing countries from accessing this market.92 On the other hand, as tender information is increasingly published in central data bases free of charge on the internet, and where as in the EU the information is published in several languages, access becomes easier for smaller companies, and suppliers from developing countries are increasingly active in the EU procurement market. 90 Stiglitz and Charlton, 2005 91 Stiglitz, 2004 92 Rege, 2001


The use of public procurement to achieve social outcomes is widespread among both developed and developing countries but detailed information about how it operates is often sketchy. The rational for using public procurement for achieving social objectives is also clear in the European Commission communication on Public Procurement. The Communication states that ‘the best value for money objective in public procurement does not exclude taking environmental, social and consumer protection considerations into account”. The Commission goes on to argue that: ‘Contracting authorities and entities can therefore be called upon to implement the various aspects of social policy in awarding contracts, public purchases in practice constituting a significant means of influencing the behaviour of economic operators’ (Commission of the European Communities, 1998, p.26).93 And further notes that: ‘it is possible for public administrations to lay down as a condition of execution of public contracts, compliance with obligations of a social character, aimed for example at promoting the employment of women or encouraging the protection of certain disadvantaged groups’ (Commission of the European Communities, 1998, p.28) Ideally, there would be a robust evidence base to substantiate the claims made regarding the potential negative and positive impacts associated with government procurement reform in developing countries. Unfortunately, with the notable exception of the study published in 2004 by the European Commission demonstrating significant potential for cost savings (some 30%; see above), to date, there is not enough solid evidence on the effect of liberalizing government procurement markets.94 This being said, there is a widely held view that opaque procurement practices are a significant source corruption, and a key obstacle to a sustainable management of public finances. Liberalisation of government procurement remains a complex issue, and a move towards a rule based agreement may be perceived by some stakeholders as a potential weakening of domestic policy autonomy. However, as an increasing number of developing countries are engaging in public procurement reform, there is likely to be an increasing opportunity to test the validity of these arguments. 6.4 SIA Findings for Public Procurement Mercosur

The coverage of an agreement of government procurement could range from an agreement on greater transparency in government contracting with the private sector to formal agreement on national treatment of foreign firms. In the context of the EU - Mercosur negotiations, given the sensitivity and importance of government procurement for Mercosur industrial policy, it is assumed that a realistic liberalisation scenario would focus mainly on improving transparency in relation to the extent of national treatment and non-discrimination in government procurement and public works concessions.

93 Quoted in Chinnock and Collinson (1999) 94 Evenett and Hoekman (2005:3) argue that ‘a convincing, evidence-based case for the incorporation of further binding constraints in the WTO has not been made.’


positive and negative impacts likely to be experienced according to context (may be lesser or greater as above) impact has been evaluated as non-significant compared with the base situation


7. CROSS CUTTING ISSUES 7.1 Rural Livelihoods and Gender95 Introduction The Phase 1 Trade SIA for Agriculture found that the economic impact of the EC-Mercosur trade liberalisation scenario was positive in Mercosur. At the same time, it was found that the social impacts were mixed, and in some instances potentially significant social impacts in the rural sector were identified.(Table 11 above). As a result, the potential impact of trade liberalisation on rural livelihoods (and gender), was identified as an issue for detailed assessment in Phase 2. Stakeholder consultations confirmed in desirability of a more detailed assessment of these issues in Phase 2. The case study for biofuels that was undertaken as part of the Agriculture SIA highlighted the potential adverse social impacts of an expansion in biofuels production that resulted from EU-Mercosur trade liberalisation. The Phase 2 Inception Report suggested that cross-linking indirect pressures could arise from reallocation of land resources between crop production, cattle grazing and forested areas once increased demand of agricultural products and biofuels in particular, occurs as a result of trade liberalization. The underlying trend towards agricultural expansion, including biofuels since the 1980s has been based on the development of large-scale sugarcane plantations due to their comparative efficiency and competitiveness in comparison to small scale production.96 According to some commentators,97 this expansion has had negative consequences for deforestation, biodiversity loss, land use conversion and dispossession of smallholders’ land; all these with severe consequences for rising poverty. Further expansion attributable to EU Mercosur trade liberalisation could intensify the trends in the absence of effective policies to combat these effects. Production of cattle and sugarcane is predominately on large estates in Brazil98 Areas of cane expansion with greater future potential are those that combine three conditions: quality of the soil, pluviometric precipitation and logistics (particularly, infrastructure to deliver the production of ethanol to consumer centres or to harbours for export). Currently, those areas are located in the Brazilian ‘Triangulo Mineiro’ (Minas Gerais State), northwest of Sao Paulo State, Mato Grosso do Sur State, Goias State and the north of Espirito Santo State99. In other areas of the country, expansion would require big investments in irrigation which eventually could be made due to the land lower cost. Most expansion on existing sugarcane areas is taking place on degraded and pasture lands100.

95 This section is based on a report prepared by Dr Leonith Hinojosa, University of Manchester 96 Johnson and Rosillo-Calle 2007. 97 See, for instance, Hazell and Pachauri 2006, Doornbosch and Steenblik 2007. 98 Johnson and Rosillo-Calle, 2007. 99 Goldenberg et.al. 2008. 100 For instance, Lora et.al. 2006 (quoted in Goldenberg et.al. 2008) reports that the expansion of sugarcane production has replaced pasturelands and small farms of varied crops. Plantations for sugar and ethanol production have expanded mainly into areas once used for cattle grazing, as cattle are mainly confined to cattle ranching and in a small scale to new pastureland (which may include cleared rainforest).


(represented by plain and dashed coloured arrows) mediate their impact on livelihood strategies. Whilst red arrows represent a negative effect, green arrows represent a positive effect. As already shown in the Agriculture SIA (see Table 11 above), these effects are expected to be mixed. It has also been shown that the effects of trade on particular groups of rural population are differentiated (for instance women103). That makes the point that special attention has to be pay to heterogeneity among rural population or even the poor. The likelihood that trade will impact positively on people’s livelihoods (represented in the diagram by green plain arrows) depends on the extent to which general and complementary policy (macroeconomic, social, energy, sectoral and other ad hoc policies) minimise the risks of adverse effects on the poor and the most vulnerable groups to trade shocks.104 In general terms, if trade liberalization facilitates sector diversification, the expected effect of trade policies on livelihood strategies are assumed to be positive due to new job opportunities, which facilitate the development of off-farm strategies. Where trade facilitates agriculture intensification, positive effects are expected if job opportunities are created (for instance in new large plantations) or, alternatively, if the need for intensification induces small producers to associate. Both possibilities increase the chances for small producers to develop farm and off-farm strategies in the rural area. However, a negative effect due to dispossession of land and other natural assets is also expected105. In that case, landlessness forces a faster process of diversification and labor market development. The magnitude and time period of the ‘adjustment costs’ associated with this process depend on the conditions in which the new landless are integrated into the labor market of the rest of the economic sectors106. Rural livelihoods in Mercosur countries Poverty and particularly rural poverty are still widespread in all Mercosur countries with the exception of Uruguay (see Table 53). According to some estimates, the incidence of rural poverty is particularly high in Brazil with 41 per cent of rural population living under the poverty line. Within groups of rural population the most vulnerable groups are women, young people and ethnic minorities such as Afro-descendants in Brazil107 and indigenous people in Paraguay.

103 See, for instance, the material available in APRODEV’s website about the relationships between trade and gender. 104 McCulloch and others (2001), who initially studied the linkages between trade liberalization and poverty, support this argument based on an analysis of the effects of trade on enterprises, distribution and government. 105 The process of “accumulation by dispossession” has been described by Harvey (2003) as a phenomenon that accompanies the restructuration of social relations and property in neoliberal contexts. Although Harvey imprints a class-interpretation to that term, in this paper “dispossession” is adopted as a term that describes changes in property within situations where market practices involve tension and perhaps conflict. 106 Given that currently no Mercosur country has social protection programmes to cover unemployment, the landless have no other option than to develop any kind of off-farm livelihood strategies. 107 The International Fund for Agricultural Development (IFAD) reports that, in poor areas of Brazil, households headed by women account for 27 per cent of the rural poor and almost 40 per cent of all children between the ages of 10 and 14 work to supplement family incomes (http://www ruralpovertyportal.org/english/regions/americas/bra/index htm).


Table 53: Rural population, land availability and poverty in Mercosur countries Country Rural

Pop 2006 (%)

Rural Pop growth (annual %)

Agricultural land (% of land area 2003)

Arable land (% of land area 2003)

Agricultural land (Ha. per person rural pop. 2003)

Arable land (Ha. per person rural pop. 2003)

Poverty gap at $2 a day (PPP 2003)

PHR at rural poverty line*

Argentina 9.7 -1.6 47.0 10.2 33.0 7.16 8.4 n.a. Brazil 15.3 -1.0 31.2 7.0 8.6 1.91 8.3 41.0 Paraguay 40.9 1.6 62.5 7.7 10.2 1.25 13.8 n.a. Uruguay 7.9 -2.6 85.4 7.8 54.7 5.01 1.6 n.a. Venezuela 6.3 -0.3 24.5 2.9 11.2 1.35 19.2 n.a. Notes: (*) Poverty headcount ratio at rural poverty line (% of rural pop. 2003). Source: World Bank, WDI (2007). In many ways the poor in rural areas are more disadvantaged than the poor from urban areas due to insufficient infrastructure, difficult access to public services and limited access to technology. This reduces opportunities for the rural population to supplement farming incomes through salaried labour and it also makes it more difficult to develop small-scale non-farm and off-farm activities. Given these constraints, much of the discussion about the likely effects of large scale investments and trade-led development strategies is centred on the competition that trade liberalization would produce for land – and water – between large scale investments (and/or companies) to small farmers and/or community groups (whether indigenous people or peasant communities). As shown in Table 53, even though countries such as Argentina, Paraguay and Uruguay are well endowed with agricultural land, the proportion of arable land (usable for cropping purposes) ranges between 2.9 and 10.2 per cent of total land extension. With that amount of land, the countries most endowed with agricultural and arable land are Argentina and Uruguay, and Brazil is the less advantaged. That implies that, if the rural population is mostly dedicated to agricultural activities, a rural household would have between 40 to 60 hectares of agricultural land in countries such as Brazil, Paraguay and Venezuela, 165 hectares in Argentina and 273 hectares in Uruguay. Considering arable land only, the same households would have 6 to 10 hectares in Paraguay, Venezuela and Brazil, and 25 and 36 hectares in Uruguay and Argentina108. Averages, however, do not reveal distribution and, even though these numbers suggest relative land availability, in practice it is also fair to say that land, while available – and even abundant – for some, is scarce to others. Over time, land concentration has developed in a context where increased market liberalization has produced incentives for scale economies. Table 54 illustrates this suggestion for the Brazilian case. In Brazil, about 95% of livestock farmers are land owners. Fewer than 10% of farms hold two thirds of the herd.109 That implies that most of the agricultural land is under private property of large farmers.

108 Estimations consider an average of 5 persons per rural household. 109 Beef production is developed in farms over 100 ha, which involve 82% of livestock. Milk production, by contrast, has a large number of livestock in farms of less than 50 ha, which contribute 39% of national production. (FAO, Brazil - country profile).


Table 54: Brazil: land tenure in cattle enterprises

Percentage of the herd Farm size Percentage of farms

27.19 > 1000 ha 0 94

38.77 100-1000 ha 9 35

24.0 10-100 ha 34.06

8.25 < 10 ha 43.96

Source: FAO, Brazil, country profile.110 In Paraguay, concentration has been favourable to foreign investments (mainly Brazilian and Argentinean) which developed extensive cattle ranges and soy plantations in The Chaco region.111 In Uruguay, farms over 10 hectares represent 99.6 percent of the total area and many smaller farms which proved to be economically non-profitable have been abandoned in the last three decades. Argentina is a land-rich country with average size of 518 hectares, ranging between 74 hectares in Misiones and 21,012 in Santa Cruz. A few holdings exceed a million hectares in Patagonia or the dry west or 200,000 ha in the humid Pampas or Campos or Chaco. Only 20% of this area is cultivated.112 In those conditions, EU-Mercosur trade liberalisation that results in a growth in cattle grazing and biofuels feedstock production, would imply additional pressure towards land concentration. The potential impacts on the livelihoods of the poor are discussed in the following sections. Part of the concern about agricultural expansion through large agriculture investments is related to its potential effects on indigenous people. Forest clearing and further expansion of the agricultural frontier into the Brazilian Amazon or the Gran Chaco region (a territory involving Paraguay, Uruguay and Argentina) reduces the natural resources – land and biodiversity – on which the livelihoods of indigenous people depend. Past increases in production are reported to have led to dispossession of the land possessed by small landholders or indigenous groups113. Unless this is prevented by effective counterbalancing policies, the EU-Mercosur agreement would add to existing pressures. The EC certification scheme for biofuels imports aims to address this and other related issues. As an illustration of potential conflicts between biofuels feedstock fields and indigenous’ territories, Table 55 shows the magnitude of indigenous population by regions in Brazil, the economic sectors which concentrate most of the economically active population, the already registered land conflicts in each region and a forecast for sugarcane fields expansion. The following points are noteworthy: firstly, the critical region where the proportion of indigenous people in rural area is higher, there have been land conflicts and the prospects for biofuels feedstock are relatively high is the Center West. In other regions the potential overlap problem seems to be less critical. Secondly, the effects of restrictive regulation for agricultural frontier expansion can be different in the short than in the long run. Given the relative low cattle density in the Brazilian pasturelands (100 head/Km2 compared to higher averages (120-140) in developed countries), it is possible that, in the short run, range-cattle intensification may not overstress pressure on indigenous’ lands. In the long run, however, a 110 Data at 2001 www.fao.org/ag/AGP/AGPC/doc/Counprof/Brazil.htm#5.%20THE%20PASTURE 111 According to the 1981 census, 1 percent of the nation's more than 273,000 farms covered 79 percent of the nation's farmland in use. These large farms had an average landholding of almost 7,300 hectares. Dannin and Meditz (ed) (1988). 112 Data at 2004. http://www fao.org/ag/AGP/AGPC/doc/Counprof/Argentina/argentina.htm 113 Advocacy groups have largely claimed that such a dispossession process is conducted through legal and illegal mechanisms (see, for instance, IPS’ articles covering land conflicts - http://www.ips.org)


combined effect of substitution between cattle ranges by sugarcane fields with the relocation of high-yield cattle ranges would necessarily imply a inevitable displacement – and, potentially, elimination – of lower-yield small-scale cattle grazing and agriculture. Thirdly, land conflicts originated by processes of dispossession – that is, by accumulation of large farmers to the expenses of small or indigenous farmers – create an unsuitable scenario for new investments and political unrest. The trade agreement would add to these pressures unless they are countered by effective national policies. Table 55: Expansion of sugarcane in indigenous territories in Brazil

ons Indigenous Indigenous Rural tion

Population economically Sugarcane Land t-

Regi

Population (2000) a/

population in rural area b/

populac/

active in main economic activities in the region d/

expansion forecast

conflicrelated deaths e/

Brazil 734127 350829 31845211 Agricult. 17.9% Re.Veh.

ct. 13.3

n.r. 777 f/ (0.4%) (1.1%) (18.8%) W&R trade-

16.6% Manufa

North 213443 167140 3886339 Re.Veh.

n.r. 584 (1.7%) (4.3%) (30.1%)

Agricult. 17.9% W&R trade-16.6%

North- 170389 64661 14766286 . 30.4% Re.Veh.

n.r. 105 East (0.4%)

(0.4%) (30.9%)

AgricultW&R trade-15.0%

South- 61189 20544 6863217 trade-Re.Veh.

ct. 15.6%

Sao Paulo

de

n.r. East

1(0.2%) (0.3%) (9.5%)

W&R 17.5% ManufaAgric. 9.6%

35% MinasGerais 18% Rio Janeiro 1%

South 84747 32500 4785617 Agric. 19.7% %

e.Veh.

na n.r. (0.3%) (0.7%) (19.1%) Manufact. 17.3

W&R trade-R16.2%

Para4%

Center- 104360 65985 1543752 trade-Re.Veh.

ct. 15.1%

Goias 10%

do

88 West (0.9%) (4.3%) (13.3%)

W&R 17.9% ManufaAgric. 9.9%

Mato GrossSul 9%

Source: Population is census data. Other columns a oldenberg et. national or

ths in the Legal Brazilian Amazon, 1985–1999

flicts registered.

rocesses of conversion from small-scale to large-scale agriculture (both for soybean and

re based on G al. 2008.Notes: Numbers in parentheses are percentages of each category’s correspondingregional entire population: a/ percentage of entire population; b/ percentage of rural population; c/ percentage of entire population. d/ Percentage of population economically active (>10 years old) per economic sector. Agric.: Agriculture and hunting; W&R trade-Re.Veh.: Wholesale and retail trade, repair of motor vehicles; Manufact.: Manufacturing. e/ Land conflict-related deaf/ Amazon region only n.r.: no plantations/con Pcattle production) have led to land concentration and displacement of small farmers who either have migrated into urban areas or moved into forest areas.114 But, conflicts have also been produced between small farmers (the colonizers) and indigenous communities. In some cases conflicts have implied violent expulsion of squatters in the process of land appropriation

114 Myers (1993); Kaimowithz and Smith (2001).


and consolidation115. When displacement has led to urbanization, the new “urban” political groups have put pressure (via large-scale occupation) on governments to expand urban settlements in forest areas exacerbating deforestation rates.116 The SIA for the manufacturing sector (Section 4) suggests that the trade agreement will have a negative effect on urban employment in the short term with potential for a larger increase in the longer term. In the short term, the displacement of small farmers would directly affect indigenous communites in forest areas, while in the longer term the effect would occur indirectly through further urban expansion. The trade agreement can therefore be expected to exacerbate existing pressures unless these are countered by effective national policies. In addition, developmental projects of infrastructure have had an unexpected effect on land

he evidence provided above identifies how the more vulnerable groups in rural areas of

ural livelihoods strategies

eference has already been made to the likelihood of both positive and negative social

iversified livelihoods

distribution and appropriation. Conflicts over land in the Amazon region have increased in those areas where agricultural land has been made accessible by development efforts, particularly road construction. New immigrants, small farmers and large ranchers fight for increasing access to those lands which, if unattractive before, now that are closer to markets are worth to fight for. TMercosur are being affected by the ongoing process of agricultural development. In so far as EC_Mercosur trade liberalisation accelerated this process of agricultural expansion, it can be expected to amplify these adverse social impacts on vulnerable groups in the rural areas unless these trends are countered by effective national policies. An assessment of the potential effects of the EU-Mercosur TA on livelihoods requires looking at the possible effects on other non-agricultural strategies on which rural households rely. This point is addressed in the following section. R Rimpacts of trade liberalisation on rural poverty and livelihood117. This section aims to provide insights on various factors that explain such mixed effects. The argument presented in this section hinges around a discussion of: the full composition of households’ livelihood strategies, the spatial (rural-urban) linkages involved in those strategies and the implications in terms of women’s welfare and gender relationships. D

tudies on rural livelihoods in Latin America118 show that individuals and households from

hat being the case, it is noteworthy that the composition of livelihood strategies (that is, the

Srural areas develop diversified strategies that combine farm, non-farm and off-farm activities (among them: agriculture, cattle grazing, food processing, hand crafting, petty commerce, wage labor in agriculture as well as in temporary or even permanent urban employment). Tweight of each one of the economic activities on the households output and income, as well as on individuals’ use of time) changes over time. In the recent history of Mercosur countries,

115 Schmink and Wood (1992). 116 Simmons and others (2003). 117 A number of the comments on the Phase 1 Overall and sectoral SIA studies during the consultation process point out to an apparent duality – and perhaps ambiguity – of the conclusions reached in all reports with regards to a ‘double sided view of beneficial impact on rural poverty and adverse impacts of trade liberalization’see, for instance, FDCL’s comments. 118 See, for instance, Berdegue and others (2001); Bebbington (2004); Hinojosa (2006).


part of that change has followed general trends of migration linked to urbanization and, in cases such as Brazil and Argentina, industrialization processes which have induced forms of “natural” and “voluntary” change. In recent decades, farm mechanization, technological change and diversification in production have contributed to loss of rural employment, pushed people to migration and produced “unwanted” and “tense” change.. Diversified livelihoods in the rural area mean that many of the economic units (either formal

there a rural-urban divide?

or informal enterprises) are formed under initiative and labor participation of the household members. In the Brazil case, for example, a hundred per cent of agricultural units (estabelecimentos) reported kinship links between “employer” (the producer) and “employees” (labourers); only 13.9 per cent of hired labor had not kinship relationships with the head of the economic unit (5.9 per cent in the South East and 20.6 in the Center West, both regions important in terms of biofuels feedstock production).119 Whilst the productive potential of family network has been demonstrated beneficial for developing entrepreneurship at small and medium scale – particularly in the informal sector – studies also show that informality and kinship relationships have been used to reproduce mechanisms of labor exploitation – particularly damaging for women and children. Is

iversified livelihoods at the household level produce dynamic effects on urbanization and

ovements between rural and urban spaces are not in one direction only. In the same way as

is within this two-directions (rural-urban and urban-rural) scenario that alternative

these arguments about the strength of diversified livelihood strategies and the narrow

Ddeforestation, but (in time) they also produce incentives for specialization and more productive use of available assets at the individual’s level. This implies that the rural-urban divide becomes a narrow line in regions where both agriculture and non-agriculture activities are profitable whether in terms of business or the households’ food security. Mthe rural population moves temporarily into urban areas looking for wage labour, a substantial number of urban dwellers are employed as wage labor in the rural areas. In the Brazilian Amazon, for example, despite the rapid pace of urbanization, urban dwellers are employed as wage labor in the rural areas tied to agro-extractive production systems. Itunderstandings of resource allocation and land conflicts may be needed in order to foresee implications of trade liberalisation policies which provide incentives for expanding the agricultural frontier. The dynamics produced in the urban-rural space and the implications it has for vulnerable population (both from rural and urban areas – increasingly the same households spread in both areas) requires a balanced view of the costs and benefits of further development of the natural resource-based industries. In the same vein, the trade-offs involved between short-run effects and long-run impacts need to be interpreted in a framework that includes the various dimensions in which “rural” households develop their livelihood strategies. Ifurban-rural divide are accepted, the likely impacts of a trade agreement ought to be assessed in terms of both the agricultural and non-agricultural strategies that households develop. As discussed above, the trade agreement is expected to increase existing incentives for conversion from small scale to large scale agriculture, with consequent effects on rural livelihoods. The direct effects regard the opportunities open or constraints imposed to rural households in their access to natural resources (mainly land and water) on which agricultural

119 Estimations based on census data (at 2001).


livelihood strategies rely. In parallel, direct effects can also be expected on employment in agro-industry. The indirect effects regard the induced effects on livelihood strategies change by facilitating or constraining access to other forms of assets (human, financial and physical assets) which enable the development of new forms of livelihood strategies. The rapid growth in non-food agriculture output has raised concern about the likely negative

able 57: Land availability land food security in Mercosur countries

Country Surface Surface

els

Food s

f

Percentage of

effects on food prices which affect in particular the poor who spend a large share of their income on food.120 In regard to suspected restrictions imposed by land availability, food security should not be a problem in Mercosur countries, with the exception of Venezuela (see Table 57). However, despite the exceeding availability of land for food production and the high percentage of food exports, the percentage of undernourished population (notably in Venezuela and Paraguay, and to a lesser extent in Brazil) is also high. Furthermore, in the period between 1990-92 and 2001-03 countries such as Venezuela, Argentina and Paraguay indicators of malnutrition got worse with reference to established World Food Summit goals. This fact highlights the need to consider the potential impact on food security of an export-oriented agricultural policy, as illustrated in the biofuels sector. The trade agreement will tend to reinforce this export orientation, and hence amplify the need for effective domestic policies to counter malnutrition. T

required for food

required for biofua/

export(% oexports) (2004)

undernourished population

Argentina 28 < 5 8 >40 Brazil 65 11 0 0 20 - 4 5 - 1Paraguay 42 3 >40 10 - 20 Uruguay 51 12 >40 < 5 Venezuela 20 209 24 0 - 20 10 -

/ Estimates based on each country’s expected demand at 2020 (improvements in biofuel crops

rom an agricultural view of rural livelihoods, one of the main causes of poverty in rural

n alternative scenario of land and/or product agglomeration that has facilitated economies of

aincluded). Statistics do not include additional land surface needed to satisfy foreign demand. Sources: Based on Pistonesi et.al. 2008; ECLAC-GTZ (2008) FBrazil is the extreme inequality of land tenure. Where commercial agriculture expands and further concentration occurs, small landholders keep developing subsistence farming 121 and push further into the forest in search of new land to settle, they increasingly work part time in order to supplement their livelihoods or move to the city in search of permanent employment.122 However, the transition from agriculture to more profitable activities is limited by their reduced access to financial capital and low access to formal education and non-agricultural skills training, combined with a limited access to basic infrastructure. This is an existing problem related to internal policies, which will become more pressing as a result of the additional incentives for export production created by the EU-Mercosur FTA. Ascale and produced mechanisms of equitable growth has emphasized the development of cooperatives, producer associations and the like. The “via cooperative” in Latin America is a

120 UN-Energy 2007 – Sustainable bioenergy: A framework for decision makers. United Nations. 121 Foweraker, 1981;Wood, 1983. 122 Walker and Homma, 1996


longstanding experience.123,124 Not all cooperatives, however, have been always successful at achieving competitiveness and promoting equitable development within their members. Weak management skills, conflict of interests and insufficient government or external support may be at the root of some problems. Nonetheless, further development of cooperatives and related approaches may make an important contribution to countering the potentially adverse effects a more open trade environment. Expected impact on welfare of women and gender relationships According to WIDE (a women’s-rights-based and social-justice-oriented network) ‘gender is surprisingly invisible in mainstream discussions on economic policy on trade and on development’125. Main concerns about the effects of trade liberalization in agriculture on women’s welfare and gender relationships are related to the likely exacerbation of inequalities and deeper ‘feminisation of poverty’. Reasons why it would happen are underpinned by men and women (as well as male- and female-headed households)126 differentiated access to and control of land and other productive assets, their level of participation in decision-making and socio-economic activities, unequal employment opportunities and working conditions, and differentiated effects in terms of food security127. The main issues raised in a scenario of agricultural expansion are related to its impact on women’s access to and control of capital assets, and the conditions in which they participate in agricultural markets. Those issues are summarized in Table 58. Table 58: Gender Vulnerabilities Category Gender disparities Land ownership Land ownership is traditionally skewed towards men (e.g. in Brazil only

11% of land is owned by women) Access to financial capital

Restricted access to credit by women due to the impossibility of using land as collateral

Access and protection of human capital

Women’s specialized knowledge of their natural environment makes them more vulnerable to potential biodiversity loss when monocultures are expanded. This also produces narrower future options of economic diversification

Human capital: time and effort management

Women in rural areas dedicate considerable part of their time to water and firewood collection for domestic use.

Access to and self-sufficiency of physical capital

Women have lower access to pesticides and external inputs, consequently, are more vulnerable to market shocks (fluctuation in the price of cash crops and external inputs)

Access to employment

Women’s levels of literacy and school enrolment are lower than men’s.

Labor income The gender gap in earnings is particularly high in informal employment. Also, unpaid work (for women and children) has been registered in cases of piece-rate employment arrangements in sugarcane plantations.

Working Casual or temporary jobs to which women have more access usually

123In the bioethanol industry there are established sugarcane cooperatives as well as other agricultural cooperatives that produce on sugarcane renewal areas http://www.acdivoca.org 124 http://www.tierramerica.info 125 WIDE – Women in Development (2007, p. 5). 126 Households headed by women account for 27 per cent of the rural poor 127 See, for instance, the material produced by the UN agency Women Watch (http://www.un.org/womenwatch).


conditions include few – if any – social benefits. Access to decent work is hard to achieve (in Latin America, 40 percent of waged agricultural workers under informal labour arrangements are women).

Food security Female-headed households are more vulnerable to food price increases. Source: Adapted from Rossie and Lambrou 2008 and the references therein. All of these issues indicate that women are particularly vulnerable to the changes in agricultural production systems that will be stimulated by the free trade area. Effective domestic policies will be needed to maximise opportunities for women and counter potentially adverse effects. Conclusion The purpose of this section has been to develop a more detailed assessment of the potential social impacts of EU_Mercosur trade liberalisation on rural livelihoods, poverty and gender inequality that were identified in the Agriculture SIA (see Table 11 above). Additional evidence has been presented that EU-Mercosur trade liberalisation will tend to reinforce existing trends and processes of change. In the long term, the transition from small scale to large scale agriculture and to other high wage activities can have significantly beneficial social effects, but a number of adverse transitional effects have been observed which would be increased incrementally by the trade agreement unless they are effectively countered. The significance of these incremental effects of trade liberalisation on rural livelihoods, poverty and gender inequality is related to the SIA methodolgy’s standard criteria of significance ( see Section 1.2). Where the existing level of stress is close to a critical threshold level, any further deterioration is likely to be judged as significant and therefore requiring careful consideration on the part of trade negotiators and domestic ploicy-makers in Mercosur countries. 7.2 Foreign Investment and Growth: Automobile Sector Introduction It is widely recognised that the theoretical analysis of the potential economic gains from trade liberalisation focuses mainly on the static welfare gains that result from the reallocation of resources on the basis of competitive advantage. However, it is important to give consideration to the potential long term dynamic gains that may accrue from trade liberalisation and market opening. The most significant of these gains will be linked to increased access to foreign direct investment and technological diffusion. This is particularly important in the manufacturing sector. The Phase 1 Automobile SIA provides a detailed case study of the dynamic effects of trade liberalisation in terms of the cross linkages between trade liberalisation, foreign investment, technological diffusion and productivity growth. Trade Liberalisation and Foreign Direct Investment Theory Foreign direct investment is considered by most countries to be an important component of their development strategy and trade liberalisation policy is accordingly intended to simulate the inward flow of foreign investment. Investment is the single most important determinant of economic growth and foreign direct investment inflows can make a significant addition to the overall level of investment in the economy.


An important motivation for this interest is the possible existence of FDI spillovers, a concept that embodies the fact that MNEs (multinational enterprises) own the technology which can be transmitted to domestic firms and thereby raise their productivity level.128 Foreign direct investment is generally considered as the main channel of international technology diffusion. The reason is that FDI creates many interactions between foreign and domestic firms that can be opportunities for technology to be diffused.129 Gorg and Greenaway (2004) identify several channels, associated with technology diffusion, through which FDI impacts on productivity growth and per capita income growth rates in a host country:

• Imitation – The theory of the multinational firm proposes that multinational corporations have a technological advantage over local firms that outweighs the cost of doing business in external markets. The inflow of new knowledge may benefit domestic firms through imitation and learning of technology or managerial and organizational practice.130 One mechanism commonly alluded to in the literature is reverse engineering.

• Skill acquisition – Adoption of new technology can occur through the acquisition of human capital. MNEs invest in training and it is impossible to lock in such resources completely. The movement of labour from multinationals firms to other existing or new firms can generate productivity improvements through two mechanisms: through a direct spillover to complementary workers and through knowledge carried by workers who move to another firm. Empirical studies show that training of local employees in MNC affiliates might contribute to a positive spillover effect if the level of turnover is high.131 Nevertheless, it is important to stress a possible negative impact arising through this channel, as MNEs may attract the best workers from domestic firms by offering higher wages.132

• Competition – Entry of multinational firms puts pressure on local companies to use existing technology more efficiently. This facilitates a reduction in X- inefficiency yielding productivity gains. In addition, competition may increase the speed of adoption of new technology.

• Exports – An indirect source of productivity gain might be through exports. Exporting generally involves fixed cost to establish distribution networks, create transport infrastructure, and learn about consumers’ tastes in overseas markets. Multinationals firms generally come already armed with such information and exploit it to export form the new host country. Trough collaboration or imitation domestic firms can learn how to penetrate export markets.

Various interactions that facilitate technology diffusion can occur at several levels within an economy. The literature usually distinguishes between backward linkages (with domestic suppliers), forward linkages (with customer firms and firms down the production chain) and horizontal linkages (with competing firms). As noted by Nordas et. al (2006) with imperfect competition and scale economies, the impact on domestic firms of the entry of foreign companies can be twofold. On the one hand, domestic firms can expect productivity gains through technological spillovers. On the other hand, the increased competition from foreign firms diminishes the production of domestic firms and increase their average costs (market- 128 Crespo and Fountoura, 2005 129 Nordas, 2006 130 Blomström 1986 131 Djankov and Hoeckman, 2000 132 Sinani and Meyer, 2000


stealing effect). As a consequence, the net impact of FDI on productivity can be either positive or negative. Thus, whether spillovers from multinationals raise host-country welfare is, ultimately, an empirical question. The way in which FDI affects productivity and growth is likely to depend on the economic and technological conditions in the host country.133 The level, the existence, sign and magnitude of FDI spillovers to domestic firms depend on a multiplicity of factors related to the characteristics of the MNEs and of foreign investment, as well as on the characteristics of the host countries, sectors and firms (Crespo and Fountoura, 2005). In particular, it appears that developing countries may need to reach a threshold level of development, in education and infrastructure, before they are able to capture fully the benefits associated with FDI (Hansen and Rand 2006). Borensztein et al. (1998) find that host economies have needed an educational capacity to absorb the positive technological spillover effects. Balasubramanyam et al. (1996) find that openness to trade is essential for the growth effects of foreign investment. Hermes and Lensink (2003) and Alfaro et al. (2004) find that countries with better financial systems and financial market regulations can exploit FDI more efficiently and achieve a higher growth rate. Evidence Out of six studies that were review by Hansen and Rand (2006), five have found that FDI, on average, has an impact on growth which led the authors to conclude that, at macro level, there is indeed a strong causal relationship between FDI and growth. Medvedev (2006) tests for a relationship between preferential liberalization and net FDI inflows by country and finds that PTA membership is associated with a positive change in net FDI inflows. The results show that the FDI benefits of preferential liberalization increase with the size of PTA partners and their proximity to the host country. There is a threshold (membership) and a market size component to the PTA-FDI relationship, although the latter seems more important. The study also finds that the relationship is mainly driven by the developing countries in the sample, which implies that the effect is due mostly to North-South PTAs. Finally, the link between preferential liberalization and FDI is strongest in the late 1990s and early 2000s—a period when most “deep integration” agreements have been signed. Empirical evidence at firm level that analyses the spillover effect of MNC in domestic firms productivity gives a more mixed picture. Gorg and Greeenaway (2004) review over 40 studies of horizontal productivity spillovers in manufacturing industries in developing, developed and transition economies. Of those, 22 report unambiguously positive and statistically significant horizontal spillovers effects, but the majority of these studies use cross-sectional data, which may lead to biased results. Selection bias may arise as sectors where FDI is important are generally those where productivity is the highest and productivity growth strong. Multinationals will tend to invest in sectors with the most promising growth rate and will pick the best companies in the host country which are likely to be the most productive. Cross-sectional data would show a positive and statistically significant relationship between the level of foreign investment and productivity consistent with spillovers, even though foreign investment did not cause a high level of productivity but rather was attracted by it. Gorg and Greenaway find that only eight studies use panel data and solve for the selectivity bias, but in all cases, find positive evidence of spillover. The few studies that have looked at the potential for vertical (inter-industry) spillover find evidence that vertical spillover may be a more important channel for knowledge externalities than horizontal spillover.134 133 Busse and Groizard, 2006 134 Javorcik, 2004


The micro level evidence also confirms that absorptive capacity of domestic firms is an important determinant of whether domestic firms benefit from FDI in the same sector. Other studies135 support the hypothesis that only firms with some minimum level of absorptive capacity benefit from productivity spillover. Finally, there is also evidence that geographical proximity matters i.e. domestic firms located near multinationals may be more likely to benefit from multinationals than other firms. The most robust empirical result relates to the importance of the absorptive capacity and geographical proximity of domestic firms, which appears to be a fundamental precondition for enabling them to capture these indirect benefits from FDI.136 Trade Liberalisation, Foreign Investment and the Automobile Sector Globalisation of Production and Ownership In order to provide a robust and credible analysis of the potential dynamic impacts of trade liberalisation in the automobile sector, it is necessary to understand the underlying drivers of change within the automobile industry as a whole. A distinguishing feature of the automobile sector is the high degree of global integration in production activities. The value added chain is unbundled at the global level, with different stages in the production chain located in different countries.137 With the lowering of trade barriers and advances in globalisation, production location decisions are increasingly determined by the international competitiveness of production in a particular location, rather than as was the case historically, by the size and growth potential of the domestic market. As a result of this vertical disintegration of production across borders, international competitiveness is determined at the level of different tasks within the automobile sector, rather than at the level of the industry.138 The pursuit of economies of scale has increased in importance for global vehicle companies as vehicle models are replaced more frequently and have become more complex and sophisticated. Economies of scale in assembly have been largely achieved, even though inefficient low-volume assembly continued in many emerging markets in the late 1990s. However, the search for economies of scale is still important in the areas of components production and vehicle design. For some components, economic production scales reach millions of units per year. As passenger vehicles become more complex, components such as engines, gearboxes and electronic systems become more sophisticated and complicated to produce. With trade liberalization in developing countries and the introduction of duty drawback schemes, the sourcing of more sophisticated components, particularly electronic products, for passenger vehicles assembled in developing countries has switched from domestic production to imports. For some items, production may be concentrated in just a few locations around the world. The pursuit of global design is confronted with the need for local adaptation of vehicles, and differentiation of models according to local income, customer preferences or standards and regulation. Strategies to develop a ‘global’ model have so far failed due to significant differences in the market structure between developed and emerging markets. Corporate strategies in regard to globalization vary depending on the starting point of individual firms, but there seems to be a large measure of convergence toward building vehicles where they are

135 See Girma, 2002 136 Crespo and Fountoura, 2005 137 Dicken, 2006 138 Baldwin, 2006; Grossman and Rossi-Hansberg, 2006


sold and designing vehicles with common platforms while retaining the ability to adapt other characteristics to local conditions.139 There are limitations to the standardization of models across markets; one consequence of this is that it opens up the possibility of certain developing countries becoming global specialists in the production of both vehicles and components. For example, Brazil specializes in the production of so-called “third-world cars.” These cars are specifically designed for markets in developing countries, with regard to both cost and durability. The Fiat Palio was first launched in Brazil, and although much of the design work was carried out in Italy, designers from both Fiat and first-tier component companies in Brazil were involved. If a group of developing countries constitutes a market with distinctive characteristics, and if the tariff and logistical barriers to trade between them can be reduced, then particular countries within the group may become specialists in the production of a certain type of vehicle. The globalisation of automobile production has occurred as part of the strategic decision making processes of the small number of multinationals that dominate the industry. At the beginning of the decade, the largest 20 firms produced more than 95 per cent of the world’s vehicles. At present, some 529 plants located in 45 countries are owned by 27 automakers.140 As for supplier plant location, 2211 plants located in 60 countries are owned by 150 automobile suppliers. With respect to engine production, 168 plants are located in 24 countries and owned by 16 companies. In the 1990s, the globalisation of competition, particularly the reduction and/or elimination of trade barriers and the need to find new emerging markets to compensate for stagnant home markets in the advanced economies encouraged vehicle manufacturers to adopt internationalisation strategies suited to the changing international context. That is, they chose to move beyond the stand-alone plant abroad to more integrated international production. This did not necessarily imply a globalisation strategy or a global automotive market, notwithstanding the production and marketing of so-called “world cars”. Instead, the significant level of joint inputs across plants and plant-level scale economies in the industry as well as government policy incentives pointed to internationalisation occurring either within the framework of regionalisation or in a format referred to as “focused globalisation”.141 The internationalisation strategies of multinational enterprises (MNEs) in the automotive industry prioritised reorganising their value chain so as to increase cost-effectiveness; they adapted their productive structure to the emergence of large trade blocs. These strategic priorities have encouraged the adoption of lean production on the one hand, and emphasised specialisation and defining a regional division of labour on the other. This has often led to de-verticalisation of MNE investments within a country to allow for cross-border specialisation and global sourcing, which only becomes feasible due to the implementation of complementary government policies such as trade liberalisation, de-regulation and other market-oriented reforms.142

139 Sturgeon and Florida, 2000 140 Sturgeon and Florida, 2000 141 Freyssenet and Lung, 2000; Balcet and Enrietti, 2002 142 Doctor, 2003


The EU and Mercosur Automobile Sector European Union The European automotive industry is the largest automotive producing region in the world. The industry comprises nearly 34% of the world’s production of automobiles and approximately 7% of the manufacturing sector in the EU.143 There are six major automobile producers in the EU: Volkswagen, BMW, General Motors Europe, Renault, Fiat and DiamlerChrysler. Within the EU, production of motor vehicles as a share of total manufacturing is dominant in Sweden, Germany, France and Spain. The automotive sector, including the production of both vehicles and components, provided employment for over 2.2 million persons in 2004 and supported an additional 10 million indirect jobs in large companies and SMEs. In total, the industry accounts for abut 7% of total European manufacturing employment. The largest number of people working within the industry is in Germany, followed by France, the UK, Italy and Spain and these five countries accounted for nearly 90% of employment in 2002 in the sector. The automobile industry has a complex value chain and about two thirds of the value added in vehicle production comes from automotive suppliers while the retail and repairs sector comprises 350,000 small and medium sized enterprises with a turnover of 529billion euros and employing about 2.5 million people.144 The automobile sector in Europe invests heavily in R&D and is the largest private investor in R&D in the EU, accounting for around 20% of all European manufacturing R&D. The growing importance of production in the new Member States is evident with an increasing share of total EU production from 4% in 2003 to 8% by 2005. In the new Member States, the industry at the national level is a major contributor to the economy in the States specialising in automotive manufacturing, such as the Czech Republic, Hungary and Poland. The enlargement of the EU has brought about integration of the auto sector in the accession countries, which consists primarily of local operations of trans-national companies, with inward foreign direct investment has playing an important role in the development of the sector in the new MSs A key area of competitive advantage of the new Member States is low wages and high productivity. The automotive industry is characterised by increasing competition on a world-wide scale, prompting all leading European automotive manufacturers to operate in all major regions of the world. Competition in such a diverse market requires high productivity, competitive pricing, product reliability and diversification, as well as technological innovation. Exchange rates play a key role in profit rates in such a global market. The industry has maintained a key international position both in exports, where it has increased in recent years, and in global sales. In 2004, automobile products accounted for about euros 78 billion of extra-EU exports and about euros 32 billion extra-EU imports with a positive trade balance of euros 46 billion. The home market in the EU is large and sophisticated and European brands dominate, giving the automotive industry a competitive “home” advantage within the EU. The German and French brands dominate market share and have expanded between 1998 and 2002, while the Italian and UK market presence declined over the same period. The EU automobile sector has an overall trade surplus with the rest of the world due mainly to its exports to the US and the Central and Eastern European countries. 143 EC, 2007b 144 EC, 2007b


The automotive sector is characterised by a relatively low trade/sales ratio and market-oriented FDI is a dominant feature of the sector. The Mercosur Automobile Sector145 In 2003, Mercosur had the seventh largest vehicle fleet in the world, and the largest among developing countries. In 2004, Mercosur’s combined vehicle production of just less than 2.6 million units was ranked seventh in the world and third highest among developing countries with only China and South Korea producing more). In 2004, it exported just over 900 thousand units, making it the ninth largest exporter of vehicles in the world. The automobile sector in Mercosur is dominated by Brazil and Argentina. Automobiles are produced in Mercosur by subsidiaries of multinational corporations, in association with local investors. There is significant foreign involvement in the Mercosur automobile sector, with the presence of all the main European, American and Japanese vehicle manufacturers as well as many of the most important Tier 1 and 2 automotive parts and components suppliers. Production is mainly for the domestic and Mercosur markets. There are a small number of car manufacturers that do not have production facilities in the region and whose cars are only available through imports; these account for a small share of domestic sales in Brazil and Argentina and are subject to a more restrictive trade regime. Cars produced in Argentina and Brazil are mostly compact, small and medium cars, while models imported from other countries include larger vehicles and SUVs. Historically, the industry has been heavily protected, with few imports during the 1970s and 1980s. Integration of the two auto industries began officially with the signing of the Economic Complementation Agreement in Buenos Aires in 1990. This agreement allowed for tariff-free trade in automotive products between the two countries, subject to trade balancing and quotas. Quotas were also used to balance bilateral trade in units, and assigned to individual firms. Due to a combination of the signing of the Mercosur agreement, the reversal of trade liberalisation for vehicles adopted in Brazil in the early 1990’s and the development of similar auto industry sectoral policies in both Argentina and Brazil, regional trade in the industry increased significantly during this period. The automobile sector was listed as an exception to the customs union that went into effect in 1995 and the initial timetable for free trade in the sector was set for 2000, later delayed to 2006. The first version of the Mercosur Automobile Policy (MAP) was signed by Brazil, Argentina and Uruguay in Florianopolis in December 2000, and then by Paraguay in March 2001. A revised agreement was accepted in Buenos Aires in July 2002, and formally signed on 26 September 2002 in Brasilia. A new transition agreement was signed on 23 June 2006. It is valid for two years, until 31 June 2008. The main changes in the new version of the MAP are with respect to the “flex”, which on Argentina’s request was narrowed from 2.6 to 1.95 (this permitted US$ 195 worth of duty free vehicle imports for each US$ 100 exported to the other country). Brazil implicitly recognised the reserved 30% Argentine local content until a new auto parts sector agreement was signed. Brazil continued to apply a 40% discount off the CET for auto parts. The June 2006 agreement did not finalise a date for the end of the trade balancing arrangements, nor did it finalise provisions related to the auto parts sector. Instead, both sides agreed to evaluate the evolution of bilateral trade in vehicles and auto parts before defining a longer-term policy at the end of the transition period. By the late 1990’s a regional automotive production system was developing in Mercosur, based on a complex division of labour in vehicle and

145 The Final SIA Report for the Automobile Sector included detailed modelling, econometric and case study evidence relating to the impact of trade liberalisation on the automobile sector in Mercosur and EU.


components production between Argentina and Brazil.146 Vehicles and components are flowing within the region in both directions, and there are important two-way flows of vehicles and components from Brazil to all of the Triad (NAFTA, Europe and Japan) economies. The global trends in the automobile sector that were described earlier have implications for the Mercosur automobile sector. Firstly, the increasing integration of the sector in the global value chain, and secondly, globalisation and specialization of production. Inward orientation of Brazilian industry can be illustrated clearly by examining domestic sales which accounted for more than three quarters of domestic output in 2003. Brazil’s automotive industry is specializing in small, low cost vehicles with high fuel economy, which are affordable to consumers with lower purchasing power. Specialization in compact automobiles has allowed the Brazilian economy to gain economies of scale and take advantage of new trade agreements. Furthermore, flexfuel cars, which run on a blend of ethanol and gasoline, are slowly replacing standard automobiles. In early 2006, about 77% of new cars sold had flexfuel engines. Inward orientation of Brazilian automobile industry and specialization in niche production of low-cost emerging market and flexfuel models protect its domestic market vis-à-vis the trade opening in the EU-Mercosur FTA, as Brazil is the biggest producer and consumer of this type of vehicle. The recent upsurge in export performance indicates increasing competitiveness of the sector in the world market but it is too early to predict whether this is a long term structural shift towards more export oriented strategies. The Argentinean automobile industry is strongly dependent on the Brazilian market for exports as well as being protected from surges in imports from Brazil by the Mercosur Automotive Policy. The industry focuses on producing more luxurious models, midsize and four-door models which under any EU-Mercosur trade liberalisation agreement could face competition from European manufacturers. The convergence of global automobile investment trends with economic policy and sectoral developments within Mercosur resulted in a ‘wave’ of investment in the automotive industry during the 1990s.147,148 Originally, most investments were conceived of as market-seeking (focused on the wider regional market), but subsequently, after a series of economic and financial crises hit the region, there was a sharp shift towards more export-oriented and efficiency-seeking strategies. During the 1990s, vehicle manufacturers often found that their priorities tied in with the policy inclinations of Mercosur members. Together, this resulted in industrial restructuring and rationalisation, modernisation of installations and models, and entry of new competitors into the Southern Cone automotive market. These factors all led to an increase in output, exports and production facilities within Mercosur. The investment strategies in the Mercosur automotive industry resulted in unprecedented levels of specialisation and trade in vehicles and auto parts. Vehicle manufacturers developed a new Mercosur-based production and market configuration, which sought to multiply the advantages of each country. This Mercosur automobile sector now has the following features:149

o Up-dating the models produced and sold in the region; o Producing high volume, small cars with small engines in Brazil; o Producing small/medium cars with larger engines in Argentina;

146 Humphrey and Memedovic, 2003 147 Ozden and Parodi, 2004 148 For example, in 1996, The Economist noted that "hardly a week goes by without the announcement of a new factory, a new model or a new entrant in Brazil." 149 Laplane & Sarti, 2000.


o Importing large and luxury models from the USA and European Union; o Using an increasing number of auto parts imported from within and outside the region; o Placing growing emphasis on exporting beyond Mercosur.

Policy incentives and restraints, combined with favourable macro-economic conditions, reinforced corporate decisions to develop trade in the regional automotive industry. Intra-regional trade as a share of total vehicle exports grew from less than 9% in 1986 to more than 58% in 2001. Brazilian vehicle exports to Argentina increased from under 38 thousand units in 1990 to more than 105 thousand units in 2000 (representing about 30% of Brazilian vehicle exports). Brazilian imports from Argentina increased from only 3,946 units in 1991, to over 120 thousand units in 2001 (representing about 69% of vehicle imports). The global conditions facing the Mercosur automotive industry have shifted significantly in the past few years for multiple reasons. Firstly, there is growing competition from China, both as a location for investment to supply the Chinese market, as well as a platform for export production. Secondly, many European-based vehicle manufacturers have preferred to invest more in Eastern Europe, which is seen as an alternative location to produce vehicles in an increasingly competitive world. Thirdly, global over-capacity in the industry is forcing the automobile multinationals to re-evaluate their commitments around the world. EU–Mercosur Investment Flows in the Automobile Sector For Latin America as a whole, the automobile sector is the largest foreign private owned sector accounting for 6 percent of total sales of the top 500 companies (Table 59). Vehicle parts companies account for a further 1.6 percent. Table 59: Main Sectors and Ownership of Top 500 Companies, 2000-2004 Sector 2000 2001 2002 2003 2004 State-owned Hydrocarbons 16.9 16.0 16.1 18.1 19.1 Energy 3.0 4.0 4.2 3.8 3.5 Mining 0.4 0.5 0.6 0.5 0.8 Public services 0.3 0.2 0.3 0.3 0.7 Transport 0.1 0.3 0.4 0.4 0.3 Others 1.3 2.0 1.7 20 0.2 Total state-owned 22.1 23.0 23.3 25.0 24.7 Local-Private Commerce 7.3 7.9 8.3 8.3 7.8 Telecommunications 2.8 3.8 4.0 4.1 4.4 Steel 2.6 3.3 3.8 4.2 4.4 Soft drinks/beer 3.1 3.5 3.8 3.6 3.1 Hydrocarbons 1.0 1.0 1.1 1.5 3.1 Agribusiness 3.1 3.2 3.5 3.5 3.0 Mining 1.8 1.6 1.8 2.0 2.5 Cement 1.1 1.4 1.5 1.3 1.4 Petrochemicals 1.3 1.2 1.4 1.9 1.3 Energy 0.7 0.9 0.7 0.9 1.3 Total local private 38.7 41.6 42.3 43.8 46.6 Foreign private Automobile 7.3 6.7 7.3 6.5 6.0 Telecommunications 6.5 4.0 3.4 3.9 3.0


Hydrocarbons 3.6 3.2 2.9 3.2 2.7 Commerce 3.1 3.2 3.1 3.0 2.5 Electronics 4.2 3.9 4.4 2.6 2.1 Energy 2.6 2.8 1.9 2.1 2.0 Agribusiness 1.6 2.0 1.9 2.1 1.8 Autoparts 2.4 1.5 2.1 1.0 1.6 Mining 0.4 0.4 0.8 0.9 1.5 Chemicals 0.9 1.1 1.0 0.8 1.3 Others 6.6 6.7 5.6 5.0 3.6 Total foreign private 39.2 35.4 34.4 31.2 28. Total 500 companies 100 100 100 100 100 Total 500 companies (sales in billion $US)

852361 830433 734710 831772 1073755

Source: Amann and Vodusek (2004) By the late 1990s, the European countries had become the major source of FDI flows to the Latin America and Caribbean region (Table 60). The EU is the main investor in South America, with a FDI stock of $137 billion compared to $83 billion for the United States. European FDI is concentrated in the Southern Cone countries, with the Mercosur countries accounting for 65% or $112 billion, of which Brazil is responsible for 38 percent ($66 billion) and Argentina for 26 percent ($44 billion). Spain is the most important European investor and Spanish assets in the region account represent around one-half of total EU FDI stock. Table 60: EU FDI Stock in Latin America, 2001 (Outward stock, Millions Euros)

Latin Americaa

Argentina Brazil Chile Columbia Mexico Venezuela

European Union (%)

194738 50397 74508 15064 5902 25945 7493

100 26 38 8 3 13 4 France 19504 5553 8389 698 262 1556 1647 Germany 17829 2336 7481 537 505 5102 966 Netherlands 12296 1646 5223 899 -533 2630 1075 United Kingdom

16963 3622 4508 2947 2085 2283 666

Italy 9117 3147 4648 91 60 387 229 Portugal 8515 96 8185 16 0 88 5 Otherb 110514 33997 36074 9876 3522 13900 2905

Source: Amann and Vodusek, 2004 aEurostat Balance-of-Payments (BOP) Economic Zone of Latin America includes: Argentina, Bolivia, Brazil, Chile, Columbia, Costa Rica, Cuba, Ecuador, El Salvador, Guatemala, Honduras, Mexico Nicaragua, Panama, Paraguay, Peru, Uruguay and Venezuela b“Other” has been computed as the difference between the estimated EU aggregate and the sum of the selected declaring countries. Note: Data on Spanish assets in Latin America are not separately available: it can be assumed they account for a significant part of “Other”.


Dynamic Impacts of Trade Liberalisation for Mercosur and EU Automobile Sector Mercosur For the automotive sector, the CETM predicts that output in the automobile sector in Mercosur would decline as a result of full liberalisation. In Brazil, the share of motor vehicles in total output declines from 0.8 percent to 0.6 percent. In Argentina, the fall in motor vehicle output as a share of total output is from 0.9 percent to 0.8 percent. In the new equilibrium, when factors of production have been reallocated in response to the change in relative prices caused by trade liberalisation, employment levels in automobiles sector are also lower in both Brazil and Argentina. Exports of automobiles from Argentina increase while exports from Brazil are predicted to decline. Argentina’s imports of motor vehicles increase, as do those of Brazil. These results are dependent, however, on the assumptions that no other changes in economic parameters occur, that resources shift instantaneously between sectors, and that economic decisions are made entirely on the basis of market prices. In reality, changes in the output of the automobile sector will be determined by a complex set of factors relating to institutional and policy variables, corporate strategy and long term trends in productivity and market demand. Viewed in a dynamic perspective, trade liberalisation can expose domestic producers to greater competition, from imports. These competitive pressures can in turn stimulate growth in productivity. However, where there is market concentration and where the main producers are foreign owned, the response of producers to trade liberalisation is likely to be affected by the longer term global strategic goals of the automobile multinationals who increasingly privilege the search for efficiency over the search for markets in order to establish FDI financed international or regional production systems. What effect might a reduction in tariff levels and NTBs phased in over a period of ten years have on output levels in the automobile sector in Mercosur?150 Mercosur automobile imports are mainly more expensive models and specialist vehicles, which will have a relatively low price elasticity and limited substitutability with locally produced models. The reduction in the local price of imports following trade liberalisation is unlikely therefore to have a significant effect in terms of imports displacing local production. Similarly, the reduction in tariffs in the European market is unlikely to have a significant effect on the level of Mercosur automobile exports to the European market. This suggests that in the short term, liberalisation of trade with the EU is unlikely to have a significant impact on the output of the automobile assembly sector in Mercosur. In the longer term, however, the sector faces a challenge in maintaining momentum in export growth, given its current specialisation in the production of low cost vehicles designed for the local (Brazilian) market. Achieving sustained growth in exports will involve adapting production and designing models for global markets and achieving greater integration into global production chains. In turn, this has implications for national policy towards FDI in the automobile sector, with a shift away from policies intended to encourage production for the local market and removing any anti-export bias in automobile sector policy measures. As the industry moves towards greater international integration of production, and as income levels rise in Mercosur, a failure to adapt to the pressures of international competition is likely to

150 Note that the duration of the transition period is likely to be longer in Mercosur than in the EU.


make the local industry increasingly vulnerable to competition in export markets and to imports from Europe. In recent years, the Brazilian auto parts industry has experienced a sharp contraction in domestic demand and in local technological development capacity as a result of changes in automobile makers’ requirements, and the increased use of imported inputs as part of a global strategy aimed at ensuing international competitiveness. In so far as trade liberalisation reinforces these underlying processes of globalization and international competitiveness in the automobile sector, the short term impact on the parts sub-sector may be less benign than for end of line automobile manufacturing. A reduction in tariff and non-tariff barriers on imports of parts will reinforce the trend towards the use of imported rather than domestically produced parts by the multinational automobile assembly companies. In the longer term, the parts sector will face increasing pressure as the automobile multinationals strive to maintain international competitiveness by global sourcing of parts, thereby reducing the existing dependence on local production linkages. For multinational parts producers, future investment will reflect ‘follow client’ strategies and locally owned SMEs producers of parts products will be increasingly vulnerable to changes in global sourcing by the manufacturing TNCs. To conclude, the impact of EU-Mercosur trade liberalisation on the output of the automobile sector in Mercosur can be expected to reinforce the existing trends towards global production chains and increased international competitiveness. In the short term, the vehicle manufacturing sub-sector is unlikely to change significantly in terms of its exports and imports with the EU. In the longer term, the lowering of import barriers can be expected to increase competition in the Mercosur market and imports from Europe may increase, as disposable income rises and consumer tastes change. The increased competition may also increase the pressure on local producers to diversify away from the dependence on domestic and Mercosur markets towards extra-Mercosur exports although this may require changes in product design which adapts the existing production of compact cars to the requirements in export markets. For the parts sub-sector, trade liberalisation is expected to intensify the pressure on local producers, as vehicle manufacturing firms increase the proportion of imported parts used in vehicle production. The weakening of the linkages of assembly firms with local parts companies increases the need to raise efficiency levels in the parts sub-sector and to target export markets. However, export growth is constrained by the earlier dependence of the sector on producing parts designed for the local market. What effect might EU – Mercosur liberalisation have on investment in the automobile sector in Mercosur? The primary motive for the inflow of auto sector FDI in the 1990s was to supply the domestic market from local production. Here, the objectives of government policy and the multinationals were complementary, with foreign investors benefiting from various incentives provided by national and state governments. The key determinants of FDI for ‘behind the border’ production are the size, stability and growth of the domestic market, the quality of the business environment that determines the costs of doing business in the country; and the soundness of macroeconomic conditions, including exchange rate policy and the regulatory controls on and other foreign capital transactions. The major exchange rate realignments in Brazil and Argentina in 1999 and 2002 improved the export competitiveness of the automobile sector and encouraged MNCs to switch production towards export markets outside Mercosur. Car manufacturers announced major new investment projects in 2004, mainly in Brazil but also in Argentina, notably export oriented projects in compact cars. FDI in the automobile industry that targeted the Mercosur market in


the 1990s is shifting towards export-oriented production for markets outside Mercosur, particularly to Mexico with whom Mercosur members signed bilateral agreements that supported this new export strategy through the reduction of tariffs.151 In the short term, the reduction of tariff and non-tariff barriers is not expected to have a significant impact on the ‘fundamentals’ of FDI flows. In the long term, the removal of non-tariff barriers to trade and investment flows will contribute to an improvement in investors’ judgements of the business environment for inward foreign investment in the automobile sector. The removal of non-tariff constraints on trade and investment in the automobile sector will facilitate the global production networking and associated export and import of parts and services, which is now a dominant feature of the industry. It would also act as a ‘signal’ to European investors of a realignment of government policy towards raising the industry’s productivity and international competitiveness as necessary conditions to establishing a sustained growth in automobile exports from Mercosur.152 At the same time, the liberalisation of trade and investment flows in Mercosur is likely to further expose the weaknesses in the supplier sub-sector. European Union The further opening of the Mercosur automobile market to European automobile companies is likely to increase investor confidence, and reinforce the recent increase of European FDI into the Brazilian and Argentinean automobile sectors. The recent upsurge in investment in the automobile sector has been directed towards production for exports, as part of the global production strategies being followed by the major automobile TNCs. The phased liberalisation of trade is expected, therefore, to facilitate the shift towards increased international competitiveness of the domestic assembly and parts sectors in Brazil and Argentina, and to result in a continued growth of exports from Mercosur to third markets. Automobile exports from Mercosur to Europe are a small proportion of total exports, and the phased removal of EU barriers to Mercosur automobiles is not expected to lead to a significant increase in EU imports from Mercosur. EU exports of automobiles may increase as a result of liberalisation, but the growth will be limited to the more luxury brands and specialists vehicles for which the price elasticity of demand in Mercosur is lower than for ‘popular’ brands supplied by Mercosur production. With the opening of Central European countries to global markets since 1989, the auto industry in Central Europe is now increasingly integrated into the European industry. Integration between the motor industries of Western and Central Europe has taken two forms.153 First, there has been an increasing two-way trade in vehicles, in which Central Europe offered both growing domestic markets and low-cost production sites to Western European assemblers (including firms from Japan and North America with operations in Western Europe). Second, a number of export-oriented engine and component plants were built in Central Europe in the 1990s. Car production in the new EU members now accounts for 9.5% of total EU25 production (UNCTAD, 2006). Employment in automobile sector in EU 15 has declined slightly in the last six years, whereas employment has increased in EU10, reflecting the shift in locational advantage within the EU. The liberalisation of automobile sector trade between the EU and Mercosur is not expected to significantly affect these industry shifts between the EU 15 and EU 10 members.

151 UNCTAD, 2003 152 The potential impacts of liberalising trade with the EU are likely to be different from the effects of multilateral liberalisation of the automobile sector. In the latter case, the Mercosur automobile sector would face domestic market competition from imports from other low cost emerging market producers. 153 Dicken, 2003


Other Impacts Employment How might employment in Mercosur in automobiles be affected by EU–Mersosur trade liberalisation? The new outward oriented development strategy of the 1990s and the increased globalization of production worldwide led to a FDI boom in the region. The impact of large FDI inflows on employment, however, was to a large extent disappointing, which can largely be explained by the form of investment.154 Economic liberalization led to increased competitiveness and thus to restructuring strategies in order to increase productivity, which often involved rationalization measures and, as a result, labour shedding. In addition, FDI mainly went into low to medium labour-intensive sectors. Already present manufacturing TNCs made little, if any, contribution to employment creation. Even though capital-intensive industries, such as automobiles and chemicals, were major recipients of FDI, these sectors experienced an overall decline in employment in the 1990s. On the other hand, they experienced a rise in productivity and competitiveness as well as a further export orientation of their products. Wages in FDI dominated sectors, including automobiles, rose above average in the manufacturing sector, especially with regard to skilled workers, which was mainly related to a rise in labour productivity.155 In the longer term, however, the main influences on employment growth in automobiles will be the growth of the domestic and export markets and the trend in labour saving productivity. The removal of protection can be expected to reinforce the underlying pressures on employment in the automobile sector as the firms continue to seek labour savings productivity gains and a reduction in the share of labour costs. The decline in employment due to productivity improvements will be offset by the growth in output for export markets where the productivity improvements raises the international competitiveness of Mercosur automobile exports. The trend towards global sourcing of parts could have an adverse impact on employment, although here also, the magnitude of the loss in jobs will depend partly on the capacity of the parts sector to improve its competitiveness through product redesign and production which can compete in international markets, allowing exports to replace the decline in demand from Mercosur auto producers for locally produced parts. Social Impacts The labour force in automobiles is predominantly skilled and male. Wages are above the national average for manufacturing. The impact of trade liberalisation in the automobile sector is not expected therefore, to have a significant poverty impact. If labour is displaced by labour-saving technological change within the sector it can be expected to find alternative employment in other sectors where demand for skilled labour is growing. Persistent poverty in Mercosur, as in most Latin American countries, is largely a distributive problem. Inequality in the distribution of income is high, and this inequality undermines the potentially positive impacts of growth on the poor, as well as hindering growth itself. Where growth has been achieved, its potential positive ‘trickle down’ impact on the poor, for example through low wage unskilled employment generation, has been reduced by the inequalities which are reflected in patterns of domestic market production and demand.

154 Ernst, 2005a 155 Ernst, 2005a


The long term process of productivity improvement and integration into global production export markets can be expected to stimulate improvement in labour and managerial skills in the automobile sector. Environmental Impacts The effect of trade and investment liberalisation on the environment is theoretically ambiguous.156 This is hardly surprising, given the complex interdependencies that exist between trade, investment, regulation and environmental quality. The different assumptions and possibilities in the theoretical literature suggest that the impact of trade liberalisation on environmental quality may not necessarily follow a single or unique pattern, and is likely to depend on country specifics, the nature of the environmental problem under investigation, as well as policy and institutional measures accompanying the trade reform process. EU–Mercosur trade liberalisation in the automobile sector is expected to reinforce the underlying trend within Mercosur towards greater openness and integration into the global production chains that characterise the industry. The inflow of FDI aimed at reducing the dependence on domestic market sales by increasing exports of vehicles and parts is likely to ensure a continuation of the upward trend in production which has been experienced since the early 2000s . The scale effect of trade liberalisation can therefore be expected, ceteris paribus, to be negative in terms of additional environmental costs related to production and consumption of motor vehicles. The composition effect of trade liberalisation is not expected to be significant for the automobile sector, given its capacity to respond positively over time to the increased competitiveness pressures induced by trade liberalisation. The technology effect of trade liberalisation in Mercosur may be more significant for the automobile sector, if it leads to the adoption of environment-saving production methods, either through the increased imports of environmental goods and services or through imported technology embodied in foreign investment. Air pollution is a primary negative externality of automobile usage and production. Green House Gases (GHGs) from automobiles are a significant contributor to global warming. Respiratory illnesses from automobile emissions, including particulate matter and other harmful substances, is a leading cause of morbidity and mortality. With the predicted growth in automobile production in the largest manufacturing countries of Brazil and Argentina, emissions from automobile production locally are likely to increase. On the other hand, any change in technology towards cleaner methods of production will have an offsetting effect. Continued growth in domestic market demand will also contribute to increased air pollution. Increased air emissions from greater automotive use and production could potentially affect the local economy in different ways. Rising emissions in the Mercosur countries are likely to lead to increased health costs from higher levels of morbidity and mortality.157 An increase in automotive use results in increased respirable particulate matter (most widely studied are PM2.5 and PM10) and epidemiological studies have shown such pollutants to have the extensive negative impacts on health. Air pollution can have a negative direct impact on welfare of the population exposed to reduced air quality and this can have direct and indirect economic costs, primarily in the form of increased morbidity and mortality. A study for Sao Paulo, Brazil, showed dramatic reductions in deaths and illnesses related to air pollution ( asthma and acute bronchitis) could be avoided if PM10 levels were reduced.158 156 Kirkpatrick and Scrieciu, 2006a 157 Lopez-Silva, 2004 158 Cifuentes, Borja-Aburto et al. 2001


Automobile emissions are, nonetheless, difficult to measure due to variation in simulated tests compared to actual driving cycles.159 There are over 12 characteristics of a vehicle, (e.g. engine size and fuel use), combined with numerous driving scenarios (e.g. idling vs. stop-go traffic) that ultimately effect emissions levels. In the Brazilian context, the choice of fuel has a significant effect on emissions. Therefore, knowing precise reductions attributable to different policies (fuel use efficiency vs. engine type) is not straight forward.160 Brazil has been at the forefront in developing fuel technology of growing interest to the automotive industry and policy-makers worldwide. Ethanol technology is already mature in Brazil, and the country accounts for 38% of world ethanol production. Infrastructure is also already in place to deal with the distribution161 and supply of bio-fuels. By 2003, Brazil had launched its first flex-fuel cars, which ran on any blend of ethanol and gasoline. By 2006, seven car makers produced flex-fuel cars for the domestic market (many with tri-fuel engines): Volkswagen, GM, Fiat, Ford, Renault, Peugeot and Citroën. Honda expected to launch its flex-fuel car by end 2006 and Toyota was to follow in 2007. In early 2006, about 77% of new cars sold had flex-fuel engines, and this trend looked set to continue. The shift towards bio-fuels has been encouraged by government regulation. In Brazil, the government has developed a programme to support bio-fuel production with the so-called ‘social fuel’ label. This was only available to mills that bought a minimum percentage of their source crops from small family holdings and poor farmers. 500 million litres of this type of bio-fuel was produced in 2005, and the volume of the special label fuel was growing. Among Mercosur governments, Brazil is probably most advanced in its policies towards controlling emissions, dealing with solid wastes and chemicals, and other environmental concerns arising from vehicle use. A good example of this is the 20 year old National Programme for the Control of Automotive Emissions (PROCONVE), which reduced polluting emissions at source (the vehicle) significantly since its inception in 1985. The use of Compressed Natural Gas (CNG) as a substitute for gasoline or diesel fuel has increased significantly in Argentina and Brazil and these two countries now have the largest fleets of CNG vehicles. Conversion has been facilitated by a substantial price differential with liquid fuels, locally-produced conversion equipment and a growing CNG-delivery infrastructure. Argentina has been the leader in the shift to CNG, and more than 10 per cent of the vehicle market is now powered by natural gas. In Argentina, the price of natural gas is less than one third the cost of premium gasoline.162 CNG is environmentally cleaner than gasoline and diesel and the continued switch to this produce should result in some reduction in environmentally damaging emissions linked to road transport. An additional environmental issue related to the automobile sector relates to the import of used tyres, which was prohibited in Brazil from 1991 (there was a special procedure available for tyre re-treaders). Tyres are difficult to discard since they do not bio-degrade making disposing of used tyres an important public concern. Brazil, like the EU, only allows tyres to be re-treaded once. The government argued that imports of used tyres only have a “half-life” where after they only added to the problem of their disposal. Although the EU complained

159 (Wang, Lyons et al. 2000) 160 The most common practice is to describe emissions and fuel consumption from motor vehicles by an average value over a trip Fuel economy regulation can be formalised as E = (P/G * G/M) where (E) emissions per mile of driving equals emissions per gallon (P/G) multiplied by gallons per mile (G/M). 161 There are over 30,000 filling stations that sell pure ethanol or a blend at pumps. 162 Papageorgiou, 2005


about this to the WTO, Brazil argued that the used tyre import ban only sought to protect the environment and public health.163 7.3 Mercosur Integration 164 Introduction This section provides a broad overview of the issues and debates relevant to deepening regional integration within the Common Market of the South (Mercosur) and to its potential impacts (economic, social, political, environmental). First, it briefly notes the development and early successes of regional integration in Mercosur. Next, it discusses the challenges to further integration, examining internal crises and external constraints, and also considers ways of overcoming them. Finally, it examines both the implications of deepening as well as failing to revive Mercosur. Development and Successes of Mercosur Integration Regional integration projects were nothing new in the latter half of twentieth century Latin America. The Latin American Free Trade Association of the 1960s was an attractive idea politically, but doomed to failure due to the inherent contradictions of integration via trade liberalisation in the context of the prevalent protectionist logic of import substitution industrialisation. The next attempt at economic integration was the creation of the Latin American Integration Association (ALADI) in 1980, but this stalled at the outset as a consequence of the economic turmoil brought on by the debt crisis. In the mid 1980s, the newly democratic governments of Argentina and Brazil turned to creating an integration project that was narrower in scope with initial cooperation focused on political issues, especially on creating mutual support for democratisation and pre-empting anti-democratic challenges based on military-nationalist (and security) platforms. All the same, the early agreements signed in the latter half of the1980s often used explicitly economic objectives (typically a sector-by-sector approach to regional trade liberalisation) to implicitly support the underlying political and security objectives. It is only in the early 1990s, when Argentina and Brazil embarked on their economic liberalisation and structural reform processes, that specifically economic objectives related to regional free trade and global investment integration became increasingly attractive to policy-making elites. The Buenos Aires Act of July 1990 was a first step in what became a broader integration project that also included Uruguay and Paraguay with the signing of the Treaty of Asuncion establishing Mercosur in March1991. At this point, regionalism was a heavily state-led process relying on presidential diplomacy and definition of priorities. In the early years, Mercosur was closely linked to locking in each member government’s (neo-liberal) economic reforms and easing the region’s integration into the globalisation process. The ideological prominence of neo-liberalism at the time slanted preferences towards a narrow focus on trade and away from institutionalisation. Thus, it was launched as a strictly inter-governmental organisation with three decision-making organs at its peak: the Common Market Council (CMC) responsible for outlining Mercosur’s political direction and making common decisions, the Common Market Group (GMC) accorded with some implementation functions, and the Mercosur Trade Commission (CCM) restricted to dealing with trade issues. Subsequently, other bodies were added (although not all were up and running in the expected timeframe, often due to lack of budget allocations), such as the 163 Brazilian Ministry of Environment (www mma.gov.br). 164 This section has been written by Dr Mahrukh Doctor


US$ 20.3 billion in 1997, and the share of intra-regional trade in total trade rose from 8.9% in 1990 to a peak of 24.5% in 1997 (see Figure 8). After a sharp slump in intra-regional trade during the crises of 1998-2002, trade picked up again and by 2007 stood at approximately US$ 39 billion. Although Mercosur’s participation in world trade was just above 1% and the share of intra-regional trade in members’ total trade was low at 15% in 2005, since then the volume of trade increased substantially and intra-regional trade remained especially significant for the smaller partners. Thus, for example, 26% of Argentine, 37% of Uruguayan and 56% of Paraguayan trade was with its Mercosur partners, but only 9.4% of Brazil’s trade was with Mercosur. In addition, Mercosur attracted over US$315 billion in foreign direct investment (FDI) between 1990 and 2005, much of it was based on specifically regionalist strategies of large trans-national corporations setting up or expanding operations in the region (Chudnovsky & Lopez 2001). One of the most significant recipient sectors was the automotive industry, which received over US$40 billion since the launch of Mercosur (however, the sector was subject to an administered trade regime within Mercosur with little sign of progress towards sectoral free trade, notwithstanding years of negotiation). Mercosur’s political benefits should not be dismissed nor underestimated: the four partners experienced a definitive reduction in border tensions and arms races since the 1980s, and also supported each other’s commitment to democratic governance (this was especially important for Paraguay) and upholding citizenship and human rights. Some would argue that a regional identity was gradually emerging, although it was still fragile (Crawley 2004; Grugel 2007). What was essentially an elite statist project was seeing growing projection within society. For example, the middle and working classes were increasingly aware of and interested in the regional integration project, and there were more signs of cultural exchange than ever before: evidence suggests that samba and capoeira schools abound in Argentina, and Spanish language classes flourish in Brazil. Finally, Mercosur was also remarkably successful in projecting itself internationally, and some would argue that it was the external agenda that provided the ‘glue’ to keep Mercosur alive in the face of the many challenges to deepening the integration process (Phillips 2003). For Brazil particularly, the international dimension of Mercosur success was crucial in its strategic vision for claiming leadership in South America and enhancing leverage and bargaining power in international fora such as the World Trade Organisation, United Nations, etc. Mercosur won recognition in international trade negotiations: it signed some 22 preferential trade agreements with a variety of countries, including the Andean Community (October 2004), India and the South African Customs Union (December 2004) and Israel (December 2007). It was also engaged in trade talks with a number of partners such as the European Union, Russia, Mexico and China. Mercosur also attracted a number of associate members: it successfully signed up associate members in the region, including Chile and Bolivia (joined 1996), Peru (2003), Venezuela, Ecuador and Colombia (2004). A number of associate members, such as Bolivia and Chile, were hesitant to apply for full membership because their tariff levels were already lower than the Mercosur CET, although Bolivia recently requested full membership based on more political objectives. In July 2006, Mercosur and Venezuela signed an adhesion protocol with the latter’s eventual accession as a full member awaiting approval by all Mercosur members’ parliaments.166 However, it was

166 Should this process be completed (and there are various problems with it), it would make Mercosur one of the world’s leading producers of food and energy as well as a range of manufactured goods. However, President Chavez’ subsequent dismissive statements on Mercosur, even calling for its dissolution, raised questions, especially in Brazil, about any value to clearing Venezuela’s definitive entry into the bloc.


hard to overlook the criticism that the widening agenda, while attractive in itself, was also a distraction from the lack of progress on the deepening front. Challenges to Further Integration Notwithstanding the above mentioned successes, Mercosur was plagued by repeated crises that endangered its very survival or threatened to doom it to irrelevance. Although the conjunctural factors surrounding these crises were often not directly within Mercosur’s control as such, various analysts correctly noted that certain ‘deficits’ in Mercosur’s structures could be blamed for the failure to respond effectively to these crises and to deepen integration. Four deficits were identified: economic growth, institutional, social and democratic deficits. Together they contributed to the internal crises facing Mercosur and slowed the integration necessary for the region to engage more actively in global trade and production chains. Compared to other regions, Mercosur growth performance in the past decade was rather lacklustre. Between 1994 and 2005, growth at an only 2.2% annual average was lower than the already modest Latin American average of 2.6%. Brazil, the largest partner representing some 70% of regional GDP, grew at an average annual rate of 2.4%. Argentina grew at an average 1.8%, while Paraguay (1.6%) and Uruguay (1.2%) grew even less in the same period. Since 2003, growth picked up in all four economies, but it is still too soon to dismiss a return to the boom-bust cycles typical in Latin American economies (See Table 61). The low growth problem in each economy had been compounded by the underlying structural issues at the regional level, including incompatible macroeconomic (especially exchange rate) policies, asynchronous macroeconomic cycles and atomised policy responses during much of Mercosur’s existence. This had created disharmony in the latter half of the 1990s and more intransigent attitudes towards integration thereafter. By the turn of the millennium, these macroeconomic issues had blown up into what seemed to be almost insurmountable crises, and the crises (discussed below) still coloured policy-makers attitudes towards Mercosur development.

Table 61: Gross Domestic Product – Growth Rates in Mercosur Percent Variation over Previous Year

2004 2005 2006 2007 Argentina 9.0 9.2 8.5 8.6 Brazil 5.7 2.9 3.7 5.7 Paraguay 4.1 2.9 4.2 5.5 Uruguay 11.8 6.6 7.0 7.5 Source: ECLAC, 2007 Mercosur members had to deal with two major crises: (i) the maxi-devaluation of the Brazilian currency, the real, in January 1999; and (ii) the near collapse of the Argentine economy (and subsequent devaluation of the peso) in 2001-02. The Brazilian devaluation of 1999 became the trigger for bitter disputes on trade, investment and other integration related matters. The devaluation caused a severe contraction in intra-Mercosur trade (plummeting from US$ 22 billion in 1998 to US$15.4 billion in 1999), an aggravation of trade disputes (with mutual increases in barriers to trade and taking of complaints to the WTO), and recessions in all four Mercosur economies. Both Argentina and Brazil prioritised national solutions to their crises and threatened to abandon Mercosur at different points in the years 1999-2000, but then decided to keep it afloat with a ‘re-launch’ announced in 2000. All the same, by March 2001, the customs union was virtually dead, given the deteriorating situation


in Argentina. The Argentine government unilaterally suspended the CET affecting some 2700 items in the tariff code. Although condemning the move, Brazil and other members agreed in the CMC that Argentina would be allowed these exceptions to the CET so as to give it a chance to recover from recession and the huge pressures on its exchange rate regime. A few months later in December 2001, the collapse of the Argentine political and economic systems dampened (if not obliterated) any chance of progress in the near-term. The two main crises and other lesser ones such as the run on Uruguayan banks by their Argentine clients and the election year economic turbulence in Brazil, both in 2002, cumulatively had a marked impact on both growth and regional integration. Each crisis had severe repercussions not only in the relevant domestic economy, but also in the other Mercosur economies, especially in Uruguay and Paraguay. Economic contraction, stagnation, and slow growth impacted consumption and trade patterns directly, and also aggravated competition and conflict among the partners. Business and labour, already battered by poor domestic economic conditions, were disinclined to tolerate more competition from or to lose market share and jobs to imports. Thus, not surprisingly, fragile governments resorted to defensive strategies; they became increasingly willing to accommodate the demands of their domestic constituents rather than adhere to what they saw as tenuous commitments made to regional partners. The growth deficit linked into the second major challenge facing Mercosur, the so-called institutional deficit of the integration process. While the initial low institutional profile might have been appropriate, after 1995 with the up-grade to (incomplete) customs union status, policy coordination assumed increasing importance and the reliance on inter-governmental structures resulted in the inadequate transposition of Mercosur norms and protocols into national legislation (only about half of Mercosur rules had been incorporated into national legislation by 2007). The absence of regional institutions or a regional bureaucracy meant that policy-makers and their technocratic teams still operated at the national level and remained politically accountable to their national governments. Not surprisingly, the lack of supra-national institutions also provoked relative gains conflicts, which were further aggravated by the size asymmetries among Mercosur partners (Manzetti 1993-94). Weak institutionalisation allowed rules to be flouted with ease and often resulted in unilateral protectionist actions without any institutional sanctions. For example, when Argentina decided to go back on its earlier commitment to liberalise intra-regional automotive industry trade by 2006, nothing much was done to prevent it from doing so. Equally problematic were inadequate dispute settlement mechanisms, which reduced the credibility of integration policy among traders and investors more generally. It also often necessitated that complaints be settled in international rather than regional for a (the on-going Uruguayan-Argentine dispute on the building of paper mills along a shared river was an excellent example of this). Finally, it is unclear how new members, such as Venezuela, would contribute to Mercosur institutionalisation. Early comments, reported in the press, suggested that further politicisation rather than institutionalisation was on the cards. Moreover, what institutionalisation did occur was unlikely to reassure neither business nor many potential foreign partners willing to negotiate with Mercosur. Thus, on balance, evidence demonstrated how the resistance to institutionalisation and the reluctance to pool sovereignty created many barriers to deepening integration, made joint problem solving very difficult especially in the midst of crisis, and reduced the credibility of Mercosur among societal actors (especially business). The social and democratic deficits are best discussed together, since they relate to criticisms of the highly state-centric nature of Mercosur regionalism. These critiques became more


strident after the harsh economic impacts of the crises. In their defence, Mercosur elites often argued that although not based on a democratic consultation of society, it was precisely the democratisation and economic reform agendas that were uppermost in policy-makers minds before signing the regional integration agreement. For example, Paraguayan state elites saw Mercosur membership as an opportunity to end the country’s international isolation, seek support for its new democracy and help reactivate its economy (Kaltenhaler & Mora 2002). Others argued that in the early days of integration, the low profile of societal actors might actually have helped speed up agreement to move forward with regional integration. Protectionist business and fearful labour were not given a chance to voice their preferences, thus removing possible obstruction to the early push for liberalisation in regional trade.

Table 62: Mercosur Integration Deficits Type of Deficit

Some Impacts

Economic Growth • Aggravated Mercosur structural inconsistencies • Generated trade disputes and recourse to unilateral measures • Fostered a relative gains approach to integration • Failed to lessen income inequalities and reduce poverty via

‘wealth creation’ gains from integration Institutional • Relied on high level diplomacy and inter-governmental

frameworks to solve disputes and other issues • Lowered transparency, accountability and credibility of the

integration process • Lacked well functioning dispute settlement mechanisms • Bureaucracies operated at the national level • Increased difficulties in completing the customs union and

moving towards a common market • Reduced investment due to higher uncertainties • Neglected to develop a common vision and identity

Democratic and Social

• Excluded the wider national political class/actors from identifying with the strategic objectives of integration

• Minimal consultation with and participation of civil society • Lacked a sense of social ‘ownership’ of the integration

project • Failed to garner additional support for integration from

societal actors in times of crisis • Reduced the likelihood of creating a regional identity that

transcended traditional rivalries and suspicions • Business remained wary and unconvinced about the

regionalism project and was hesitant to invest

Source: author’s elaboration However, over the years and especially during the crises, it was hard to disagree with those who argued that the absence of society and the lack of social ‘ownership’ of the project had not only reduced the credibility of the project, but also added to the difficulties of responding to the crises with the active participation and acceptance of societal actors. This reduced the effectiveness of regionalism as a means of creating conditions for a more balanced and equitable development in and among Mercosur members (Mecham 2003; Cammack 1999). Interestingly, one of the key lessons of the economic crises was that increased participation and interest from civil society - labour unions, business associations, small and medium


enterprises (SMEs) - could actually support policy-makers objectives and help strengthen Mercosur. For example, SMEs were a significant untapped source of potential integration gains in Mercosur. Here trade facilitation aspects of the Mercosur work programme could be used to enhance SME opportunities to benefit from a deepening Mercosur. More importantly, a wider participation of small businesses in all Mercosur member countries was likely to influence investment decisions favourably, enhance employment prospects and augment competitiveness, alongside all the associated social and economic impacts of these forces. It would also lend greater legitimacy to and support for Mercosur. There were those who argued that a ‘regionalism from below’ that put pressure on Mercosur elites to democratise and deepen the project would not only deal with the democratic deficit, but also increase Mercosur’s prospects for survival and relevance (Carranza 2006). Ironically, in this instance, addressing the democratic deficit would require creating effective supra-national institutions to give all members a strong voice.167 These genuinely pan-Mercosur institutions could then develop a clearer strategy for macroeconomic coordination to support regional development and reduce economic inequalities. The above problems, stemming from internal crises and integration-related deficits, were further exacerbated by a number of constraints arising from Mercosur’s links to the global economy. Some of the constraints arising from Mercosur’s external agenda could be resolved by Mercosur action alone (e.g. developing a common vision for integration into the global economy and completing the customs union), while others were wider issues that lay outside the direct control of Mercosur (e.g. European Union and the United States’ trade policy priorities and negotiating strategies as well as their shifting interest towards Asian markets; moreover, slow progress/stagnation in the Doha Development Round also hampered the Mercosur agenda). Both aspects of the external agenda needed to be addressed in order to deepen integration. Moreover, potential external partners needed to be attuned to the intricate links between Mercosur’s internal and external agendas, when negotiating with the bloc. The question of whether the internal and external integration agendas could be treated separately or whether they reinforced each other was extensively debated in academic as well as policy circles. Some argued that the external agenda (for example, negotiations with the European Union) provided the ‘glue’ to hold the project together (Phillips 2003), while others argued that the stalling of the internal agenda became the main obstacle to progress on the external (Carranza 2006). Others argued that the potential benefits from signing an inter-regional agreement with the EU could actually be harnessed to serve as an impetus to consolidating Mercosur (Rios & Doctor 2004). In the first view, the process of engagement with external negotiations was key to understanding the continuing survival of Mercosur. According to Phillips (2001), one of the ways Mercosur weathered the storms of the late 1990s was to re-launch and redefine the project as a political platform for attaining shared external objectives. By having an external focus, where bargaining as a bloc made sense and improved the prospects for influencing outcomes at home, Mercosur’s external negotiations provided an arena where some progress was possible. For example, the external agenda with the EU linked closely with discussing the normative aspects of Mercosur’s agenda (democracy and social inclusion) and it is here that the ‘glue’ was most effective. In addition, by providing areas where the members could agree on, the ability to hone in on common concerns, interests and values helped keep (and still is keeping) Mercosur alive. The EU’s insistence on negotiating with Mercosur only as a bloc provided a vital focus and an indirect means of keeping the partners together. 167 Here it is worth pointing out that in the European context, it is the supra-national institutions that are blamed for the EU’s ‘democratic deficit’.


The second argument, most clearly stated in Carranza (2006), was that if Mercosur policy-makers did not take the initiative in working for greater internal consolidation of the bloc, then the external agenda was meaningless and simply insufficient for Mercosur survival. In other words, the external agenda was not a substitute for facing up to Mercosur’s many internal deficits. Moreover, Mercosur risked being stuck in a rut, if it failed to pursue the many aspects highlighted in the discussion of these deficits (see next section). In this view, Brazil was seen as the key driver of the regional project and its reluctance to surrender national sovereignty to regional institutions was seen as the main brake on further integration. This argument was held by those unconvinced about Brazil’s willingness to re-evaluate its strategic calculations, as well as those who were more pessimistic about the possibility of Mercosur consolidation piggy-backing on the attraction of signing agreements with the EU not to mention the now all-but-dead Free Trade Area of the Americas (FTAA). In the third argument, the potential substantive gain from finalising inter-regional negotiations was a carrot for deepening of the intra-regional integration agenda. In some ways similar to the first argument, favouring inter-locking of the internal and external agendas, it emphasised the substantive outcomes as a motivation for moving forward in both areas. It acknowledged that implicitly, the anticipated benefits from the reform ‘lock-in’ aspect of integration had now shifted from the intra-regional to the inter-regional level. Inter-regionalism was now expected not only to increase trade flows, but also to result in more investment, better and credible regulatory regimes, and improved systemic competitiveness (Doctor 2007). Smaller members especially thought it would be a way of ameliorating the impact of power asymmetries within the bloc. Also, given that Mercosur members increasingly justified pursuing integration in terms of providing a reliable platform for the dynamic application of developmental polices (and the European Commission supports it in these goals168), then delivering a consolidated Mercosur with meaningful mechanisms for regional governance was imperative. In the absence of greater institutionalisation within the region in the first instance, international agreements could provide that additional impetus and resolve to policy-makers to sustain deeper integration. However, internal conditions shaped the ability of policy-makers to embark on this option. Undoubtedly, the economic crises of 1999-2002 exposed the difficulties that intra-regional trade disputes could create for coming up with a joint strategy for integrating members into the global economy. Thus, it became increasingly difficult to put forward common negotiating positions on issues such as the CET, anti-dumping policies, services trade, government procurement, and trade facilitation (especially movement of goods within Mercosur and ending double taxation of imported goods crossing borders within the bloc). These problems were reinforced by the institutional deficit, which exposed the lack of credibility of the project and touched all areas of negotiation (Motta Veiga 2004). The overlap of the two agendas was best illustrated with reference to the incomplete customs union. Firstly, an important theoretical insight appeared to have been forgotten - in order to allow ‘wealth creation’ gains to outweigh ‘trade diversion’ losses from ‘open regionalism’ a consistent and wide-ranging liberal trade policy was necessary within Mercosur. Next, while the various mechanisms used by Argentina and Brazil to breach the spirit of the customs union aggravated intra-bloc tensions and increased business uncertainties, these also impacted the ability to coordinate policy positions in external negotiations and to sign meaningful inter-regional agreements. Therefore, it was not surprising that the smaller partners, Uruguay and Paraguay, became openly dissatisfied with this process and requested permission to seek

168 See the EU Regional Strategy papers published in 2002 and 2007.


separate deals with third countries, especially the United States. The Montevideo Summit in December 2007 saw little progress made towards completing the customs union and deepening Mercosur. A common customs code was not finalised, double tariff charges were not eliminated, some 100 products remained exempted from the CET (until 2009 for Argentina and Brazil; until 2015 for Uruguay and Paraguay); and agreement on institutional reform, especially dispute settlement, was further delayed. Overcoming Constraints to Further Integration The above crises and concomitant deficits put a number of constraints on furthering regional integration. Overcoming these constraints required action to minimize the impact of the above four deficits on Mercosur regional integration, but this was often not forthcoming. Events and decisions of the past decade demonstrated how the various crises and ‘deficits’ periodically required Mercosur to subject itself to intensive care treatment. Once the worst moments of the crises were overcome, Mercosur survival usually depended on presidential level diplomacy coming to the rescue with much effort directed at reviving the project. For example, a year after the Brazilian devaluation crisis, in April 2000, the CMC announced the ‘re-launch’ of Mercosur and put forward a timetable with specific integration targets such as: (a) harmonising national statistics; (b) deciding common standards for fiscal responsibility; and (c) publishing regular reports on each economy’s efforts towards stabilisation. Again, a year after the next major crisis, in 2003, the Asuncion Summit reaffirmed members commitment to Mercosur, and outlined specific targets and deadlines to achieve five specified goals: (a) agreeing a common trade defence and competition policy; (b) eliminating anti-dumping and countervailing duties in intra-bloc trade; (c) determining a common discipline for export incentives; (d) harmonising macroeconomic indicators; and (e) strengthening Mercosur’s institutional structure.169 A common theme in these efforts related to overcoming the institutional deficit and reviving the trade agenda. In addition, underlying these institutional, trade policy, macroeconomic, and external agenda issues were two central difficulties: on the one hand, dealing with the predicaments arising from the significant size asymmetries among Mercosur members, and on the other hand, addressing the apparent lack of leadership and political will to deepen integration. It was worth bearing in mind that the de facto asymmetry was often less of an issue than the policy asymmetries arising from the way in which domestic political agendas regularly seemed to override the regional project (Crawley 2004). Any examination of Brazil’s position regarding institutional deepening of Mercosur, revealed its reluctance to build supra-national institutions and thereby cede autonomy to smaller partners; meanwhile the smaller partners, given their less significant economic weight and higher trade interdependence, were vulnerable to Brazilian policy decisions. Thus, both sides tended to fall back on an ‘inter-governmental syndrome’ with a fixation on avoiding a loss of national sovereignty over policy-making (Valliant 2007). In addition, Brazil saw itself as a global trader rather than bound to the regional market, and it used Mercosur as a stage for enhancing its clout in global trade negotiations and boosting its global competitiveness with an eye to the long-run. Uruguay and Paraguay, and to a lesser extent Argentina, were much more focused on the short and medium term benefits available from using Mercosur to access the Brazilian market. This picture was further complicated by the uneven distribution of trade diversion costs, with Brazilian exports to Mercosur partners 169 See Carranza (2006) and Taccone & Nogueira (2004) for more details on these attempts at re-launching Mercosur.


concentrated in products where it did not have a global competitive advantage, while the smaller countries’ (especially Paraguayan and Uruguayan) intra-bloc exports often were in products where they had a global competitive advantage (Valliant 2007). Thus, Brazil and its smaller partners’ divergent strategic visions of Mercosur as well as differing trade patterns often scuppered policy convergence not only on trade issues, but also on dealing with the various deficits discussed above. On a more positive note, Mercosur countries appeared willing to address their problems and recent decisions of the CMC demonstrated an evolving commitment to addressing questions of institutionalisation and policy coordination. In the past five years, Mercosur decisions and its work programme increasingly dealt with strengthening the institutional structure of Mercosur. Since 2003, various new organs and processes of consultation were set up: the Technical Secretariat, CRPM, Joint Parliamentary Commission, Mercosur Parliament, Permanent Review Tribunal (TPR) as well as procedures for the ad hoc arbitration tribunals, Structural Convergence Fund, and so on.170 There were also more consistent efforts made to share knowledge and increase opportunities for networking among officials so as to encourage mutual understanding and develop a pro-integration community among Mercosur’s national bureaucracies. Thus, recent policy statements showed evidence to suggest that Mercosur governments had taken on the idea that credibility-maximising and legitimacy-generating mechanisms would not only enhance regional collaboration, but could also smooth their integration into global markets (Phillips 2002). Another positive sign was in terms of Brazil’s changing leadership role and attitude towards foreign policy. While President Lula da Silva’s first term in office (2003-2006) was marked with ideological posturing and claims to leadership in diverse regional settings (e.g. the short-lived Community of South American Nations, CASA), his second term saw a tendency for Brazil to go back to presenting itself in cautious, pragmatic, moderate and non-ideological terms, where professional diplomats took the lead in formulation and implementation of foreign policy. A concrete manifestation of this trend was Brazil’s support and engagement in the newly formed Union of South American Nations (UNASUR) with its eventual objectives of a region-wide customs union and defence council, but intermediate objectives focused on infrastructure integration and trade cooperation to enhance business opportunities. This new attitude could yield promising results in addressing some of the key issues on the Mercosur agenda.

Table 63: Recommendations for a New Mercosur Trade Agenda 1. Eliminate NTBs and adopt measures in the Mercosur Business Facilitation Programme 2. Transpose agreements into domestic law 3.Discipline and harmonise production, export and investment incentives 4. Foster integration of production chains and stimulate exports 5. Develop financing instruments to facilitate integration 6. Avoid new regulations or barriers that distort or impede intra-bloc trade 7. Regulate Mercosur regime incentives (especially Special Customs Areas) 8. Maintain cohesion in external negotiations (coordinate WTO positions) 9. Rationalise the CET structure and correct distortions 10. Adopt complementary measures to strengthen the customs union 11. Agree on a common customs code and the distribution of customs revenues 12. Work on macroeconomic coordination, especially for exchange rate fluctuations Source: Crawley, 2004 170 See the European Commission’s Mercosur: Regional Strategy Paper 2007-2013 (2007) for a detailed list of the recent institutional evolution of Mercosur.


However, other elements on the new agenda, as identified by the 2004 Inter-American Development Bank Workshop (Crawley 2004), had made little progress even as late as mid 2008. These included a number of pragmatic issues related to trade such as elimination of major non-tariff barriers, formulation of a common trade programme (especially agreeing to and enforcing a CET), and free circulation of goods within Mercosur (See Table 63 for a detailed list of recommendations). Other issues, such as improving arrangements for rule making, rules transposition and rules implementation as well as better macroeconomic coordination, also had not received the attention they merit. Finally, the workshop emphasised the need to forge a common vision that involved governments and societies in creating a new ‘community of interest’ that would support Mercosur deepening. It even came up with proposals on how to address these concerns and constraints on deepening Mercosur. Given that many of the issues remained relevant even four years later, it was worth reiterating them. The workshop report suggested that Mercosur leaders:

• upgrade and consolidate Mercosur via a new constitutive treaty; • strengthen the CMC and increase regularity of meeting of senior officials; • increase involvement of national parliaments (to enhance legitimacy and stimulate

public debate on Mercosur issues); • reinforce the Technical Secretariat; • encourage private sector to take a greater role in shaping the integration process; • provide wide access to Mercosur documentation (e.g. via internet) to increase

transparency of rule-making. Implications of Deepening Mercosur Integration In 1991, the Treaty of Asunción clearly laid out the main objectives of Mercosur as “economic development with social justice”, thus, broadening the scope of the regional integration project beyond purely trade liberalisation objectives. Meanwhile, although the internationalist pro-globalisation neo-liberal coalition (Carranza 2006) that assisted in the birth of Mercosur had given way to what may be called a ‘post-Washington consensus’/ ‘progressive’ political conjuncture, in many ways Mercosur remained an attractive project that many believed could enhance economic development and social justice outcomes, if managed correctly. Moreover, Gomez Mera (2005: 140) noted that there was a “joint perception that despite its economic flaws, the strategic idea and political project of Mercosur should not be questioned and (was) very much worth keeping alive.” However, notwithstanding such optimistic evaluations, the process of deepening Mercosur integration was neither inevitable nor undisputed. It was very much linked to the domestic political struggles between winners and losers in the process balanced by external pressures on the four Mercosur states. Mercosur deepening would have crucial positive impacts on a variety of levels (societal, national, and regional) in a range of areas for all four members: economic development, politics and governance, social and environmental. Some of these issues were discussed in depth in the EU-Mercosur Sustainability Impact Assessment (SIA) carried out in 2007; The SIA report also included sections with detailed analysis of particular sectors. Although the focus in the SIA was on the benefits of signing an inter-regional agreement, many of the benefits identified in the report depended on better Mercosur integration in the first instance. The economic crises of 1999-2002 had seen a sharp reduction in intra-regional trade (see Figure 1), a contraction of all four economies and a big rise in poverty (the most spectacular rise in poverty was registered in Argentina, where the poverty rate rose from 32.8% in 2000 to over 50% in 2002). Although much of the political rhetoric at the height of the crises partially


blamed Mercosur for adding to economic grievances, and at moments it seemed like the project would be abandoned altogether, the ideals (and one could argue the longer-sighted pragmatism) of regional cooperation somehow survived. Clearly, enough policy-makers were convinced that deepening and consolidating Mercosur integration could be expected to create important benefits from further trade liberalisation as per the insights of traditional trade, customs union and strategic/new trade theories (where opportunities for specialisation, economies of scale, etc. increased competitiveness of the economy). Moreover, in the ten years since the launch of the customs union in 1995, Mercosur economies, with the exception of Paraguay, had increased their economic openness (See Table 64). In addition, non-traditional benefits such as increasing private sector confidence and attracting FDI were not negligible, given the many structural factors that impeded sustained investment flows to the region. Thus, deepening integration could help reverse problems related to low systemic competitiveness, inadequate regulatory regimes and deficient transparency, high levels of corruption, and unstable domestic markets related to income inequalities and uneven growth (Doctor 2007: 306).

Table 64: Openness of Mercosur Economies (in % of GDP) 1995 2000 2005 Argentina 19.7 22.4 44.3 Brazil 16.0 21.7 26.7 Paraguay 130.7 86.9 104.7 Uruguay 38.1 40.3 59.5 Source: ECLAC 2007

There were strong indications that regional integration could boost development, contribute to developing regional infrastructure and help build local capabilities by creating markets for non-traditional exports (perhaps with a higher technological content than otherwise). Where progress had occurred in Mercosur integration, new opportunities and encouraging results were already evident. These benefits in turn could be used strategically by both Brazil and its smaller partners to prepare for competing in global markets. With respect to competitiveness and technological upgrades, Mercosur economies could expect deeper integration to also enhance aggregate employment opportunities (although particular sectors would inevitably lose out), increase average incomes and consumption, further boosting the size of local markets. All these considerations were made more palatable with the economic recovery from 2003 and the apparent ideological affinities among Mercosur’s new leaders (often described as ‘progressive’ governments, they were voted into power between 2002 and 2004). Equally, however, potential outcomes also remained very contingent on political economy struggles, lobbying activities and the national political agendas of leaders, who rarely ventured to go forward steadfastly on deepening macroeconomic coordination and entrenching free trade within the bloc. Closer economic integration, including the necessary infrastructure integration, provided economic opportunities, but also environmental threats. Although Mercosur had a permanent working group – SGT6 – which was responsible for discussing regional environmental issues related to trade and economic relations and for coordinating their positions in international conferences, members often disagreed on a number of environmental issues which were seen to touch on the national interest. Deforestation and inappropriate re-forestation, large-scale as well as intensive farming, poor water management, soil and water contamination, urbanisation and inadequate regimes to protect biodiversity were problems in each of the Mercosur countries. Deepening integration could create an opportunity for a more coordinated and longer-term approach to dealing with these problems on a supra-national basis that also


involved civil society groups in each country. These were precisely the sort of issues that bodies such as the Mercosur Parliament would be best equipped to deal with, especially in terms of societal input and democratic legitimacy. Moreover, Mercosur could provide the institutional framework and know-how for members with weaker environmental protection institutions, such as Paraguay. It could also use Mercosur rules to lock-in environmental legislation (similar to the argument used for economic reforms in the 1990s) so as to support a national government’s resistance to particularly persistent lobbies. Deepening Mercosur implied that Brazil, but also Argentina, must acknowledge the relevance of and urgent need to address the issue of asymmetries - of size, geography, competitiveness, capabilities, levels of development, and policy. The growing importance of the various aspects of asymmetry for the two smaller economies, Uruguay and Paraguay, could be seen in their growing disenchantment from limiting their options to Mercosur and relying on the larger economies to open access to other markets on their behalf. Finally, in recognition of this problem (and in response to the two demanding the right to negotiate separate bilateral trade agreements with third countries, particularly the United States), the CMC agreed to create a high level group to study the issue and come up with a strategic plan to overcome the asymmetries (CMC Decision 33/07 on 10 October 2007). It was decided to tackle the issue in terms of four pillars: (i) landlocked countries and infrastructure; (ii) support for competitiveness (especially mutual recognition); (iii) market access (reducing non-tariff barriers, increasing transparency); and (iv) institutionalisation (creating relevant institutions and rules, financing support for SMEs, assistance for smaller economies with technical norms and quality control, etc.). Following through on any initiatives that emerged from this process could go some way towards appeasing the demands of the smaller members, and thus contribute to the overall effectiveness of and identification with Mercosur integration. However, the larger economies had to go beyond muddling through or merely paying lip-service to the concerns raised by the smaller ones. Finally, a significant consideration in deepening Mercosur and entrenching a rules-based integration project was that creating more rules was not necessarily the solution, but rather efforts should be expended on ensuring good quality rules that were actually enforced. Similarly, correcting the institutional deficit should not be seen as an occasion for creating more institutions or new bodies within the Mercosur structure, but rather a reason to focus on developing a credible system for the formulation, implementation and enforcement of agreed rules. Finally, some analysts advocated the benefits of reducing the undue flexibility of the architecture of Mercosur as a means of consolidating the project (Motta Veiga 2004). Fifteen years after its creation, coming to terms with the implication of a potential failure to reinforce Mercosur integration was no longer an exercise exclusively limited to the Mercosur pessimist. The narrow and rather ungenerous terms of engagement on the part of its members, at one time or the other, were hard to ignore. Perhaps the controversy raised by Venezuela shortly after signing up to become a full member171 was exactly what was needed, i.e. a reminder of the basic motivations of its founders. Afterall, Argentina and Brazil, later joined by Uruguay and Paraguay, had defined clear values and goals, when they had set out on the process of regional integration in the early 1990s. Back then, regional elites had been convinced of the positive correlation between regional integration and domestic issues related to security, economic reform and development, and democratisation. Unfortunately, fifteen years later many political elites were hard pressed to remember the ideals as well as pragmatic outcomes awaited from Mercosur integration. Gradually, the 171 President Chavez basically called for the dissolution of Mercosur, criticising it as a neo-liberal elite capitalist project, while touting his own Bolivarian Alternative for the Americas (ALBA).


optimistic mood accompanying the early years of Mercosur integration had dissipated in the face of repeated shocks to the economic and political systems of its members. It became increasingly easy to focus on its many failures – persistent exceptions to free trade, a fractured customs union, innumerable trade disputes with recourse to unilateral mechanisms for dealing with them, poor policy coordination and weak engagement with civil society. However, few wanted to acknowledge that the impact of these failures could be compounded many times over should Mercosur be abandoned altogether. This argument should not be seen as an argument to allow Mercosur to languish without direction, but rather as a warning that the stakes were too high to be ignored. Having noted the above, equally there was no genuine benefit from not making a bold decision to either forge ahead with deepening the integration project or terminating it once and for all. Political dithering was not to society’s benefit. In conclusion, amongst the issues that needed to be addressed urgently, or risked plunging Mercosur into irrelevance, were:

(i) a strong commitment by national governments to transpose already agreed Mercosur decisions and protocols, so as to incorporate them into each member’s national legislation;

(ii) a clear push to complete all aspects relevant to a fully-operating customs union, so that goods and services circulated freely within the area and it eased the completion of trade negotiations with third parties; and

(iii) a consistent effort to involve business, labour and other societal actors in the expansion and deepening of regional integration, so as to foster a sense of inclusion and to develop a regional identity that embraced the broader development goals of the project.

In addition, the shifting international context made deeper integration ever more urgent. Mercosur, not only faced real challenges in terms of its legitimacy and identity, but also needed to come to grips with issues such as energy and food security, global environmental and climate change, and the overall governance of these increasingly inter-locking policy areas. Crucially, these were issue areas where the European Union not only faced similar challenges, but could also provide genuine support to Mercosur. It was becoming increasingly clear to Mercosur watchers (and hopefully to policy-makers) that should all the above mentioned issues not get almost immediate attention and clear-sighted commitments for their resolution, Mercosur might as well begin to contemplate the many negative implications of its failure to deepen integration.


8. CONSULTATION AND DISSEMINATION STRATEGY

8.1 Consultation Process Consultation processes are an integral part of the SIA methodology. Consultations with stakeholders have been carried out since the inception of the Phase 2 EU Mercosur SIA programme. This process of engagement with stakeholders and interested parties has been conducted by the development of an experts network, website usage, public meetings in Brussels and Mercosur to discuss the Inception Report, networking with other groups and parties involved in EU and Mercosur trade policy, and dissemination of general Trade SIA outputs to the research and policy communities through publications and conference presentations. The draft Inception Report was distributed electronically at the beginning of April, and a Civil Society meeting to discuss the inception report was held in Brussels on the Inception Report on 28th April, 2008. An abridged version of the Inception Report was made available in Portuguese and Spanish. In addition to the comments received at the public meeting, the consultants have received comments sent electronically the project website. The consultants’ response to the comments received are given below. Comments and Responses – Public Consultation, Brussels Civil Society Comments Consultants’ Reply Public Consultation Meeting 28 April 2008 The comments received from civil society on the final Phase 1 report would also be taken into account in the Phase 2 Midterm Report.

Will be examined in Midterm Report

The definition of trade facilitation used in the study was described in relation to the WTO definition. This will be clarified in the Inception Report.

Included in revised Inception Report

The consultants confirmed that background documentation on the Phase 2 Project would be prepared in Spanish and Portuguese for distribution before the Montevideo workshop. The executive summaries of the Mid term and Final reports would also be translated into Spanish and Portuguese.

Completed

A discussion took place on the practicability of certification schemes for ensuring that timber is produced from authorised and sustainable sources, as discussed in the report’s summary of the Phase 1 recommendations. This issue will be explored further in Phase 2.

Will be examined in Final Report as part of Flanking Measures.

Comments and Responses - Website Civil Society Comments Consultants’ Reply ALOP (Latin American Association of Development NGOs

1. welcome the updated statistics and the opening of consultation process with civil society groups in Mercosur

2. Absence of translations into Spanish and Portuguese

Noted An abridged version of the Inception report was translated into Spanish and Portuguese for the Montevideo meeting with civil society. The translations were put on the


3. Time available before the public meetings for consultees to respond to the reports should be increased

4. The criteria used to select stakeholders for the

consultation process in Mercosur needs clarification. We would like to point out the need to include other civil society actors that can contribute to the quality of the study.

5. The Final Overview mid term report should update not only the Phase 1 Preliminary Overview but also the recommendations and comments made by civil society during the consultation process of Phase 1

6. The Mid term report should include the phase 1 sector

reports

7. We welcome the identification of priority areas such as rural livelihoods and potential impact on the Mercosur regional integration process.These should be given high importance and specific attention in the Overview report

8. The considerations in section 5.4 on the legal status of Mercosur treaties in Mercosur countries should be revised

9. We have concerns about the one-off consultation process in Mercosur and also with the way in which participants were selected. We encourage DG Trade to continue promoting the regional consultation workshops, paying particular to those elements that affect the effectiveness of the stakeholders’ participation in Mercosur countries.

project website Noted Civil society were invited to propose names for the Montevideo meeting. The organisations proposed were supplemented by organisations/individuals on the project’s expert data base. The consultants would welcome additional names for inclusion in the consultation and dissemination contacts database We have endeavoured to include our response to the Phase 1 comments, in the Phase 2 reports. The main findings of the Phase 1 sector reports have been included in the mid term report Both issues are included in the mid term Overview report. We think this comment refers to section 5.3 which is part of the Trade Facilitation inception report. This section will be corrected. Noted.


are very general, within which specific impact indicators are identified in the course of each individual study.

• A discussion took place of the extent to which the results of previous SIA studies had influenced negotiations and their outcomes.

presented an update on the EU-Mercosur negotiations from their particular perspectives. In the subsequent discussion several key points were made.

• It is now 13 years since the two regions formally engaged in 1995. Significant progress in the EU-Mercosur negotiations was made after the EC negotiating mandate was agreed in 2001, but since 2004 talks have continued at a general level only, partly because of uncertainty in the outcome of the multilateral Doha negotiations.

• A conclusion to the Doha round would facilitate re-starting the EU-Mercosur negotiations, but the impasse over the current offers will still have to be addressed.

• The two sides differ in their interpretation of “substantially all trade” as required for WTO compatibility.

• Differences also arise over the extent to which special and differential treatment should be incorporated into the trade agreement, particularly for agriculture.

• Some of the difficulties have arisen because both the EU and Mercosur are large agricultural producers, resulting in significant potential impacts from liberalisation.

• Agriculture is less of a stumbling block than it was, largely because Mercosur is already finding other markets for its exports.

• Bigger issues arise for manufacturing and services, for which concerns arise in Mercosur over the influence on industrial structure. Public procurement issues are important in this context. Some of the EC requests cannot be accommodated without constitutional reforms, notably in Brazil.

• The global changes that have occurred since 1995, including the increasing economic influence of China, climate change, pressures on energy supplies and rising food prices, may necessitate a fundamental re-evaluation of the motives for EU-Mercosur collaboration. The two regions need to identify their common ground for acting in partnership in the new global context.

The consultants presented a summary of the Phase 1 SIA findings. The following points were raised in discussion.

• It was not clear how the effective tariff rates given in Table 3.7 of the Overall Preliminary SIA for Phase 1 had been calculated. The consultants gave a brief explanation.

• It was pointed out that many of the measures listed in Table 3.10 of the report should be described as Non-Tariff Measures, not Non-Tariff Barriers. Many similar measures are applied by the EU. The report is unbalanced in presenting this table for Mercosur without a corresponding table for the EU. This would be rectified in the final overview SIA report.

• It was noted that complex issues arise with some of these measures, such as export taxes on raw hides. The aim of many of these measures is to assist Mercosur’s transition to environmentally sound high added value processing activities.

• A discussion took place of the extent to which the final stage of the study would address particular industrial sub-sectors, particularly in the smaller countries of Uruguay and Paraguay. The consultants stated that Phase 2 would not re-visit the work that had already


been done on this in Phase 1, although it would be possible to incorporate any additional information which delegates could provide.

• It was pointed out that the effects of services liberalisation could vary significantly between the member Mercosur states.

• It was noted that the economic model suggests large impacts in Paraguay, which may be associated with inadequacies in the data. For example, the model may not take full account of intra-Mercosur trade in Paraguayan imports of electronic goods.

• The calculations that had been done on greenhouse gas emissions and energy balance for different types of biofuels were briefly described, including fuels derived from Mercosur sugar cane and EU sugar beet.

• A discussion took place on the equations used in the CGE model. These are described in Annex 4 of the overall SIA report.

• It was suggested that the SIA recommendations could include making certain obligations conditional on development objectives being achieved. It was pointed out that this would make it difficult to make reciprocal commitments, and that all countries experience difficulties in meeting their social or environmental objectives.

• It was argued that the recommendations for monitoring should not include establishing a new monitoring body, whose effectiveness might be limited by the existence of many other regional institutions.

• The monitoring recommendations should include both Mercosur and the EU for implementing trade facilitation measures, with a high degree of transparency (e.g. published on the internet).

• The influence of production chains on impacts was stressed, particularly in relation to poverty. These had been examined in some depth in the Phase 1 sectoral studies.

• Impacts on social cohesion were discussed. The studies had addressed this indirectly through analysis of distributional effects and recommendations for appropriate flanking measures.

• Proposals are currently being developed for the 2007-2013 EU-Mercosur Cooperation Programme which are relevant to the SIA recommendations. Linkages between trade and development assistance are now better than they have been in the past, and efforts are being made to strengthen them further.

• It was suggested that the recommendations should include measures to enhance Mercosur investments in the EU, which lag behind outward investment in the US and other countries.

Wednesday 21 May

• The consultants summarised their proposals for the key sectors and sustainability issues to be examined in Phase 2 of the study, as described in the Inception Report. The following points were raised in the subsequent discussion.

• The extent to which Venezuela might be included in the analysis was discussed. Regional issues such as energy supply may for example be covered in the final overview SIA, for which the role of Venezuela would be significant. An analysis of energy supply issues might also include liberalisation of oil services, which would be relevant to Venezuela. It may also be practicable to update the Phase 1 assessment from documents which delegates might provide, e.g. for the automobiles sector.

• There was strong support for including energy issues in the study.


• It was suggested that an impact assessment should be carried out for overall EU energy policy. It was noted that this will already have been done to some extent, since all major EU policy proposals require an impact assessment under the EC’s IA procedures. [Note: EU policy proposals and their impact assessments may be downloaded from http://ec.europa.eu/governance/impact/practice_en.htm. The EU does not yet have an overall energy policy, but a step towards developing one was taken with the Strategic EU Energy Review of January 2007. This was accompanied by an initial IA screening. Fuller impact assessments have been undertaken for specific aspects of EU energy policy, including an IA of the EU Biofuels Strategy, which is referenced in the ethanol case study of the Phase 1 Agriculture Sector SIA.]

• The relationship between financial services liberalisation and instruments such as Banco del Sur was discussed. This would be examined in the study.

• Extensive discussion took place on the role of small and medium sized enterprises (SMEs) in Mercosur in relation to trade facilitation. It was stressed that the impact on SMEs was just one of many aspects that would be assessed in the study. Others included the likely cost savings and implementation costs of an EU-Mercosur agreement on trade facilitation as distinct from those of unilateral action, the effects of such an agreement on EU-Mercosur trade and intra-Mercosur trade, the effects of exposure to greater import competition, the influence on investment, employment and growth, and associated social and environmental impacts.

• A clear distinction should be drawn between the relatively small number of SMEs that export directly (e.g. precious stones), and the much bigger number that are part of the supply chains of large exporting companies. A great deal of technology and local design is involved for many cases.

• Impacts on non-exporting SMEs should also be examined.

• The availability of credit to small farmers was argued to be a major issue. Large agricultural enterprises do not necessarily create jobs or provide high wages and working conditions.

• It was noted that problems have arisen over rules for loan collateral, for example in Paraguay. It was requested that the study should examine the potential influence of financial services liberalisation on this issue.

• Some aspects of the Inception Report chapter on financial services present an unbalanced perspective in relation to the interests of the banking sector and those of the economy as a whole (e.g. item 2 on page 40).

• The Inception Report is not fully up to date in relation to implementation of Decision 54 on the Common External Tariff. The analysis should reflect the considerable amount of work that has been done on the issue, for which information is available from the Mercosur Secretariat in Montevideo.

• It was noted that full implementation of Decision 54 is primarily an internal issue for Mercosur. However, it may have significant influence on the impacts of EU-Mercosur liberalisation.

• It should be noted that harmonisation of standards is not complete in the EU, which presents problems for Mercosur exporters similar to those faced by EU exporters. The study should reflect an appropriate balance.

• It was requested that the study should take account of the impact of the financial crisis in the EU (and US) on the banking sector in Mercosur. Liberalisation of financial services


between the EU and Mercosur is likely to necessitate the development or strengthening of joint mechanisms for ensuring joint financial stability.

• The study should examine the impact of financial services liberalisation on asymmetries between the funding of EU companies investing in Mercosur and Mercosur companies investing in Europe.

• A discussion took place on the relative importance of animal welfare (identified in the Inception Report as a priority issue) and human welfare. Key issues include poverty, employment, literacy and structural unemployment.

• Civil aviation services were suggested as a candidate for further study. Mercosur airlines are all privately owned, whereas several in Europe benefit from state involvement.

• It was asked that gender impacts in services should receive further study.

• Liberalisation of trade in organic agricultural products was another candidate for study. It has high labour content and benefits small farmers. It is however a niche market.

• Trade in genetically modified products might also be examined. A discussion took place on the volumes, prices, trade barriers and certification costs for Mercosur exports of GMO and non-GMO soya and soya bean cake to the EU and China, for human use and as animal feedstocks.

• There is considerable evidence of adverse environmental impacts from soya production (deforestation, water pollution, biodiversity loss).

• The MERCOPOL study on agricultural impacts includes in in-depth analysis of effects in rural areas. The consultants would make full use of this in Phase 2.

• Further study on biofuels should take account of interactions with food prices, the influence of trade liberalisation on the food crisis and the complex relationships between sugarcane production and deforestation.

• Forestry issues include carbon sequestration and the impacts of the paper and pulp industry as well as deforestation. These had been examined in the Phase 1 forestry SIA, and a detailed case study on the paper and pulp industry had been considered. It was noted that there are significant differences between the EU and Mercosur forestry industries. Much EU forestry is on state owned land, and the Mercosur industry tends to use faster growing trees.

• Co-financing between the EU and Mercosur for carbon sequestration in forestry should be considered.

• Joint funding was also suggested for promoting linkages between Mercosur SMEs and global supply chains (e.g. in the automotive industry).

• Flexfuel technology presents another opportunity for cooperation. A large proportion of Brazilian cars are flexfuel, but in Europe it is only used widely in Sweden.

• On greater integration within Mercosur the question arises of whether the trade agreement can help to accelerate integration, or Mercosur needs to integrate in order to prepare for and benefit from the trade agreement. The study might examine this.

The organisers and consultants thanked delegates for their extremely helpful contributions. Any comments which delegates would like to reinforce in writing would be most welcome. Delegates were also asked to send any supporting research reports or other documents which they would like to be taken into account in the final stage of the SIA.


University of Manchester 30 May 2008 It has not been possible in the time available, to incorporate all comment made at the Montevideo meeting in the mid term report. The Final Report will address each of the points made at the Regional Public Consultation Workshop. 8.2 Ongoing Consultation Process Dialogue with stakeholders will continue to cover all the areas of the trade negotiations. The principal mechanism for achieving this is through the Experts Network database which has been accumulated through the SIA programme. This includes stakeholder organisations and individuals in the European Community member states and Mercosur, including experts with knowledge in a wide range of environmental, social and economic areas. Electronic communication with stakeholder representatives is being supported by the posting of reports and other information on the project website, and through the website’s feedback facility and email correspondence with participants. Direct dialogue with stakeholders will continue to be pursued through attendance at international events involving civil society and governmental representatives. The contractor has continued to run the open access website at www.sia-trade.org. The existing database of nearly 1300 stakeholder organisations and individuals was used to distribute electronically an announcement of the commencement of the current phase of the work programme. All interested parties, whether individuals or organisations have been invited to participate in the current phase of the SIA programme, using the dedicated email address for comments – [email protected] The contractor will continue to respond to the comments received, using the feedback-comment function that is incorporated in the website to facilitate dialogue with stakeholders and other interested parties. 8.3 Networking and Dissemination Activities The contractor has continued to engage in the wider policy debate on issues relating to trade policy analysis, impact assessment and sustainability impact assessment. And to disseminate the results of the SIA work through publications. . Publications: George C. and B. Goldsmith eds. (2006) Impact Assessment and Project Appraisal .Vol. 24, December, Special Issue on ‘Trade Assessment and Sustainable Development’. Kirkpatrick C. and C. George (2006) ‘Methodological Issues in the Impact Assessment of Trade Policy: Experience from the European Commission’s Sustainability Impact Assessment (SIA) Programme’. Impact Assessment and Project Appraisal, vol. 24, December. George, C. (2007)‘Sustainable Development and Global Governance’.Journal of Environment and Development.


Franz J. and C. Kirkpatrick (2007) ‘Integrating Sustainable Development into European Policymaking: The Role of Impact Assessments’.Journal of Environmental Assessment Policy Management, vol.9, no.2, June, pp.1–20. Franz J. and C. Kirkpatrick (2008) ‘Improving the quality of integrated policy analysis: impact assessment for sustainable development in the European Commission’ Evidence and Policy, 4, 2, May Iwanow T. and C. Kirkpatrick (2007) ‘Trade facilitation, regulatory quality and export performance in developing countries’ Journal of International Development. George C., T. Iwanow and C. Kirkpatrick (2007) (forthcoming) ‘EU Trade Strategy and Regionalism: Assessing the Impact on Europe’s Trading Partners’ in De Lombaerde P. and Schulz M. eds. The Makability of Regions: An Evaluation of EU Monitoring and Support to Regional Integration Worldwide. Brugge, UNU-CRIS. George C. and Kirkpatrick C.(2008, forthcoming) ‘The influence of the EU’s Sustainability Impact Assessments on Trade Negotiations’ in D. Tussie (ed) The Politics of Trade: The Role of Research in Trade Policy and Negotiations. Brill: Leiden Kirkpatrick C. and Scrieciu S. (2008) ‘The Environmental Impact of Trade and Investment Liberalization: Assessing the Economic Evidence’ Journal of Environmental Planning and Management Stakeholders are invited to comment on this Consultation Draft Mid Term Report, and comments and suggestions can be sent to the project email address;

[email protected]


9. CONTENT AND TIMETABLE FOR FINAL REPORT The Final Overview Report will provide a comprehensive synthesis of the results of the Phase 1 and Phase 2 reports, including the sectoral studies currently being carried out for trade facilitation and financial services. Particular attention will be given to the development of proposals for flanking measures and policy recommendations. It will also describe any developments to the SIA methodology and will give a detailed description of the consultation process, including comments received and responses given by the consultants. The provisional timetable for the Final Report is: - Draft Final Report: October 2008 - Revised Final Report: November 2008


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Table 2: Indicators Modelled in the CETM Core Indicator Output from the CETM Economic indicators Real Income Savings, Consumption, Expenditure Fixed capital formation Indication of the incentives to invest and build up capital stock Employment General and per sector Social indicators General General information on sectoral and country-level effects

(expansions and declines) Equity Wage effect for skilled and unskilled labour Environmental indicators General General information on sectoral and country-level effects

(expansions and declines) Environmental quality Energy usage and CO2 emissions The model calculates impacts on a wide range of economic variables for each individual country, including:

Economic welfare (measured as equivalent variation) Real income Total employment Employment by sector and skill-level Real wages Return on capital Economy-wide value added (GDP) Value added by sector Real prices for both domestic and imported goods and services Output and market sizes for goods and services Imports and exports by sector Tariff revenues Energy usage CO2 emissions

The CETM can also analyse the distributional effects of macroeconomic and sectoral effects following trade reforms. The outputs include quantitative changes in real wages and sectoral employment for skilled and unskilled labour. The results will show in which sectors jobs will be lost, in which sectors employment will increase, and the aggregate effect on wage levels for skilled and unskilled workers in each country. The model will therefore provide a direct first insight into where the most crucial social effects can be found, giving focus for the subsequent social impact analysis. The focus of the environmental modules in the CETM is energy usage (electricity, oil, coal, gas) and greenhouse gas emissions (CO2). The GTAP energy data set (EDS) is used, which covers among other variables the quantity of energy usage by energy commodity and energy use class. The energy and CO2 impacts of international transport are also included in the model. The GTAP6 database provides the majority of the data for the empirical implementation of the model. The database is the most recently updated source for internally consistent data on production, consumption and international trade by country and sector on a global level. It is based on detailed national accounts and balance of payments data from both national sources and international organisations. Compared to previous versions of the GTAP database,


version 6 includes several important improvements with respect the EU-Mercosur context, all of which are incorporated in the CETM:

• improved domestic databases for Argentina and Brazil • improved treatment of data on services trade • improved tariff coverage using MAcMaps data on preferential rates

The GTAP6 database originally consists of 57 different sectors and 87 regions; however, a practical maximum of sectors and regions in a general equilibrium analysis is less. As a minimum, each of the four Mercosur countries will be modelled separately, along with the EU15, the new member states, the USA, Canada, the rest of the Free Trade Area of the Americas (FTAA), and the rest of the world. Paraguay is not incorporated directly in the GTAP database. As a proxy for Paraguay we use the GTAP region “Rest of South America”, a group of countries consisting of Paraguay, Guyana and Surinam. The two latter countries together account for 20 % of total GDP in this group, while Paraguay accounts for 80% of total GDP in these three countries. Hence, we think that using this group of countries will provide a good approximation for the effects on Paraguay, but we will keep the approximation in mind when analysing the results. Table 3 shows the sector aggregation in the CETM model. The 57 sectors from the GTAP database have been aggregated into 25 sectors reflecting the most common goods traded in the Mercosur region. For instance, agricultural products are among the most exported goods from Mercosur to the EU, while motor vehicles and transport equipment are important import goods. Besides the agricultural and manufacturing sectors, the service sectors are important. For all four Mercosur countries more than 50% of total value added stems from the service sectors and the main part of the labour force works in these sectors as well. Table 3: Sector aggregation in the CETM model Sector GTAP sector Corresponding ISIC/CPC

codes Vegetables, Fruits, Nuts

Vegetables, fruit, nuts; CPC 012-013

Oil Seeds Oil Seeds CPC 014 Other Agriculture Oil seeds; Sugar cane, sugar beet;

Plant-based fibres; Crops nec Paddy rice; Wheat; Cereal grains nec. Bovine cattle, sheep and goats, horses; Animal products nec; Raw milk

CPC 015-017, 019, CPC 0111-0116, 0119, CPC 0211-0212, 0291-0295, 0297-0299

Forestry Forestry CPC 03 Fishing Fishing ISIC 015 Energy, minerals Coal; Oil; Gas; Minerals nec ISIC 101-103, 111-112, 12-

14 Meat Products Bovine meat products; Meat

products nec; CPC 21611-21620, 21132-21260

Sugar Sugar CPC 1542 Food Products Vegetable oils and fats; Dairy

products; Processed rice; Sugar; Food products nec; Beverages and tobacco products

CPC 216-218, 22-25

Textiles and wearing

Wool, silk-worm cocoons; Textiles; Wearing apparel; Leather products

CPC 0296, ISIC 17-19, 243

Wood and paper Wood products; Paper products, ISIC 20-22



publishing Petroleum, coal products

Petroleum, coal products; ISIC 23

Motor vehicles and parts

Motor vehicles and parts ISIC 34

Transport equipment Transport equipment nec ISIC 35 Electronic equipment

Electronic Equipment ISIC 32

Machinery Machinery and equipment nec; ISIC 29-31, 33, Other Manufacturing products

Chemical, rubber, plastic products; Mineral products nec; Ferrous metals; Metals nec; Metal products; Manufactures nec

ISIC 24-25, ISIC 26-28, 36-37

Electricity, gas, water

Electricity; Gas manufacture, distribution; Water

ISIC 40-41

Construction Construction ISIC 45 Distribution services Trade ISIC 50-55, Communication Communication ISIC 64 Transport service Transport nec; Water transport; Air

transport ISIC 60-63

Financial services Financial services nec; Insurance ISIC 65-67 Business services Business services nec; ISIC 70-74 Other services Recreational and other services;

Public Administration, Defence, Education, Health; Dwellings

ISIC 75, 80, 85, 90-99

Source: Copenhagen Economics and GTAP database ver. 6 For tariffs on agricultural and non-agricultural goods, the CETM includes a set of consistent and exhaustive ad valorem equivalents (AVEs) of applied border protection across the world. The data originates from the MAcMap database, which is the result of a joint effort by the International Trade Centre (governed by UNCTAD and WTO) and CEPII. The source information concerns various instruments, such as specific tariffs, mixed tariffs and quotas, which cannot be directly compared or summed, and which are not readily usable in a CGE model. Therefore, each instrument is converted into an AVE. Importantly, the model replaces the standard tariff information in GTAP. In the standard information the detailed tariffs for individual products are aggregated into GTAP sector level with a simple import-weighted average, which gives insufficient weight to high tariffs, due to their distorting nature. For example, an extremely high tariff reduces imports to zero, which results in a weight of zero in a simple import-weighted average. We will therefore use a tariff data set based on region-group clustering aggregation (for more information, see Bouët et al, 2006). The welfare effects of agricultural and non-agricultural liberalisation will be identified separately. Although the GTAP6 database provides improved data on services trade, the data remain burdened with considerably more uncertainty than for trade in goods, and the modelling of services barriers entails a particularly high degree of approximation. For this reason, the CETM model will be used only to give a broad indication of the possible magnitude of the economic impacts of the agreement on services, for comparison with other estimates available in the literature.

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FINAL OVERVIEW TRADE SIA EU-MERCOSUR · Food and Agricultural Organization of the United Nations . FDI : Foreign Direct Investment . FLEGT : Forest law Enforcement, Governance and