February 4, 2016 Samuel George, Cornelius Fleischhaker

Brazil & Mega-Trade Deals

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A number of major economies in Latin America are not participating in the mega-deals. However, since the proposed agreements include many of their key trading partners, outsiders will still be effected. In this blog post, we have a look at how this could affect the region’s largest economy: Brazil.

In the 1990s, Brazil enjoyed a period of trade liberalization. However, at the time, it tied itself to MERCOSUR, whose charter does not permit bilateral agreements between member states and nonmember countries.

Consequently, Brazil is not a member in any of the mega-deals and has not concluded any significant free trade agreements in the last 20 years. The economy thus remains comparatively closed, with increased commodity exports when market conditions are favorable, and rendering the non-commodity sector ever more dependent on a protected market at home and within MERCOSUR.

MERCOSUR continues to dominate Brazilian trade policy as it provides the basis of the bilateral relationship with Argentina, an important political partner and the largest market for Brazil’s manufacturing exports. However, Argentina’s protectionist leanings in recent years have prevented integration efforts between MERCOSUR and others.

Brazil itself has a conflicted attitude to trade, maintaining relatively high tariffs and high non-tariff barriers such as local content requirements in key industries. However, most recently, signs are emerging that the government is becoming more open to integration. A growth slowdown since 2011 and the current deep recession have once again exposed the competitiveness problems of Brazilian manufacturing and increased exposure to volatile commodity prices. The government is moving towards trade facilitation and is pushing for the completion of the MERCOSUR-EU agreement. Brazil recently supported Uruguay in a push to allow more flexibility for MERCOSUR members to pursue agreements with outside countries. This would be a way to circumvent the restrictions of MERCOSUR, rather than waiting for reluctant members to engage in MERCOSUR-wide agreements.

How will mega-deals effect Brazil?

The overall estimated effects of the mega-deals on Brazil’s welfare are rather small. This is mostly due to the closed nature of the Brazilian economy, where total trade (exports plus imports) represents less than 30 percent of GDP. Nevertheless, the structure of Brazil’s trade would be significantly affected by trade deals in which it does not participate. Overall, the mega-deals, with the exception of the FTAAP, would leave Brazil even more isolated in global trade, and ever more reduced to an exporter of commodities. In the case of the FTAAP, Brazil would benefit positively from the overall increase in world trade and GDP and in particular from the involvement of China. In recent years (2003-2011), trade between Brazil and China has grown exponentially, turning the Asian giant into Brazil’s top export destination. Under the FTAAP, Brazil’s exports to China are expected to grow by an additional 84 percent relative to the 2007 baseline.

TPP: A double-edged sword?

Brazil’s exports to China are also expected to grow moderately under the TPP (4.4 percent), supporting the notion that mega-deals strengthen ties between two large outsiders. This stems from a redirection of trade flows in many sectors. For example, the trade liberalization and regulatory convergence of the 12 member countries in the agricultural segment of the Trans-Pacific Partnership (TPP) will cause a strong deviation from Brazil’s trade flows to Asia in favor of competitors from the US, Canada and Australia.

However, any gains in exports to China under a TPP scenario are outweighed by significant losses in exports to TPP participants, especially to the US (-6.6 percent) and Mexico (-10 percent).

The results are somewhat different under the TTIP. Here, Brazil is expected to see increased exports to most major European economies (France, Germany, and Italy). Since these countries’ exports of manufacturing goods (machinery, motor vehicles) incorporate Brazilian inputs (especially minerals), an expansion of European production under the TTIP would generate increased demand for Brazilian goods. However, this comes at a cost to exports in other key markets, including to China and the US, with the result that overall trade and welfare effects remain negative.

The only sector of the Brazilian economy seeing significant value-added gains under any of the mega-deals is the mining sector (ranging from 2 percent under the TTIP to 40.3 percent under the FTAAP). Other commodity-intensive sectors such as metals and agriculture would not benefit. Brazil’s clear advantages in these sectors demonstrates the opportunity cost of remaining outside of trade agreements. The fact that other agricultural powers such as Canada or Australia would gain preferential access to important markets such as the EU and Japan would lead to the displacement of Brazilian exports, which would continue to be subject to tariff barriers.

The de-industrialization of the Brazilian economy, ongoing since the beginning of the commodity boom in the 2000s, would accelerate with the mega-trade deals. The Brazilian manufacturing sector, which still accounts for almost half of the country’s exports, is expected to shrink in all scenarios, led by the automobile industry. Even upgraded commodities and semi-manufactured products such as processed food and metals see significant losses. Again, this can be seen as a direct cost of remaining outside of trade deals and value chains, as Brazilian producers should be competitive in these areas if put on an equal footing. The weakening of the manufacturing sector is mirrored by weakening trade with MERCOSUR partners. Exports to Argentina, by far Brazil’s most important export destination in MERCOSUR and the largest market for Brazilian manufacturers, are projected to decline by up to 25.1 percent (under the FTAAP).