The economic integration’s objective is to increase economic efficiency through better economic resource allocation, economies of scale, and regional and international competition. The first part of this paper discusses these economic considerations.

The second part of this paper offers a summary of the historical conditions which led to the establishment of Mercosur. This section discusses the evolution of trade integration in Latin America.

The third part will examine the original objective of the Treaty of Asuncion and what was actually achieved in terms of elimination of tariff and non-tariff barriers, creation of a Common External Tariff, coordination of macroeconomic policies and harmonization of states member’s legislation.

The basic reason that impels a country into international trade is the possibility of obtaining economic advantages. Gains from trade liberalization are generated from economies of scale, comparative advantages and competition.

The country gains by expanding production and exporting the commodity that is relatively more valuable in the foreign market.

Another economic advantage from international trade is the exposure of firms to competition. Competition induces a more efficient use of national resources, and with the possibility of acquiring foreign capital and foreign technology, permits firms to reduce their and to improve quality.

Economic union is a process composed of at least four important stages, following this order: Free Trade Area (FTA), Customs Union(CU), Common Market(CM), and Economic Union (EU).

A Free Trade Area is defined as a situation in which all members of the agreement remove tariffs and non-tariff restrictions on each other’s products without losing their independence in establishing trade policies in relation to third countries. Even in this initial stage, economic integration implies market enlargement and influence in economic allocation of resources between members.

The second level of economic integration is a Customs Union. At this step, a Common External Tariff is adopted , implying that regardless of the importing countries all goods from third countries will be taxed with the same tariff. In the case of Mercosur, if the external common tariff on computers is agreed at 20%, any imports of that product will pay the same tax to enter in the Customs Union, whether the importer is Argentina, Brazil, Paraguay or Uruguay.

Achieving a Customs Union implies in establishing a common trade policy. When the state members commit to this stage of economic integration, they cannot engage in preferential agreements with third countries and, as a consequence, the group usually acts a body in negotiation with non-members

In addition to the traditional forms of economic integration, a third should be mentioned. A Common Market means to aggregate to the three anterior phases a free circulation of labor and capital among members. One can see that at the same time that the level of economic integration progress, a reduction in control of individual economy occurs.

The most advanced form of economic integration is an Economic Union. As the last stage in the process it includes all features of a free trade area, of a customs union and of a common market, and also implies unification of economic institutions and coordination of economic policy throughout all member countries. Even though political entities are still present, they are subject to supranational institutions whose decisions are binding upon all members.

As stated previously, the need to coordinate or to adopt common policies becomes stronger with the evolution of economic integration, or in other words, the need for all members to cede sovereignty in order to avoid isolated actions that could cause distortions in investments or trade flow increases. This political consideration is an important factor that causes delays in the process of integration.

In Latin America, agreements aiming at creating Free Trade Areas, Customs Unions or Common Markets are phenomena originated in the 60’s.

The United Nations Economic Commission for Latin America and the Caribbean’s ideas, concerning economic development in Latin America through commercial liberalization, provided the theoretical base upon was initiated the movement forward major integration among the countries of that region.

Due to the fact that Article I of the General Agreement on Tariffs and Trade (GATT), signed in 1948, established strong support for nondiscrimination, and required that all GATT members benefit from the Most-Favored-Nation clause, agreements that aimed to start a preferential trade area (less than 100% of preferences) were prohibited.

This obstacle was eliminated only in 1973, when the General Agreement on Tariffs and Trade was modified (Tokyo Round), permitting that preferential trade areas to be created by developing countries.

The Latin American Integration Association (LAIA), established in 1980, by the New Treaty of Montevideo, in substitution of Latin American Free Trade Association (LAFTA), incorporated the new international trade legal framework.

Although it had the same structure as of the previous association (LAFTA) the Latin American Integration Association presented new objectives. In fact, while the LAFTA intended to create a common market in Latin America in a short period (12 years), the LAIA objective was more modest, prioritizing the establishment of preferential trade systems.

This figure will increase when the negotiation process between the Andean Group and Mercosur is finished. By that time, 92% of the total intraregional trade will be engaged in a free circulation of goods.

The integration process between Argentina and Brazil, which began in the mid-1980s, was the precursor to the Treaty of Asuncion. This momentum is the result of two great changes experienced by these countries to in the 1980s: the transition to democracy and the revision of government intervention pattern.

These changes were not simultaneous, however. The displacement of the military regimes preceded the shift towards trade liberalization. Early movements toward integration during the Alfonsin-Sarney era were made stronger by a strategic political commitment fostering amiable relations between the two countries, after many years of rivalries and potential conflict. Still in the framework of repressive import regimes, these movements rose to an integration strategy.

In July of 1986, the Integration and Economic Cooperation Program (IECP) was established, which aimed at the selective opening of both Brazilian and Argentinean markets.

The next step occurred in 1988 when both countries signed the Treaty of Integration, Cooperation and Development, which sought the establishment of a Common Market by year 2008 through elimination of tariff and non-tariff barriers on the trade of goods and services, and the coordination of macroeconomic policies.

To accomplish these objectives, several protocols were signed during the 1986-1990 period, each one related with specific sectors such as capital goods, food, wheat, industrialized products, automobile, industry, biotechnology, etc.

An important change in the design of integration between Argentina and Brazil came immediately after the presidential changes which brought Menen and Collor to power, altering the framework of trade policies in both countries. Brazil’s decision, in March 1990, to launch a trade liberalization program cleared the way for the integration agreement.

The selective opening of markets on a product by product basis was replaced by linear and automatic tariff reductions. Through the "Ata de Buenos Aires", signed in July 1990, the creation of the Customs Union was anticipated for January, 1995. In December of the same year, Argentina and Brazil formalized those changes as a bilateral agreement in LAIA under the legal framework of the Economic Complementation Agreement NR. 14.

The signing of the Ata de Buenos Aires, followed by the US President George Bush’s speech proposing hemispheric integration, provided the impetus for a high-level meeting between representatives of Argentina, Brazil, Paraguay and Uruguay. The goal of the meeting, which took place in Brasilia in August 1990, was to discuss the idea of expanding the geographic boundary of the Common Market encompass the Southern Cone. This meeting created the conditions for the Treaty of Asuncion forming Mercosur on March 26, 1991.

Through the Treaty of Asuncion, the four signatories decided to form a Common Market on January 1, 1995, that, according to Article I of the Treaty, dictates the free circulation of goods, services and production factors by means of elimination of duties, non-tariff restrictions and other measures with an equivalent effect on trade between Argentina and Brazil by December 31, 1994, and by December 31, 1995 for trade with Uruguay and Paraguay.

They also agreed to establish a Common External Tariff (CET) and in adopting a common trade policy in relation to third countries while coordinating their position in regional and international, commercial and economic meetings.

A third item in the Agreement is the coordination of macroeconomic and sectoral policies among member states - foreign trade, agricultural, industrial, tax, monetary, exchange rate and capital, service, customs, transport and communications- in order to ensure adequate conditions for competition among states members.

The last item of the Pact establishes a commitment by member states to make any necessary legislative adjustments to strengthen the integration process.

Duties are customs rights and tariffs on foreign trade, including fiscal, monetary and exchange charges. The Agreement determined that the duties to be paid on imports can not exceed the approximate cost of services rendered.

In the Mercosur, elimination of tariffs is the object of a progressive, direct and automatic project that will benefit all products subject to taxation in member states, according to the following schedule:

The products protected under these lists reflect the wish of Treaty of Asuncion signatories of guaranteeing to their most important production sectors a longer term by comparison with 1995 for adapting to the new free trade covered by Mercosur.

A Common External Tariff (CET) is a list of products and their respective tariffs to be levied on member states’ trade with third countries. This implies that wherever is the place the merchandise enters in the union it will pay identical taxes.

During negotiations to conform the Common External Tariff there were some divergences related to capital goods, computer and telecommunications equipment. Consequently, in addition to lists of adaptation, lists of exceptions to Common External Tariffs were created. They involve the merchandises mentioned above, whose tariffs will progressively be cut until they reach 14% in 2001 on capital goods, and 16% in 2006 on the others. These lists were formed to permit the Brazilian industries in such sectors to develop the necessary competence to face external competition.

Although Argentina, like Paraguay and Uruguay, had low tariffs on capital goods, computers and telecommunications equipment to allow its firms cheap access to imported technology, the Brazilian objective was to protect its industries. Besides Brazil, none of the three countries have a significant computer and telecommunications equipment production. The agreement reached was for Argentina and the others to raise tariffs, and Brazil to reduce them.

The CET of Mercosur includes more than 85 percent of all commodities. It is based on 11 tariff levels ranging from 0 percent to 20 percent at intervals of 2 percentage points. The arithmetic average, calculated for all products, including those merchandises present in lists of exception reached 11.4 percent with a dispersion level (standard deviation) of 6.22 percent.

Apart from the exceptions agreed to intraregional trade, the exceptions to foreign commerce have a noteworthy importance in the total trade of Mercosur.

Due to macroeconomic instability in the member states some changes on tariffs on important sectors have been agreed to. During 1995, Brazil was allowed by other members to reduce temporally in same cases tariffs on 150 products bellow Common External Tariffs level in order to support its anti-inflation plan or to increase tariffs in such other segments, as cars, toys, electronic, and textile, to equilibrate its Trade Account.

Coordinated macroeconomic and sectoral policies are fundamental to guaranteeing the adequate competition conditions among the state members of Mercosur, as stated in Article I of the Treaty of Asuncion.

Coordinated policies differ from common policies. While the latter means adoption and application simultaneously of rules by all countries, or even by a supranational agent, the former consists of choosing goals but continually discussing and evaluating the goals and their accomplishments.

So far there have been no substantial alterations in the parties’ legislations. The objective of establishing a common code in Mercosur has not been achieved yet. Each member state continuous to follow its own laws legislation concerning imports from third countries. When complains arise over dumping or subsidies in intraregional importation, the decision Mercosur GMC 63/93, extended by decision Mercosur GMC 124/94, establishes a procedure consisting of exchanges of information between the two countries in order to investigate whether the damage suffered by local industries or agriculture results from a cause-effect relation with the imports.

This topic has shown the most important advances. Many decisions have been made by Common Market Council, the highest decision-making group and by the Common Market Group, the main executive body, in favor of a flowing intra-regional commerce.

Elimination of non-tariff barriers does not include any measure taken in order to control the trade of gold, silver, armaments or radioactive products, nor to protect life, health, moral principles, and the historical and artistic heritage.

The most relevant measure adopted in this area was the institution of common rules of origin. Through this legislation any product which has at least 60% of its value added within any member country is considered to have been originated in Mercosur, and thus receives duty-free treatment.

This common legislation makes it for each country to avoid establishing different rules concerning minimum requisites, which create barriers to intraregional the trade.

Up to now, the majority of the measures adopted by Mercosur has been concerned with harmonizing such technical and hygienic standards as the size, labeling, presentation, and so on, of commercialized products.

Through decision Mercosur GMC 20/93 a Common Rule of Technical Norms was created. In the area concerning sanitary control, the harmonized legislation is taking into consideration international standards such as those of the United Nations Food Agriculture Organization (FAO) and of the World Health Organization (WHO).

In December 1995, Mercosur and the European Union signed the Framework Interregional Cooperation Agreement. This agreement is the legal instrument that will eventually lead to a political and economic association between the two Customs Unions. For that purpose, the agreement establishes that the parties will maintain a regular and institutional dialogue in several areas, including trade, investment and the environment.

In June 1996 Mercosur signed a free trade agreement with Chile to form a Free Trade Area in ten years. The products listed as exceptions will converge to become duty-free after 15 to 18 years.

In December 1996, Bolivia and Mercosur signed an agreement to eliminate tariffs immediately on a number of products (400 for Mercosur and 500 for Bolivia). Most of the remaining products will be duty-free in 10 years. As with the Mercosur-Chile agreement, a list of exceptions was formed with tariffs scheduled to be removed in 15 to 18 years.

Establishment of these Free Trade Areas does not mean that either Chile or Bolivia is going to join to Mercosur. It continues to consist only of Argentina, Brazil, Paraguay and Uruguay.

One of the most important policies to ensure the stability of trade relations among the member countries of any commercial agreement is the exchange rate policy.

When trade barriers and obstacles to financial movements are removed, the importance of stable exchange rate increases. If, for any reason, the currency of a country is constantly depreciated in relation to another member state, the latter country probably will face commercial deficits. This situation may induce the damaged country to adopt compensatory mechanisms like increases on tariffs.

The strong economic instability that the Latin American countries experienced during the 80’s, accompanied by huge variations in the exchange rate, has been identified as one of the causes of the failure in projects of economic integration in the region.

Index base: Jan. 86 = 100

Source: Pereira, Lia Valls -- Mercosul: Perspectivas da Integracão, 1996

This figure shows the fluctuations of the Brazilian currency in relation to the other members of Mercosur.

Differences in the level of exchange rate have a great influence over trade flow. The low price of Brazilian currency in relation to the Argentinean currency -- verified up to 1994 -- explains, partly, the continuous Brazilian surpluses in its trade with Argentina.

In fact, the results occurred in the Balance of Trade between Brazil and Argentina follow the same pattern as the variations in the exchange rate. Between 1989-1994, Brazil evolved from a commercial deficit of US $ 528.60 million to a surplus of US $ 523.54 million with Argentina. In the same interval, the average real exchange rate(R$/P$) changed from 57.51 to 146,48.

To ensure stability to relative exchange rates and continuity in Mercosur the coordination of exchange rate policies is a necessity. In fact, differences in exchange rates can be used as a substitute for tariffs, replacing the eliminated barriers to imports.

Even though it is not necessary to utilize a system similar to the one to be implemented in the Europe Economic Union, which involves the creation of a common currency and the election of one of the Central Banks, a coordination of exchange rate policies should be adopted among the Mercosur members.

Even though coordination of exchange rate policy does not dictate that any aspect of sovereignty be renounced by each country, that decisions must be made by consensus within Mercosur brings an additional level of difficulty to reach the coordination of policies . The problem resides in the huge economic differences among the parties. It is difficult to imagine Argentina and Brazil coordinating their exchange rates according to Paraguay or Uruguay’s requirements.

Until now, nothing has been done, in pragmatic terms, to coordinate exchange policies among Mercosur’s members.

Harmonization of fiscal policies means eliminating distortions that influence capital and labor flows through the participating countries.

Depending on the importance of both the differences concerning taxation on profits and the relative prices from economic activities the tax level may cause such distortions. In other words tax levels will depend on investment return rate and the differences in cost production from one region to another.

In the case of economic integration, harmonization among member countries fiscal policy is necessary to avoid competition for international capital or to influence decisions of investments the inside region.

In fact, disputes among some Brazilian States to receive investments on car assembly lines, offering fiscal advantages to achieve that, have caused Argentinean complaints.

Taxes on intraregional trade are being gradually removed and soon will not be an issue to economic allocation of resources. On the other hand nothing has been done to harmonize fiscal policy related to the internal taxation on services, revenue and consumption.

Two protocols regulate investment in Mercosur: The Protocol for Reciprocal Promotion and Protection of Investments concerning non-member countries and the Colonia Protocol normalizing investments among member states. Capital can move freely from one place to another. Investments by partners are granted treatment no more favorable than the treatment granted to investors from the receiving country or from third countries.

The decision Mercosur/CMC/DEC 08/93 enacts the Minimum Regulation for Capital Markets, eliminating all restrictions to movement of capital were the investors are persons or companies resident or domiciled in the territory of any member state.

The same issue, now concerning investments from non-member states, was regulated by Decision Mercosur CMC/11/94. Through this decision investments from third countries were guaranteed the same favorable conditions as the treatment granted to investments within Mercosur.

Until the late 80’s the majority of Latin American countries used to adopt an economic development pattern based upon import-substitution, that meant to protect the national economy against external competition.

The new economic development strategy embraced by Argentina, Brazil, Paraguay and Uruguay is based on intraregional and international competition by means of gains in economies of scale and specialization in a larger internal market.

This new model demands a definition about convergent industrial policies to assure long-running sustainability to the integration process.

Industrial policy means to ensure macroeconomic conditions to competition through exchange rate stability, technology policy, government expenditure and commercial policy.

Exchange rate stability, as affirmed above, is necessary to avoid interference in the trade flow and in the relative competitiveness among the member countries.

Technology policy is related with creation of infrastructure, education supply, energy power, telecommunication systems and investment in research and development as a means to equalize the conditions to competition among enterprises

Government expenditure as an important component of the total demand in the economy can be used to foster competition if it was permitted that firms from all member countries participate in the government bidding system.

The commercial policy, specifically the Common External Tariff, should be used to equalize the competitive conditions in the integrated area and at the same time to incentive a higher productivity, avoiding development of inefficient industrial structures under exaggerated protection. It signifies to insure adequate protection levels to regional production, permitting utilization of advantages that were created by the common market, as well as equitable distribution of these benefits.

These policies are responsible for the maintenance of a opened and competitive market that receives competitive pressures as an element that forces the adoption of microeconomic strategies aiming at structural adjustment of industry.

Up to now, Mercosur has not taken any measure of either coordinated or common industrial policy. On the contrary, the Common External Tariff has been used in the four countries to protect inefficient sectors that do not have conditions to face intraregional or international competition.

Harmonization of internal legislation is closely related to advancements in coordination of economic policies. As stated above, the majority of the measures that have been taken within the ambit of Mercosur is related to standardization of both technical issues, hygienic procedures and rules of origin.

However, there is a relevant measure taken by Mercosur. By means of decision Mercosur CMC/25/94 the member countries approved Mercosur Customs Code, based on WTO rules, that is a common administrative code giving definitions, regulating custom procedures, setting up rights and obligations to both importer and Administration and establishing hypotheses of infraction and their penalties.

It is important to note that a decision made by Mercosur does not have immediate effect on the member countries. nce Mercosur was not built with supranational institutions with power to bind their decisions, all new rules need to be approved by each Congress. This manner, many of the regulations agreed within of Mercosur may not be in force in the states parties.

Up to now, Mercosur has been a commercial and political success. It has been able to increase significantly intra-regional trade and to tight political ties among the four countries. In the period 1991-1995, the flow of goods and services between Brazil and Argentina, the two most economically important countries, surged 44% on average in the case of Brazilian exports to Argentina and 32% concerning exports from Argentina to Brazil.

It also has worked to strengthen democracy in the region. When in April 1996 Paraguay’s army tried a coup d'état, Mercosur’s foreign ministers declared that since democracy is a formal condition to be a member Paraguay would face diplomatic and economic isolation.

In contrast, coordination of economic policies is progressing at a slow pace. Elimination of non-tariff barriers is not enough to guarantee the continuity of integration process in the long-run.

Without coordination of fiscal and industrial policies, industrial activities tend to concentrate in areas that present better both infrastructure and services, increasing the existing development disparities among member countries.

Although many agree that macroeconomic policies are less urgent, changes in commerce flow due partly to fluctuations in exchange rates and the war of fiscal incentives to attract foreign investments show that such coordination is indispensable to sustainable economic integration.