Guilherme Paiva Pinto – External Negotiations and Customs Union Stability

A Question: Why Does Mercosur Stay Together?

Since 1995, Mercosur has kept a common external tariff and an institutional rule that members negotiate trade agreements as a bloc. At the same time, small members repeatedly threaten exit, external negotiations stall, yet the bloc persists.

The paper asks whether reciprocity based external negotiations together with sector level shocks can explain both the slow progress of new trade agreements and the surprising stability of the customs union.

What we see

→ Uruguay publicly questions the rule that Mercosur must negotiate as a bloc
→ Uruguay floats China and United States bilateral deals
→ External talks with China, the United States and the European Union drag for many years
→ The bloc never actually breaks

Why it matters

→ Shapes supply chains for about two hundred eighty million people
→ Stability parallels other regional agreements that look fragile on paper
→ Sector shocks drive political pressure and change who wants external deals

Key insight: Small members gain bargaining power when they stay inside the customs union, while large members fear concentrated manufacturing losses from ambitious external deals. The same forces that make external agreements hard to sign also help the bloc remain intact.

How Mercosur Works

Customs union: internal tariffs are close to zero, common external tariff around ten percent with many product level exemptions.

Recent reforms expand the lists of exemptions to the common external tariff. Brazil plans to move from about one hundred to one hundred fifty tariff lines by 2028, Argentina mirrors this change, Uruguay from roughly two hundred twenty five to two hundred seventy five lines by 2029, and Paraguay from about six hundred forty nine to six hundred ninety nine lines by 2030. The model uses effective applied tariffs so that these exemptions are reflected in the counterfactuals.

0%

Internal tariffs on most goods

With exceptions like automobiles and sugar that keep specific regimes.

~10%

Common external tariff on average

Defined at the bloc level, with important variation across sectors.

480+

Exempted tariff lines

Countries make growing use of exemptions to adapt the common external tariff to domestic political pressure.

Why this is a good laboratory

→ Common rule: external agreements must be negotiated as a bloc
→ Extra bloc partners are large and diverse: China, United States, European Union
→ Many exemptions create heterogeneous protection inside the union
→ Rich policy history: stalled deals, threats of exit, and partial sector exemptions

Short videos with the politics in action

Presidential remarks on Mercosur unity

Debate on Uruguay and China

Mercosur summit excerpts

Who Trades with Whom?

China rises to the main trading partner for all members by 2017, while the United States and the European Union remain important but secondary.

Using GTAP eleven data from 2004 to 2017, the share of China in extra bloc trade rises steadily for every member and overtakes the United States and the European Union by the end of the period. Brazil and Uruguay show the largest proportional increases, Paraguay keeps a stronger focus on intra bloc commerce, and Uruguay maintains a balanced split across the three partners.

Brazil: diversified manufacturing

Argentina: agriculture and industry mix

Uruguay: small, high value agriculture and services

Paraguay: relies more on intra bloc trade

Trade shares for extra bloc trade (qualitative summary)

Between 2004 and 2017, China share climbs for exports and imports of all members, United States share falls especially for exports, and the European Union declines slowly but stays relevant, particularly for Uruguay.

United States: declining share in exports, still important for imports

China: from marginal partner to main extra bloc market

European Union: gradual decline, but key destination for Uruguay

Why Uruguay Gains from Staying

Quantitative simulations in the paper show that when Uruguay negotiates as part of Mercosur it earns sizeable gains from reciprocal deals with large partners. In the Mercosur China bloc simulations, Table 7 reports Uruguay welfare variation between about 0.18 and 0.46 percent over the years 2004 to 2017. In the Mercosur United States bloc simulations, the variation ranges from almost zero to about 0.56 percent, with the largest response in 2004.

These gains come mainly from better access for meat, oil seeds, and other primary exports. The model assigns the main job losses to light manufacturing sectors that have relatively small shares in total production, which keeps the political cost of participation in the customs union more manageable for Uruguay than for the large members.

Welfare gains for Uruguay in the counterfactuals

Counterfactual - Mercosur China deal, Uruguay inside the bloc Welfare gains between about 0.18 and 0.46 percent

Counterfactual - Mercosur United States deal, Uruguay inside the bloc Welfare gains between almost zero and about 0.56 percent

Counterfactual - Uruguay alone with China or United States Additional gains are small once reciprocity conditions and partner reactions are enforced

Why bloc bargaining helps Uruguay

✓ Larger joint market makes reciprocity constraints less binding for Uruguay
✓ Better terms for meat, oil seeds, and other primary exports
✓ Adverse effects fall on small manufacturing sectors with lower production shares

Why unilateral deviations are less attractive

✓ Bilateral deals without the bloc come with weaker partner concessions
✓ Reciprocity conditions restrict how much Uruguay can cut tariffs when it negotiates alone
✓ When the European Union Mercosur agreement is taken as background, the extra gains from solo Uruguay negotiations are even smaller, as the paper shows for the period around 2017

Why Large Members Block Deals and Uruguay Pushes for Them

The Counterfactual negotiation between Mercosur and China using data from 2017 generates small aggregate welfare gains for Brazil but very sharp losses in a few manufacturing industries. Uruguay faces the opposite pattern: sizable gains in a narrow set of export sectors and losses spread over light manufacturing. This asymmetry helps explain why Brazil has strong protectionist lobbies while Uruguay keeps pressing for external deals.

Key sectors under the Mercosur China 2017 scenario (Figure 9)

Numbers below are taken from Figure 9 and the discussion in the paper. ∆L is the percent change in jobs in the sector and ∆LS is the change in that sector share of national employment in percentage points.

Country	Sector	Scenario	∆L (percent)	∆LS (percentage points)
Brazil	Wearing apparel	MS China 2017	−15.35	−0.46
Brazil	Manufactures nec	MS China 2017	−1.68	−0.10
Brazil	Textiles	MS China 2017	−5.42	−0.09
Brazil	Leather products	MS China 2017	−3.35	−0.06
Uruguay	Manufactures nec	MS China 2017	−5.42	−0.49
Uruguay	Wearing apparel	MS China 2017	−33.36	−0.34
Uruguay	Chemical, rubber, plastic products	MS China 2017	−2.80	−0.17
Uruguay	Leather products	MS China 2017	−8.58	−0.16
Uruguay	Meat: cattle and related	MS China 2017	13.90	1.66
Uruguay	Oil seeds	MS China 2017	4.67	0.22
Uruguay	Textiles	MS China 2017	10.99	0.14
Uruguay	Meat: cattle and related	MS United States 2004	19.08	2.37
Uruguay	Raw and processed dairy	MS United States 2004	26.00	1.91

For Brazil the clothing sector alone loses around fifteen percent of its jobs and nearly one half of a percentage point of its share in total employment. Other manufactures and textiles lose around one to five percent of jobs and roughly one tenth of a percentage point of their employment share. Uruguay faces strong contractions in light manufacturing, including apparel, manufactures nec, chemical rubber plastic products, and leather products, yet its largest employment gains come from meat, oil seeds, and textiles. These numbers describe the central trade off in the paper: Brazil has concentrated losses in politically powerful industries, while Uruguay concentrates gains in a few export sectors and spreads its losses over smaller manufacturing activities.