Trouble ahead for Argentina-Brazil relations?
Argentina and Brazil, the two largest South American economies, have been politically in step for most of the past two decades. Now, however, a parting of the ways looks probable. Last year, the Brazilian electorate swung to the populist far right, electing Jair Bolsonaro as president. In contrast, Argentina's voters appear ready to swing back towards the populist left. Although a surprise outcome is still possible, it is likely that, from December, when Argentina's new government takes office, bilateral relations will be in the hands of Mr Bolsonaro on the right and Alberto Fernández on the (centre) left, two ideological opponents with very different world views. For now, we assume that pragmatism will prevail in bilateral relations. Nevertheless, the implications for trade and the pattern of economic development in both countries could be significant.
Helped by the global commodities boom, both Argentina and Brazil experienced a rising electoral "pink tide", with the populist Peronists ruling Argentina in 2003-15 and the centre-left Partido dos Trabalhadores (PT) running Brazil in 2003-16. As economic difficulties and corruption eventually destroyed those left-wing political projects, for three years (2016-18) it looked as if the two countries would instead follow a shared path of moderate centre-right policies. Argentina's economic crisis has now altered that path. After trouncing the incumbent president, Maurici Macri, inthe August primary election, Mr Fernández is the favourite to win the presidency on October27th
War of words
Argentina's primaries were quickly followed by a war of words. Mr Bolsonaro branded Mr Fernández and his vice-presidential running-mate, former president Cristina Fernández deKirchner (2007-15), as "left-wing criminals" and suggested that, if they took power, Brazil might have to cope with a wave of Argentinian refugees, just as it now faces an inflow of Venezuelans fleeing an authoritarian left-wing regime in Caracas. The Brazilian economy minister, Paulo Guedes, said that if Mr Fernández were to take office and close Argentina's economy, Brazil would leave Mercosur (the four-country free trade bloc, which also counts Paraguay and Uruguay among its members). Not to be outdone, Mr Fernández countered that Mr Bolsonaro was a "violent and racist misogynist". This did not look like a good beginning.
However, Brazil's threat to leave Mercosur appears more rhetorical than real. Mr Bolsonaro's style is to provoke and antagonise perceived ideological adversaries, as a way of firing up and rallying his supporters. But there are multiple ways in which withdrawing from Mercosur could harm the Brazilian economy. The Brexit experience in Europe shows that tradebloc disengagement can be longer and more complex than many politicians expect. Although Brazil is by far the largest economy in the bloc, un ravelling the Mercosur tariff regime, along with visa and passport-free travel arrangements, could create a periodof extended uncertainty for Brazilian exporters and importers, as well as posing a significant threat to jobs.
Argentina is Brazil's third-most important trading partner, after China and the US. Critically, because of zero-rated internal tariffs, it is a captive market for Brazilian value-added manufactures, products that struggle to compete on international markets. Brazil desperately needs to become more competitive. To achieve this, Mr Guedes is pursuing a range of long-term structural reforms. One of these is the recently announced Mercosur-EU free-trade agreement (FTA), laboriously negotiated over the better part of two decades. This FTA would provide phased tariff reductions to allow Brazilian companies to adjust gradually to the more competitive and open international trade environment. It would therefore be counterproductive for Brazil to ditch Mercosur, the chosen vehicle for that adjustment, precisely at the point when it could begin to deliver better integration into the world economy.
Admittedly, the EU could fail to ratify the FTA because of European concerns over environmental protection in the Amazon and protectionist sentiment over agricultural trade. Nevertheless, even putting the Mercosur question to one side, bilateral trade is important toboth parties. In 2018 Argentina's exports to Brazil totalled US$11.3bn, and the value of Brazil's exports to Argentina amounted to US$14.95bn, producing a surplus of almost US$3.7bn in Brazil's favour. However, the recession in Argentina is taking a toll and Brazil's bilateral trade surplus could evaporate. Brazilian exports to Argentina are reported to have fallen by 40% in the first eightmonths of this year. Brazilian automotive exports to Argentina fell by 53% in the same period.
A recent study by FGV, a Brazilian think-tank, suggests that Argentina's current recession could shave 0.5percentage points off Brazilian GDP growth next year. Although Argentina is undoubtedly important to Brazil, the Brazilian economy is three and a half times larger than Argentina's. Brazil is even more important to Argentina (it is Argentina's leading trade partner, ahead of both the US and China).
Business lobbies in both countries have highlighted this mutual dependence, and this may have persuaded the politicians to lower the temperature of their rhetoric. After his sharp criticism of the Brazilian president, MrFernández was relatively swift to move to a more conciliatory position, saying that he did not plan to close Argentina's economy and that continuing membership of Mercosur was "central" for his country. On the Brazilian side, the pragmatic vice-president, HamiltonMourão, also signalled that Brazil would seek to maintain its trading relationship with Argentina irrespective of who wins the Argentinian elections.
Perhaps anticipating future bilateral uncertainties, officials on both sides appear to have rushed to sign a new automotive industry agreement. Under the so-called flex agreement, there is a limit on Brazil's exports of tariff-free vehiclesand components to Argentina of 1.5times the amount Argentina sends to Brazil. It had been due to expire in June2020, ushering in unrestricted free trade in vehicles and autoparts. Given that the Brazilian assembly plants enjoy greater economies of scale, in the short term unrestricted free trade could have had a severe impact on Argentina's assembly plants and employment levels, and even sparked an early crisis in relations between Mr Bolsonaro and a newly installed Mr Fernández. The new agreement defuses that point of tension. It has been agreed that the "flex" will go up to 1.7 in favour of Brazilian automotive exports in June2020, rising further in stages to 3.0 by July2028, with full free trade in the sector coming into effect in 2029. This schedulehas been designed to dovetail with the terms of the EU agreement, which sees tariffs on imports into Mercosur of European-made vehicles and parts—currently set at 35%—reduced in phases over a ten-year period.
A return to protectionism?
It is still early to judge how two ideological opponents could end up managing bilateral relations in 2020 and the following years. But it is important to place this in a historical and strategic context. For much of the 20th century, Brazil and Argentina saw themselves as rivals for the diplomatic leadership of South America. Under military rule in the 1970s, a period that has deeply influenced Mr Bolsonaro (a former paratrooper), the two countries vied for advantage in hydroelectric and nuclear programmes. From the 1980s onwards, civilian governments then steered towards a new period of greater co-operation, marked by the foundation of Mercosur in 1991. This did not preclude the introduction of a series of non-tariff barriers on the back of increasing protectionism during Ms Fernández's presidency, but relations have been markedly better than in much of the 20th century. The era of co-operation is not necessarily over, but as Brazil in particular seeks to redefine its diplomatic role, there are signs that it is moving to prioritise trade relations with major economies outside Mercosur.
In practice, the first effect could be to slow Mercosur's recent progress in pursuing FTAs and to put paid to any near-term aspirations of, for example, deeper regional integration via an alliance between Mercosur and the freer-trading Pacific Alliance countries of Mexico, Colombia, Chile and Peru. A return to protectionism by Argentina could see non-tariff barriers ratchet up, ultimately to the detriment of trade and economic activity both there and in Brazil. We have not pencilled in such a scenario to our economic forecasts for either country, but the risk is clearly growing.