Impacts of FTAA and MERCOEURO on agribusiness in the MERCOSUL countries

Impacts of FTAA and MERCOEURO on agribusiness in the Mercosul countries¹

Luiz A. Cypriano^I; Erly C. Teixeira^II

^IDepartment of Economics, UNIOESTE-Toledo, PR., Brazil; [e-mail]

^IIDepartment of Agricultural Economics, Federal University of Viçosa, M.G., Brazil; [e-mail]

ABSTRACT

Focusing on changes in agricultural policy, this paper examines the economic impacts on MERCOSUL member country economies arising from the creation of the Free Trade Area of the Americas (FTAA) and a free trade area between MERCOSUL and the European Union (MERCOEURO). Four simulations are run using the Global Trade Analysis Project’s (GTAP) applied general equilibrium model. The results suggest these new trade alliances would cause an increase in MERCOSUL agribusiness production and a decrease in MERCOSUL manufactures production. In all simulations, agricultural trade flows are greatly altered and the exportation of MERCOSUL agribusiness products expands. However, the MERCOSUL countries experience overall economic growth in only the MERCOEURO scenarios. The elimination of agriculture production and export subsidies by members of the North American Free Trade Area (NAFTA) and European Union (E.U.) would have strong economic impacts on the economies of MERCOSUL countries.

Key words: FTAA, MERCOEURO, Agribusiness, MERCOSUL, GTAP

1. Introduction

The opportunity to create two new free trade areas is open to the countries of the Common Market of the South (MERCOSUL). One is the Free Trade Area of the Americas (FTAA), which would liberalize trade among MERCOSUL, the North America Free Trade Area (NAFTA), and all the other countries in the Americas. The other, MERCOEURO, would be a free trade area formed by MERCOSUL and the European Union (E.U.). The objective of this paper is to determine the potential impacts of FTAA and MERCOEURO on the MERCOSUL countries’ economies both with and without the removal of agribusiness production and export subsidies.

Agricultural policy is often an area of controversy in multi-country trade discussions. The U.S. and the E.U. protect their agriculture sectors with import tariffs and heavy production and export subsidies. These tariffs and subsidies negatively impact the exportation of agricultural products by the MERCOSUL countries, an important source of the South American trade union’s export earnings and economic growth. The potential economic impacts of FTAA and MERCOEURO on agribusiness, trade flow, economic growth, and welfare in the MERCOSUL countries are not well known. This paper is intended to broaden the understanding of the economic impacts arising from the creation of FTAA and MERCOEURO.

In this paper, we bring three analytical innovations to the discussion of MERCOEURO and FTAA. The first is the use of scenarios to examine the proposed free trade areas after extreme trade negotiations have been completed: not only are tariffs eliminated in the four scenarios created, but NAFTA and E.U. agricultural production and exports subsidies are eliminated in two of the four scenarios. The second innovation simulates the impact of Brazil’s Kandir Law on all scenarios by imposing the law’s conditions on our base data by way of GTAP’s Alter Tax command. Since 1996, the Kandir Law has exempted all Brazilian non-manufactured goods from export taxes. The third innovation conditions the base data with the total elimination of import tariffs and production and export subsidies on trade between Argentina, Brazil, and Uruguay, that is, MERCOSUL remains implemented.

International trade theory states that the formation of a free trade area improves welfare in the member countries if the total volume of trade increases inside the free trade area: if trade creation among the members exceeds the diversion of trade away from non-member countries (Krugman and Obstfeld, 2000). A country gains welfare if its high cost domestic production is substituted for by lower cost imports from other members of the new economic block, but the country loses welfare if participation in the free trade area leads to the substitution of low cost imports from non-members for high cost goods from members.

Figueiredo et al. (2001) applied the GTAP model to investigate the impact on Brazilian and European economies of a trade agreement between the E.U. and all Latin American and Caribbean countries. In their study, E.U. production and export subsidies were eliminated to create a sustainable free trade area. It was concluded that the benefits of trade liberalization would go to the Brazilian agribusiness sector and to the European manufactures sector. Cypriano and Teixeira (2001) also applied the GTAP model in two scenarios to investigate the impact of FTAA on each of the MERCOSUL countries’ agribusiness sector. One scenario maintained NAFTA production and export subsidies and the other eliminated them. The authors’ main conclusion was that the MERCOSUL countries would benefit more from FTAA if the agricultural production and export subsidies imposed by the United States were eliminated.

This paper is organized into four sections. It continues with a discussion of the GTAP model, our data, and the analytical scenarios, follows with a detailed presentation of the study’s results, and ends with our conclusions.

2. GTAP model, data and analytical scenarios

This study employs the Global Trade Analysis Project’s (GTAP) applied general equilibrium model (AGE) to investigate all the markets and the influences of one market on the others. The Global Trade Analysis Project (GTAP), developed by Hertel and Tsigas (1997), includes a complete general equilibrium model to analyze policy reform and trade, a software package developed by Codsi and Pearson (1988) to run the simulations, and a large data base, in its 5th version, that contains data on 66 countries and 57 commodities. The regional aggregation used in this analysis is shown in Table 1.

The economies of Brazil, Argentina, and Uruguay represent MERCOSUL. This aggregation excludes the MERCOSUL countries Paraguay and Bolivia because they do not individually take part in the database. Also, Chile, a MERCOSUL associate member, is not examined because its tariff system is lower than MERCOSUL’s Common External Tariff (CET). Imposing on Chile a higher tariff to conform to the CET would shift trade out of the country and have a negative impact on its economy.

The GTAP database reflects the economic environment of 1995 and includes the input-output (IO) matrices of the considered regions. According to Gehlhar et al. (1997), not all the countries in a region have their data in the GTAP's database, which is why the IO tables are constructed by region using economics and accounting concepts.

2.1. Analytic scenarios

The GTAP Version 5 data base excludes U.S. and E.U. subsidies to agricultural production and exports; however, those subsidies exist and have grown due to the recently passed 2002 United States Farm Bill. This study addresses the data base’s lack by incorporating U.S. and E.U. subsidy data included in the GTAP Version 4 data base.

Before simulating the FTAA and MERCOEURO free trade areas, the data base is adjusted to reflect characteristics of the MERCOSUL trade union: agricultural production and export subsidies and import tariffs for trade among the MERCOSUL countries are eliminated and MERCOSUL's Common External Tariff (CET) is applied (tariffs of 8.0 % on non-MERCOSUL corn, 10.0 % on rice, wheat, soybean, meat, and other agribusiness, 16.0 % on sugar and milk; and 18.0 % on non-MERCOSUL manufactures). MERCOSUL’s taxes on the export of primary and semi-manufactured goods are also eliminated from the data base. This, most significantly, removes Brazil’s ICMS tax, thus imposing Kandir’s Law of 1996. Inclusion of MERCOSUL’s CET and the impact of Kandir’s Law make the scenarios more realistic.

Two scenarios are simulated and then analyzed for each of the two potential free trade areas: FTAA 1 and 2 and MERCOEURO 1 and 2.

Scenario FTAA 1 simulates the creation of a free trade area made up of all the countries in the Americas by imposing zero import tariffs on goods traded between member countries. The countries of NAFTA and the non-MERCOSUL countries of Americas only apply their tariffs to goods from non-FTAA members, and similarly, MERCOSUL countries only apply their CET to goods from non-FTAA members.

Scenario FTAA 2 is the same as FTAA 1 except that additionally simulates the total elimination of agricultural production and exportation subsidies by member countries. This is expected to have a great impact on production and exportation of agricultural products by the NAFTA countries, given that the United States offers strongly subsidizes to its agricultural sector. By eliminating these subsidies in this scenario, a comparison between it and the FTAA 1 scenario makes possible an analysis of the impacts of this strong agricultural assistance, mostly by the NAFTA countries, on the FTAA member countries’ economies.

Scenario MERCOEURO 1 simulates the creation of a free trade area between members of MERCOSUL and the European Union by imposing zero tariffs on commerce between MERCOEURO member countries. In this scenario, the European Union retains its tariffs on products from non-MERCOEURO countries and the MERCOSUL countries retain their CET on products from non-MERCOEURO countries.

The last scenario, MERCOEURO 2, is the same as MERCOEURO 1 except that subsidies to agricultural production and exports are also eliminated. This is expected to have a great impact on the production and exportation of agricultural products by the European Union. By comparing the effects of this scenario with those of MERCOEURO 1, an analysis of the trade distortions arising from the strong European Union subsidies to agricultural production and exports is permitted.

Scenarios FTAA 2 and MERCOEURO 2 are considered extreme since elimination of subsidies to agricultural production and exports by the United States and the European Union would generate exceedingly negative reactions by the agricultural lobbies in the affected countries. However, when negotiating the creation of a free trade area with either the U.S. or the European Union, the MERCOSUL countries should seek elimination of all distortions to trade among member countries

3. Results

It is important to highlight that NAFTA and the European Union (E.U.) are major producers of most of the agricultural commodities addressed in this study, demonstrating the economic force these blocks wield. Though the MERCOSUL block is a less significant producer of these products, Brazil itself is a relatively important international producer of rice, soybeans, sugar, milk, meats, other agribusiness (OAgribusiness), and manufactures, Argentina produces considerable meat and soybean, and Uruguay can be highlighted for its meat production.

The production values of commodities, manufactures, and services for each of the studied country are presented in Table 2. The simulation results are submitted in the form of percentile changes in production, trade, economic growth, and welfare. The subsidies and tariffs that distort country and regional production, exportation, and importation are summarized below and are according to the GTAP Database. These distortions are the base for all the simulations.

No significant agricultural production subsidy is observed in the MERCOSUL countries; however, NAFTA and the European Union apply large subsidies to assist the production of agricultural products. According to GTAP, the average production subsidies offered by NAFTA to the studied agricultural commodities are 15% to rice, 18% to wheat, 10% to corn, 4% to soybean, and 2% to sugar, milk and meats. In the E.U., the production subsidies are larger: 58% to wheat, 53% to corn, 9% to soybean, and 4% to meats, milk and OAgribusiness.

Strong trade distorting mechanisms, in terms of subsidies to exports and tariffs on imports, have been put into place by NAFTA and the European Union. According to GTAP, NAFTA offers a 60% subsidy to sugar exports and a 59% subsidy to milk exports. In the European Union, export subsidies are greater, reaching 116% for milk, 76% for sugar, 44% for corn, and 33% for meats. In regards to agricultural product imports, NAFTA applies import tariffs of 53% on sugar, 49% on milk, 5% on rice, 4% on meats, and around 13% on wheat, soybean, and OAgribusiness. The European Union applies even higher agricultural product tariffs: 86% on milk, 76% on sugar, 85% on rice, 70% on meats, 60% on wheat, 39% on corn, 10% on soybean, and 17% on OAgribusiness. Regarding the MERCOSUL countries, Uruguay offers an average subsidy of 6% to exported agricultural products while Brazil and Argentina have no export subsidies. These three countries apply MERCOSUL’s Common External Tariff (CET).

3.1. Impacts on production and trade flow

3.1.1. Scenario FTAA 1

In this scenario, the creation of the Free Trade Area of the Americas was simulated with the elimination of import tariffs and maintenance of agricultural production and export subsidies among member countries, which are restricted to NAFTA members, the MERCOSUL countries of Brazil, Argentina, and Uruguay, and the rest of the Americas.

Table 3 shows the percentile variations in production, exportation, and importation that resulted from the simulated changes brought about in this scenario. In general, there was a fall in the production of agribusiness products within NAFTA and an increase in the MERCOSUL countries. Similar behavior is observed in the percentile variation of these products’ exportation.

Sugar is the product most sensitive to the elimination of import tariffs within FTAA. NAFTA sugar production fell 11.03% in this scenario, a direct reaction to the elimination of tariffs. The end of tariff protection reveals NAFTA countries’ lack of competitiveness in the international market for this commodity. In this scenario, sugar importation by the NAFTA countries increases 54.7%, to meet internal demand, and sugar exportation decreases 11.16%. Brazil, a traditional sugar producer and exporter, benefits by the removal of sugar import tariffs. In this scenario, Brazilian sugar production increases 2.14% and exportation increases 13.68%.

The imposition of this scenario’s conditions causes other MERCOSUL agricultural products to become more internationally competitive, as shown by the increase in exportation of soybeans, meats, milk, and OAgribusiness from Argentina, OAgribusiness products from Brazil, and meats and milk from Uruguay.

There is also a fall observed in production of manufactures by the MERCOSUL countries and a small elevation by the NAFTA countries (0.30%). It was also found that there is an increase in all manufactures’ commerce in this scenario. In NAFTA, the increase in the exportation of manufactures was greater than the increase in their importation. Just the opposite occurred in MERCOSUL, as Argentina, Brazil, and Uruguay saw an increase in manufactures importation greater than the increase in their exportation.

This scenario gives evidence of the competitive advantage enjoyed by MERCOSUL countries’ agribusiness products and the NAFTA countries competitive advantage in the realm of manufactured products.

3.1.2. Scenario FTAA 2

In this scenario, the formation of the Free trade Area of the Americas is again simulated with the elimination of tariff protection and, differentiating this scenario from the previous scenario, the total elimination of subsidies to agricultural production and exportation.

As expect, the elimination of production and export subsidies reinforced the generalized fall in NAFTA agribusiness production observed in scenario FTAA 1 (Table 4). The most sensitive NAFTA product again remains sugar, the production of which fell 14.2% in this scenario. Significant decreases were also observed in the NAFTA countries production of wheat (-13.78%), rice (-11.11%), and soybean (-5.54%). In the MERCOSUL countries, the elimination of tariffs and subsidies resulted in a generalized increase in agribusiness production, having significant impacts on the production of Argentine wheat, corn, and soybean, Brazilian soybean, sugar, and OAgribusiness, and Uruguayan milk and meats.

Although not a signatory of the FTAA agreement, the trade liberalization simulated in this scenario caused E.U. production of rice, wheat, and corn to elevate. This may be due to the retention of the European Union’s common agricultural policy, which provides a high level of agricultural protection.

Regarding trade, the impacts of scenario FTAA 1 are enhanced with elimination of subsidies in scenario FTAA 2. The effect of the end of export subsidies are clearly shown by the expressive falls in the exportation of agricultural goods by the NAFTA countries and the increased exportation of these commodities by the MERCOSUL countries. In NAFTA, sugar remains the commodity most impacted by the conditions simulated in scenario FTAA 2, which caused NAFTA sugar exports to fall 54.66% and sugar imports to increase 55.4%. In MERCOSUL's countries, the greatest impacts on exportation were felt in Brazil, as the exportation of all agricultural products increased extraordinarily.

The impacts of scenario FTAA 2 affected importation by the MERCOSUL countries in a differentiated manner, with a fall in Brazilian importation of a majority of products and an increase in the level of importation by Argentina and Uruguay. In Brazil, the elevation of manufactured product exportation (27.5%) was greater than the increase in their importation (11.54%), which can mean that Brazil’s trade balance improved.

In general, the added elimination of tariffs and subsidies to production and export simulated in scenario FTAA 2 reinforced the effects of scenario FTAA 1, in which only import tariffs were eliminated. In comparative terms, the variations were similar between the two scenarios; however, they were of greater intensity in scenario FTAA 2. This reinforces the assumption that the MERCOSUL countries are more competitive in agribusiness than the NAFTA countries and emphasizes the negative impacts on MERCOSUL production and trade caused by the NAFTA countries’ high tariffs and subsidies.

3.1.3. Scenario MERCOEURO 1

In this scenario, the formation of a free trade area between MERCOSUL and European Union was simulated with the elimination of the import tariffs among countries in these two trade blocks. Table 5 presents the results of this scenario in percentile variations of production, exportation, and importation.

The effects of this scenario on production are a generalized fall in European Union production of all agribusiness products, a small increase in the E.U’s. output of manufactures and services, generalized percentile growth in the production of Brazilian and Argentine agribusiness products, and an almost universal fall in Uruguayan agricultural product production. This scenario most influences the meats complex, with production falling in the European Union by 4.19% and significantly elevating in Argentina, Brazil, and Uruguay, 25.94%, 7.4% and 46.34% respectively. Also highlighted is the elevation of corn and milk production in Argentina (5.99% and 10.48%), and soybean, sugar, and OAgribusiness production in Brazil (3.19%, 3.34% and 1.09%). The production of manufactures grows slightly in the European Union (0.45%) and falls significantly in the MERCOSUL countries: -3.73% in Argentina, -2.05% in Brazil, and -4.56% in Uruguay.

The elimination of import tariffs through the creation of MERCOEURO in this scenario results in reduced E.U. exportation and increased importation of agribusiness products and increased exportation of the MERCOSUL countries’ main agribusiness products. Meats sector exports are the most sensitive to the elimination of tariffs. The European Union’s meat exports fall 11.19%, its meat imports increase 9.55%, and the MERCOSUL countries’ meat exports increase. As meat is Uruguay’s main agribusiness export, the country’s export earnings significantly increase in this scenario. E.U. tariff elimination also results in an increase in the export of Brazilian soybeans, sugar, and OAgribusiness products and Argentine corn and OAgribusiness products. Argentina does suffer a decline in the exportation of wheat (-3.18%) and milk (-9.55), two important products in the composition of Argentina’s agricultural trade balance.

As expected, the export of E.U. manufactures increases in this scenario, 1.02%, while corresponding MERCOSUL exportation falls in all countries other than Brazil. Although Brazil experiences a 3.29% increase in the export of manufactures, the country also experiences a significant increase in the importation of manufactures, 14.25%. The importation of manufactures also increases in the other MERCOSUL countries.

These results reflect the MERCOSUL countries’ competitive advantage over the E.U. countries in the production of agricultural commodities and the MERCOSUL countries’ competitive disadvantage to the E.U. countries in the production of manufactured goods.

3.1.4. Scenario MERCOEURO 2

This scenario simulates the elimination of import tariffs and subsidies to agricultural production and exportation by the MERCOEURO member countries. Therefore, this simulation largely eliminates the distortions to international trade coming from the European Union’s Common Agricultural Policy. The elimination of subsidies in this scenario reinforces some of the effects of the MERCOEURO 1 scenario, in which only tariffs are eliminated.

The impacts of scenario MERCOEURO 2 include a very strong reduction in the general production and export of E.U. agribusiness products and the elevation of production and export of agribusiness products by the studied MERCOSUL members other than Uruguay (Table 6). The production and export of wheat, corn, soybean, and meat are most affected. As in scenario MERCOEURO 1, Uruguayan production and export of meat and wheat grows significantly while the country’s production and export of all other agribusiness sector products decreases in scenario MERCOEURO 2.

The elimination of production and export subsidies by the European Union has a significant effect on NAFTA, although NAFTA is not included in the MERCOEURO free trade area. Due to the elimination of trade distortions by the European Union and their maintenance by NAFTA, NAFTA’s production and exportation of wheat, corn, and soybean is significantly elevated.

In this scenario, production and exportation of manufactured products grows in the European Union while falling in the studied MERCOSUL countries except Brazil. Brazilian manufactures exportation grows 7.37%; however, Brazilian manufactures importation grows at a greater percentile, 12.76%, which has a possible negative effect on the country’s trade balance.

These results demonstrate the negative effects of production and export subsidies granted by the European Union’s Common Agricultural Policy on the agribusiness sectors in Argentina and Brazil. They again reflect the MERCOSUL countries’ competitive advantage over the E.U. countries in the production of agricultural commodities and the MERCOSUL countries’ competitive disadvantage to the E.U. countries in the production of manufactured goods.

3.2. Impacts on growth and welfare

In this section, the impacts of the conditions imposed in each scenario on economic growth and welfare are compared to evaluate the potential benefits of each free trade area to the regions and countries under study. GTAP allows the calculation of variations in gross domestic product (GDP), per capita utility, and equivalent variation.

Figure 1 presents the percentile variation in GDP of the studied countries and regions brought about in the four scenarios. Regarding the FTAA scenarios, small GDP growth is observed in NAFTA, larger in scenario FTAA 2 than FTAA 1, and negative growth in the MERCOSUL countries. The performance of the manufactures sector explains this behavior.

The manufactures and services sectors each contribute more to GDP than does the agribusiness sector in all studied countries and regions, as is shown by the values of production found in Table 2. In the FTAA scenarios, NAFTA’s earnings increase due to growth in the production and trade of manufactures. In the same scenarios, the MERCOSUL countries’ earnings were increased through increased agribusiness activity but were decreased more significantly by the scenarios’ negative effects on their manufacturing sectors, particularly the effects on Brazil generated in scenario FTAA 2. Of the studied MERCOSUL countries, only Brazil obtains an increase in the production of manufactures and only in the FTAA2 scenario, which is counteracted by a fall in service sector earnings.

Analysis of GDP behavior in the MERCOEURO scenarios shows growth in both the European Union and MERCOSUL countries, with scenario MERCOEURO 2 presenting more favorable economic growth, even within NAFTA.

The behavior of the variation of GDP indicates that the formation of a free trade area formed by MERCOSUL and the European Union, simulated in scenarios MERCOEURO 1 and 2, generates greater production growth in the MERCOSUL countries than would the creation of a free trade area between NAFTA and MERCOSUL, as envisioned by FTAA. Scenario MERCOEURO 2, which eliminates tariffs and subsidies to agricultural product production and exportation, presents the best GDP results for the MERCOSUL countries. In this scenario, GDP shows growth of 5.21% in Argentina, 0.52% in Brazil, and 14.16% in Uruguay. This GDP behavior certainly offers MERCOSUL new options in the development of multilateral negotiation strategies for the formation of a free trade area with NAFTA or with the European Union.

Per capita utility and equivalent variation were chosen as this study’s welfare indicators. In the GTAP model, utility is represented by the values of private consumption, government consumption, and savings. Equivalent variation, according to Varian (1992), quantifies the change in income needed to maintain consumer utility as prices change from those found in the initial equilibrium to those in the final equilibrium.

According to the variation of per capita utility, Figure 2, there is a welfare gain for Argentina and Uruguay in the MERCOEURO scenarios, more noticeably in MERCOEURO 2. In all other countries and blocks, per capita utility variations were insignificant in all scenarios. This result allows it to be inferred that the formation of MERCOEURO with the least amount of subsidies and tariffs elevates the income level of the Argentine and Uruguayan populations, generating increased consumption and welfare.

Equivalent variation, Figure 3, expressed in US$ millions, is the product of initial income multiplied by the percentage change in per capita utility. As it considers the initial size of the affected economy and the change in welfare level (arrived at from the change in per capita utility), equivalent variation monetarily demonstrates the effect of changes in welfare on economies of different size.

NAFTA shows welfare gains in the FTAA scenarios, with the larger gain in scenario FTAA 2. The European Union gains welfare only in the MERCOEURO scenarios, with the larger earnings gains in scenario MERCOEURO 2. Similar welfare gains are found in Argentina and Uruguay in scenarios MERCOEURO 1 and 2 and in Brazil in scenarios FTAA 1 and MERCOEURO 1, however, the earnings gains are less for the MERCOSUL countries than for either NAFTA or the European Union.

Gains in this welfare indicator are explained by the size of the economic blocks as determined by production value and, to a greater extent, the elimination of import tariffs. The tariff elimination causes a fall in the domestic price level and a corresponding elevation in the level of real income and welfare.

4. Conclusion

In all scenarios, the formation of either FTAA or MERCOEURO increases the production and exportation of the studied MERCOSUL countries’ main agribusiness commodities. This demonstrates that the MERCOSUL countries’ agribusiness sectors are competitive in international markets but are strongly prejudiced by NAFTA and the European Union’s tariffs and subsidies, which guarantee the agribusiness competitiveness of NAFTA and of the European Union.

In all analyzed scenarios, the MERCOSUL countries are shown not to be internationally competitive in the production of manufactures. Therefore, these countries should implement macroeconomic policies that promote interest and tax rate reductions to improve industrial competitiveness.

Change in the economic indicator, GDP, shows economic growth in Argentina and Uruguay in both MERCOEURO scenarios. The greatest increase in these two countries GDP growth was observed when import tariffs and subsidies to agribusiness production and exportation are eliminated in scenario MERCOEURO 2. In that scenario, Brazil showed its only economic growth, a small 0.52 percent.

The welfare indicators, per capita utility and equivalent variation, improved in Brazil in scenarios FTAA 1 and MERCOEURO 1 and in Argentina and Uruguay in both MERCOEURO scenarios. Both NAFTA and the European Union show welfare gains when these blocks take part in the formation of a free trade area with MERCOSUL, which is for the most part explained by the improved performance of their manufacturing sectors.

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The authors are grateful to FAPEMIG and CNPq for their research grant. They are grateful to the RER referees for helpful comments and suggestions.

Publication Dates

• Publication in this collection
  16 July 2003
• Date of issue
  June 2003