RAIN ON MERCOSUR'S PARADE.

The 10-year-old Southern Common Market needs a ray of hope.

THE AMERICAN DREAM IS BECOMING REALITY." SO SAID Carlos Menem 10 years ago this month as the then-presidents of Argentina, Brazil, Paraguay and Uruguay signed the treaty to form the Southern Common Market (Mercosur). Yet, a decade later, divisions in the US$1 trillion bloc threaten to put a damper on Mercosur's birthday party.

After an initial boom in trade and investment, disputes have proliferated and intra-regional commerce in the 200 million consumer market has stagnated. The custom union's expansion plans have been side-tracked, possibly impacting the future of free trade in the region. Some members are looking outward for help. "This process is going very slowly," says Argentine Economy Minister Jose Luis Machinea. "Our country, through Mercosur and together with the other member countries, should speed up the process of negotiation with Nafta."

According to the LATIN TRADE Mercosur Report Card, the common market needs to pick up the pace. Total trade is increasingly important to the common market economy, but its nominal value has declined rapidly in recent years. Direct foreign investment is booming and inflation has been waylaid, but the economies have been unable to maintain steady growth. Unemployment is growing in most of the countries.

Driving the group's wagon has been particularly difficult as of late because its race horses--Brazil and Argentina--are pulling in different directions. The Brazilian economy last year grew around 4% while the Argentine economy stagnated. Following its currency devaluation in early 1999, Brazil's businesses have become more competitive compared to their Argentine counterparts.

Such differences have provoked a series of trade disputes over autos, shoes and sugar that soured relations between the two. In most cases, Argentines accused their Brazilian neighbors of dumping goods while Brazilians alleged protectionism. Early last year, Argentina went so far as to impose import restrictions on Brazilian chickens, arguing they were selling below their domestic price.

What might appear to be minor spats between otherwise friendly neighbors may eventually determine the livelihood of thousands of workers and the survival of entire sectors. Removing protective barriers on Brazilian sugar or poultry products, for instance, could eventually mean the demise of less efficient Argentine producers, creating still more unemployment there.

If Mercosur wants further economic integration, it will have to resolve underlying differences. "All the uncomfortable issues will have to be dealt with," says Jose Botafogo Goncalves, Brazil's chief Mercosur negotiator. "What's on the table is the task of replacing national policies with regional policies."

Dashed hopes. Regional policies saw a major setback late last year when Chile, an associate Mercosur member, announced it would negotiate a free trade agreement with the United States. That put Chile's entry into Mercosur on hold, dashing Brazilian hopes that Chilean membership would strengthen the bloc in the near-term.

Mercosur's unity--or disunity--could have far-reaching implications for the future of hemispheric free-trade. Its members might forge and maintain a common trade policy, or they could instead negotiate bilaterally towards a Free Trade Area of the Americas (FTAA).

Last December at a summit in Florianopolis, on Santa Catarina island off Brazil's Atlantic coast, Mercosur diplomats made their best effort to present a common front. "The way to reach the FTAA is through Mercosur," said Adalberto Rodriguez Giavarini, Argentina's foreign minister, hoping to dispel fears his country would follow Chile's footsteps and negotiate directly with the United States. Even Ricardo Lagos, Chile's president, insisted that Mercosur was still of strategic importance for his country. "The FTAA is only a trade agreement. Mercosur is a political and economic integration project," he said, in reference to Chile's cultural and historic ties with its South American neighbors.

At the meeting, Mercosur members laid aside months of bickering to approve a long-awaited automotive accord that regulates issues such as domestic content requirements and import quotas on vehicles and parts. They also adopted groundbreaking common macroeconomic targets. They agreed on an annual inflation ceiling of 5% between 2002 and 2005 and a maximum net consolidated public sector deficit of 3% of gross domestic product as of 2002. The Maastricht-style targets are Mercosur's first step toward harmonizing economic policy and preventing widely disparate economies and currencies amongst its members from damaging trade and integration.

Nonetheless, major issues remain on the table. The common market has no common agricultural policy. Without one, it will be difficult to press for concessions from members of the North American Free Trade Agreement (Nafta) on agricultural products. Sugar, for instance, is one of the principal points of contention within Mercosur but it remains outside of the custom union's overall tariff agreement.

If Mercosur can't resolve its differences, says Mauro Laviola, an adviser to the Brazilian foreign trade association, regional free trade will suffer a further setback. "How can we expand to an FTAA when some of these basic questions are not resolved?" he asks.

Common external trouble. Topping Mercosur's agenda with other trading blocs in coming months will be the pace of trade liberalization in the face of FTAA talks. If Brazil eventually wants to incorporate Chile and Bolivia and prevent other members from seeking bilateral talks with Nafta, Mercosur will have to bring down its common external tariff (GET) more quickly.

The economies of Chile and other South American countries are far more export-driven than that of Brazil and require access to new markets. Chile is also a less protected economy, with a common external tariff of only 9%, set to fall to 6%. Taken in that context, the decision in Florianopolis to cut Mercosur's common external tariff to 13.5%, from 14%, was little more than symbolic.

"It's a bad signal we're sending to the world," Jorge Batlle, Uruguay's president, said after the summit. "We'll go along with that agreement but I would like to say I'm sorry we were not able to do more.

Brazil's official line in Florianopolis was that it could not reduce the common external tariff by 3% as initially foreseen because it had forgotten to budget the resulting revenue shortfall. Observers say the explanation masks divisions within the government. The more liberal faction, including the Finance Ministry and Central Bank, argue that the exposure to competition from a cut in the CET would force business to become more efficient. "We need a continuous shock to increase productivity," says Daniel Gleizer, director of the Central Bank of Brazil.

The Ministries of Agriculture and Industry, however, oppose a larger cut in the common external tariff, heeding private sector demands for continued protection. The go-slow approach supports arguments that Brazil has yet to carry out a series of structural reforms, including tax and interest rate cuts, that would lower operating costs of Brazilian business before facing additional foreign competition.

Brazil may also be taking its time on tariffs to bargain for concessions. The country has in recent months increased its verbal attacks against European Union and U.S. import restrictions, particularly on Brazilian steel, orange juice, textiles, shoes and agricultural products. Brazil cannot cut tariffs on products that "receive subsidies that, in some cases, amount to 60% of their price," says Marcus Pratini de Moraes, Brazil's agriculture minister. He has proposed that Mercosur increase its common external tariff on sugar, rice, peaches and cotton to a maximum of 35%.

While its supporters have applauded the government for its aggressive stand, analysts caution Brazil not to overplay its hand. Using Mercosur tariffs as a bargaining chip for trade concessions from the United States could alienate Brazil's Mercosur neighbors, who seek a quicker path to new trade and investment.

Argentina's exports to Nafta, for example, have grown faster than exports to Mercosur. And Chile's decision to pursue talks with Nafta harkens back to a statement--perhaps prescient--by former Uruguayan President Luis Lacalle at Mercosur's birth, on March 26, 1991: "The presence or the absence of Chile in the long run will be a sign of Mercosur's efficiency. If Chile chooses to join, it will be proof it is working."