Brazilian Trade Policy and the United States
Released: 2006-02-03T00:00:00

Brazilian Foreign Trade Strategy

David Ricardo postulated the rationale for free trade some 200 years agowhen he argued that countries could improve their national welfare if they exploitedtheir comparative advantage by exporting those goods at which they were relativelymore efficient at producing and importing the rest. Later arguments for trade pointedto the benefits arising from intra-industry trade (and investment) in which specializedproduction along with scale economies could lead to even more efficient exchangeand innovation-driven productivity increases. These foundational ideas, whichrecognize the value of both imports and exports, remain valid today for explainingwhy countries generally wish to pursue freer trade and why trade liberalization hasbeen at the center of the economic reform debate in much of Latin America.

In practice, however, few countries have opted unilaterally to throw opentheir borders to unfettered free trade, and the call to maintain trade barriers iscommon even if it is understood that they come with a cost to society as a whole. There are many reasons for this. Perhaps most transparent is resistence by firms andworkers who stand to bear most of the adjustment costs of freer trade, even ifnational welfare is ultimately enhanced through lower priced goods and services, agreater selection of choices from imports, and overall efficiency gains that can leadto higher national income. Less obvious is that countries adopt diverse trade policiesbased on historically, socially, and politically determined "trade preferences" thatcannot be explained solely by a calculus of economic costs and benefits.

The "trade preference" framework helps explain Brazil's trade strategy. Itpegs Brazil as a "regional leader" based on its leadership in pressing for SouthAmerican economic integration, its conditional support of multilateral negotiations,and its reticence to consummate separate trade deals with developed countries. (3) Brazil's tradepreferences in order of priority are: 1) expand and strengthen Mercosul, where Brazilis the undisputed industrial hub and political leader; 2) advocate developing countryinterests in the Doha Round, especially on agricultural issues, and; 3) resist what itviews as a welfare reducing, U.S.-designed FTAA, and to a lesser extent, also apreferential trade arrangement with the European Union unless it serves as a counterinfluence to the FTAA. (4)

Brazil and the United States approach trade liberalization from differentperspectives. U.S. trade strategy has been characterized as "competitiveliberalization," (5) where simultaneously negotiating comprehensivemultilateral, regional, and bilateral pacts allows gains to be achieved where partiescan agree. It is competitive in that gains at one level of negotiation (e.g. bilateral orregional) can create new incentives or pressures to make breakthroughs at otherlevels (e.g. regional or multilateral). It is comprehensive by its inclusion of issuesthat go beyond market access such as services trade, intellectual property rights,government procurement, and investment.

Brazil has a narrower and more cautious tack, restricted largely to marketaccess and dominance in regional trade, where it feels most ready to compete. Theperceived benefits of Brazil's strategy include attaining greater bargaining powerthrough the Mercosul coalition, slowing the multilateral trade liberalization processto allow more time for economic adjustment, and enhancing its national influence inthe world by protecting domestic economic (industrial) capacity. These "tradepreferences" are not randomly determined, but are deeply embedded in the country'sindustrial, foreign, and macroeconomic policies, discussed below.

Trade and Industrial Policy

The "regional leader" category captures well the influence Brazil's economicdevelopment strategy has had on its trade preferences and policy. Brazil adopted itsown version of the import substitution industrialization (ISI) model employedthroughout much of Latin America in the 20th century. To promote industrialdevelopment, Brazil created, and protected from foreign competition, importantgovernment sponsored enterprises that still operate today, although some are nowprivatized. These include the National Steel Company (CSN) founded in 1942;Petrobras, the national petroleum company, established in the 1950s; the NationalEconomic and Social Development Bank (BNDES), created in 1952; and Embraer,a leading manufacturer of regional jets, incorporated in 1969. (6) BNDES wasat the heart of this policy, providing financing for public infrastructure and strategicindustries. It continues today as a necessary major source of long-term businessfinancing given the unique structure of Brazil's financial system.

Brazil's industrial policy achieved notable results for decades, but withpredictable tradeoffs. The inward orientation of the ISI model shielded domesticindustry from global competition, diminishing market incentives to innovate andbecome more efficient. Trade policy was essentially administeredprotectionism. (7) The large state bureaucracy also contributed toinefficiency and the high cost of doing business in Brazil. Although privatizationefforts in the 1990s have improved the competitive landscape in Brazil, the so-calledBrazil cost or "Custo Brasil" endures, which is one way of saying there are numerousmicroeconomic distortions introduced by excessive taxation, high interest rates,cumbersome regulations, and corruption. (8) The large untaxed informal economy combinedwith Brazil's big government, for example, mean that formal businesses pay up to85% of the tax burden, more than twice that of the United States. (9) These issuesdirectly diminish Brazilian productivity and indirectly deter trade liberalization. Yet,continuing to protect this regulatory regime and Brazil's "national productionstructure" remains an important aspect of the national trade strategy, a priority Brazilpursues unilaterally and through Mercosul. (10)

Trade and Foreign Policy

As with all countries, Brazil's foreign policy shapes its trade preferences, butcompared to the United States it plays a more prominent role. Unlike the UnitedStates where trade policy is constitutionally defined as the responsibility of Congressand carried out in a separate cabinet-level agency (the United States TradeRepresentative -- USTR), in Brazil it is undertaken by the executive branch under thepurview of the Ministry of Foreign Relations. The most important aspects of tradepolicy, therefore, are driven less by commercial interests and often are subordinatedto a larger foreign policy imperative, primarily, enhancing Brazil's influence in LatinAmerica and the world. In the Western Hemisphere, this implies taking on theUnited States. In the words of one Brazilian expert, "Brazil's foreign policy over thepast four decades is characterized by competition with the United States, and theobjective of developing the nation's industrial capacity as a key condition forindependent activities within the international system." (11)

Economically, there are two sides to this policy: offensively, it seeks tointegrate South America; defensively, it seeks to deter encroaching U.S. economicinfluence in the region. Brazil's government has taken steps recently to realize thisagenda, by establishing in 2004 the South America Community of Nations as aloosely interwoven example of political and economic integration and by limitingprogress on the U.S. version of the FTAA. Although intentions may not be overtlyadversarial, these two policies do present a challenge to the U.S. trade agenda. Byextension, Brazil's leadership in the region is played out at the WTO where it is anunyielding force in pushing for reductions in agricultural barriers in the Doha Round.

The foreign policy aspect of trade policy may also be seen in the emphasis ondeepening developing country trade relations. In addition to negotiating fordeveloping country interests in multilateral and regional trade talks, Brazil has alsoconsummated an agreement with the Andean countries, India, and South Africa, anddeepened relations with Portuguese-speaking African countries, by concludingvarious commitments on trade. Progress in the Doha Round, FTAA, and EUnegotiations has proven harder to achieve. (12)

Trade and Macroeconomic Issues

Macroeconomic challenges have and continue to constrain Brazil's tradepolicy options. Brazil, for example, is known for its historical accommodation toinflation, having employed for decades a comprehensive system of wage, price, andinterest rate indexation as part of its macroeconomic management. Inflation ran at"manageably" high rates for years and was fought, albeit unsuccessfully, with anumber of stabilization plans. By the 1970s, however, it eventually spiraled out ofcontrol following the oil price shocks. This led Brazil to the 1980s debt crisis alongwith much of Latin America. (13) By the 1990s, the economy was defined by itsgrowing deficits and debt, failed efforts at stabilization, slow growth (averaging only2.3% from 1980 to 2004), and reluctance to embrace reforms. An important factorin Brazil's sluggish economic performance was poor productivity growth due tomicroeconomic policy distortions discussed above, macroeconomic problems, andto some degree, also its closed trade policy. (14)

Brazilian trade policy also had to adjust to encroaching globalization in the1990s, including multilateral efforts (the conclusion of the Uruguay Round), newregional talks (the FTAA), and U.S. subregional initiatives (the North American FreeTrade Agreement -- NAFTA). Brazil responded with some unilateral liberalization,the formation of Mercosul in 1991 with Argentina, Uruguay, and Paraguay toconsolidate its trade positions in South America, and the adoption of agovernment-assisted export promotion policy to help address its large and growingexternal debt. The average tariff in Brazil fell from 51% in 1988 to 14% in 1994, butthe selective preferences given under Mercosul belied the liberalization message asBrazil continued to limit trade outside the regional pact, allowing it to managecarefully the degree to which foreign competition would be accepted. (15)

Brazil's trade policy shifted again in 1994 to accommodate the Real Plan, aprice stabilization policy imposed by then-Finance Minister (and later-President)Fernando Henrique Cardoso. It was named for a new currency that was pegged to theU.S. dollar to serve as an anchor to bring down hyperinflation. The plan actuallyworked where others had not, but in pegging the real to the dollar, the differences ininflation between the two countries caused a large real appreciation of the Braziliancurrency, as price levels between the two countries diverged. This resulted in asudden turn to trade deficits in 1995 (see Figure 2 ), an economic consequence thatran counter to the political priority given to running trade surpluses. To offset theexchange rate effect on the balance of payments, Brazil raised interest rates andredoubled its protectionist policies. (16)

The macroeconomic story was further complicated by a major financial crisisin 1998 that resulted in a currency devaluation and return to a floating exchange ratein 1999, Argentina's financial collapse in 2001, and a financial panic in 2002exaggerated by the impending presidential election of longtime Worker's Party leaderLuiz InÃ¡cio Lula da Silva. Today Brazil's macroeconomic priorities still constraintrade and other policy choices. The economy is stable, but growing at inadequatelevels to bring about desired development goals. To control inflation, the LulaAdministration has had to maintain very high real interest rates, while Brazil's largedebt service obligation has required a large primary budget surplus, approaching 5%of GDP in 2005, and a trade surplus. (17)

The cost of this development strategy has been accepting the microeconomicdistortions discussed above and inadequate social spending, which raises the prospectfor future social and political unrest given the already very high levels of incomeinequality and poverty. Subordinating trade liberalization to debt reduction and othergoals also diminishes Brazil's growth prospects, a key variable in reducing poverty. Therefore, as may be seen, Brazil's "trade preferences," which point to a cautious(some would say protective) and carefully managed approach to trade liberalization,reflect a combination of industrial, foreign, and macroeconomic policy priorities thatoften outweigh purely trade-related economic arguments, and deters progress inBrazil's long-term development. These points bear remembering when consideringspecific trade negotiation stances and disputes, discussed later.

Figure 2. Brazil's Balance of Merchandise Trade, 1988-2004

Brazilian Trade with the World

Brazil has a modern, diversified economy, with services accounting for 53%of GDP, followed by industry and manufacturing at 37%, and agriculture at 9%. Depending on how agribusiness is measured, it contributes to some 30% of GDP. Brazil is the number one producer of raw sugar, oranges, and coffee in the world, andthe second largest producer of soybean, beef, poultry, and corn. (18) It is alsoa major producer of steel, aircraft, automobiles, and auto parts. By comparativestandards, however, Brazil is actually a small trader, with total trade accounting foronly 26% of GDP in 2004, up from 14% a decade earlier, but still a relatively smallamount compared to the rest of Latin America. Brazil represents only 0.9% of worldtrade, a number that has not grown, suggesting that Brazil's trade liberalization effortshave not resulted in any change in its trade openness relative to the rest of the world.

Brazil's global trade is diversified (see Figure 3 ), with 25% of exports goingto the European Union, 21% to the United States, 20% to Latin America, and 15%to Asia. Brazil's imports mostly from the European Union (25%), Asia (20%), theUnited States (18%), and Latin America (16%). Brazil's top three trading partnersare the United States, Argentina, and Germany. Together they account for overone-third of Brazil's world trade and each, interestingly, is the dominant tradingpartner of a different region or trade group (NAFTA, Mercosul, and the EuropeanUnion).

Figure 3. Brazil's Direction of Trade, 2004

Some 30% of Brazil's merchandise exports are primary products, 14% semi-manufactured goods, and 56% manufactured goods (see Appendix 1 ). Importantly, natural resource-based goods dominate in all categories. For example,together all steel and aluminum based products, fabricated to varying levels ofcompletion, represent 10% of total exports. Agricultural products, including rawsugar and other products, as well as, manufactured goods like orange juice andrefined sugar, and semi-manufactured sugar and soybean products, account for atleast 30-40% of exports. Soybean and soybean products alone amount to 10% ofexports, more than automobile and related parts (8%) and aircraft (3%). (19) Thesenumbers provide some insight into why Brazil places such a strong emphasis onfurther opening developed country markets to its agricultural products.

Brazilian imports fall into five categories: capital goods (17.6%); consumergoods (10.8%); durable consumer goods (4.9%), fuels (16.4%); and intermediategoods (50.3%). Brazil imports capital and intermediate goods in support of its ownindustrial and agricultural growth, development, and export. These goods range fromaircraft engines to chemicals and pharmaceuticals that are used in processing othergoods. Raw materials for farming, foodstuffs, and nondurable consumer goods roundout the major imports.

Brazil's trade priorities cannot be derived entirely from a calculation of thetrade-weighted importance of trade partners. The United States is Brazil's largestsingle-country trading partner, yet Brazil has resisted increasing trade liberalizationwith the large U.S. market via the FTAA because the U.S. model of liberalization isviewed as insufficiently balanced to meet Brazilian needs. To appreciate Brazil'sapproach to the United States and the world with respect to trade negotiations, it iscritical to see how its "trade preferences," discussed above, take form in actualnegotiations. Mercosul is most important to the economic and political life of Braziland has taken on perhaps even greater priority under the Lula administration. It isdiscussed first followed by Brazil's approach to the FTAA and WTO, which willallow for a better understanding of U.S.-Brazil trade relations, as a whole.

Southern Common Market (Mercosul)

Mercosul was created in 1991, the outgrowth of Brazil-Argentine bilateralefforts in the late 1980s to address longstanding political and security concerns. Byincluding Uruguay and Paraguay, and defining the partnership along economic lines,Mercosul was expected to help the region improve its chances for mutual economicgrowth and development, and thereby stabilize regional political relations as well. Mercosul has succeeded on the political side and also developed as a crediblecollective voice in the WTO and the FTAA. Its success at economic integration ismore questionable.

Mercosul began as a free trade area, but was designed to evolve into acustoms union, defined by a common external tariff (CET), and eventually, acommon market with the free movement of goods, investment, and labor. To date,Mercosul remains an incomplete customs union with many exceptions to the CET. Early successes were measured by the doubling of intra-Mercosul trade by 1995, astariffs came down according to schedule, and cooperation remained largely positive. This trend reversed course in the late 1990s because of financial crises in Argentinaand Brazil, and the absence of macroeconomic coordination and other policyproblems. Brazilian trade within Mercosul expanded by only 13% from 1999 to2004, with Brazil's trade balance shifting from a nearly balanced position to anuncomfortably large surplus of $2.5 billion by 2004, as imports from all threeMercosul partners stagnated or declined. Argentina responded with quotas andhigher tariffs on certain Brazilian exports and calling for more equitable bilateraltrade flows.

In reality, the trade rationale for Mercosul was always limited and fraughtwith challenges. After 15 years, Mercosul accounts for only 9% of Brazil's exports. The United States and Europe remain the dominant markets for Brazilianmanufactures and agricultural goods, respectively, as well as, the major suppliers ofcapital goods. Argentina and Brazil have both resorted to raising trade barriersagainst each other in response to sectoral and macroeconomic problems, and Brazilstands alone as the industrial center, so Mercosul offers little competition intechnological and innovative-based industries that can bring deeper gains from trade.

The increased intra-dependence fostered by a successful Mercosul also carriescertain risks, as seen in the compression of trade and economic growth in Paraguayand Uruguay following financial crises and currency devaluations in Brazil (1999 and2001) and Argentina (2002). These setbacks merely confirmed what has been widelyunderstood, that Mercosul was really launched as a "political project carried out inthe economic and commercial realms." (20) Deeper economic integration, under thesecircumstances, has proved elusive.

In response, Mercosul turned to broadening its membership rather thandeepening the arrangement. Chile and Bolivia acceded to Mercosul in 1996 asassociate members (not subject to the CET and other provisions), and after years ofnegotiation, the Andean Community of Nations (Ecuador, Bolivia, Venezuela, Peru,Colombia) was added in October 2004. Brazil took a further step in organizing theSouth American Community of Nations in December 2004, which is a very loosearrangement of the twelve major South American countries. (21) InDecember 2005, Venezuela agreed to become a full member of Mercosul, and hasbeen promised full membership status, except for voting, despite its inability to adoptthe CET and other policies. A similar proposal has been suggested for Boliviafollowing the presidential election of leftist Evo Morales in December 2005. Thesedecisions suggest that Mercosul continues to operate based primarily on politicalincentives.

Mercosul has been negotiating with the European Union for an FTA for manyyears. These talks, once considered promising, have bogged down on market accessand other issues that have similarly hindered progress on the FTAA. Brazil wantsbetter access for agricultural goods, while the EU wants Brazil to lower tariffs onindustrial goods. Brazil is unwilling to make such a commitment until the EU alsoaddresses its agricultural subsidy program. Currently, the talks are stalled, with littleexpectation of significant movement in the near future, a prospect, as with the FTAA,that may hinge on developments in the Doha negotiations.

Despite the undisputed expansion in Mercosul affiliation, growth in trade hasstagnated and after 15 years, by most accounts, the pact still lacks institutionalstrength and coordination, providing little evidence of enhanced trade-relatedproductivity gains. (22) Still, support for the pact is strong despite itstroubles. The smaller economies benefit from preferential access to the largeBrazilian market, and Brazil sees a unified Mercosul as being the definitivecounterbalance to the United States in FTAA negotiations, where the FTAA isviewed as a complement to, not a substitute for, Mercosul. The technical distinctionbetween a free trade agreement and a customs unions becomes important here. Acustoms union with a CET implies that its members will negotiate trade agreementscollectively with the outside world, or the union becomes largely meaningless. (23)

For these many reasons, Mercosul remains at the heart of Brazil's tradestrategy. Brazil relies on the customs union to strengthen its regional economicleadership, and by extension, its trade negotiating position outside of Mercosul. Conversely, Brazil's strength would be undermined if any members of Mercosulopted for FTA status or chose to go their own way with extra-regional negotiations,a position Uruguay flirted with in January 2006, although apparently with no realconviction. Mercosul also serves Brazil's trade strategy precisely because Brazil canset the levels of deepening to ensure a balance between maintaining its industrialpolicy and co-opting regional voices in approaching the EU, WTO, or FTAA. Finally, Brazil uses Mercosul as a way to ease its transition to trade liberalization inthe global economy because it has a ready-made regional comparative advantage inmanufacturing.

Free Trade Area of the Americas (FTAA)

The FTAA is a proposed free trade area that would include 34 nations (allexcept Cuba) of the Western Hemisphere. It has been under consideration for adecade, but talks effectively stalled in late 2003. Problems arose over differencesbetween Brazil and the United States, which as the co-chairs of the TradeNegotiations Committee (TNC), hold the key to consummating the agreement. Atthe heart of the disagreement are their diametrically opposing positions that reflectnot only differences in sectoral and industry issues, but in broader trade preferencesas well. The United States remains committed to an agreement that includesnegotiating investment, services, intellectual property rights, and governmentprocurement, among other issues. Brazil has not deviated from its more limitedsupport of dealing mostly with market access, and its refusal to engage on these otherissues unless the United States concedes to address agricultural subsidies and traderemedy issues. (24)

This impasse resulted in a compromise unveiled at the 2003 FTAAMinisterial meeting in Miami calling for a two-tier agreement under which countriescould assume different levels of commitment. The proposed framework, viewed bythe United States as an accommodation to Brazil, would include a common set ofrights and obligations for all countries along with optional obligations that could beentered into on a plurilateral basis. Defining these various commitments so far hasproven unworkable, and the breadth of an emerging resistence to the FTAA becameclearer at the fourth Summit of the Americas held on November 4-5, 2005, in Mardel Plata, Argentina. Amid dramatic and sometimes violent public demonstrationsagainst President George W. Bush and the FTAA, it was evident that Latin Americawas divided over how to proceed. A total of 29 countries supported renewingnegotiations, and the United States pushed to set a specific date in 2006.

Brazil, Argentina, Uruguay, and Paraguay (the Mercosul countries) rejectedthis idea, arguing that the conditions for achieving a balanced and equitableagreement did not yet exist. Taking a more extreme position, Venezuela lobbied toend any further effort on the FTAA and for unified resistence against U.S. policiesand presence in Latin America. The Summit declaration called for a time to exploreproblems in the FTAA process, while awaiting the outcome of the upcoming WorldTrade Organization (WTO) ministerial, indicating that at this juncture, there is nounified vision on how to proceed with the proposed FTAA. Brazil continues to offerto negotiate market access talks between the Mercosul countries and the UnitedStates (the so-called "4+1" option), an overture the USTR has repeatedly declined.

Brazil sees little advantage to an FTAA at this point in time, particularly onethat does not address its interests, and so appears content with the status quo for theindefinite future. The United States, by contrast, has been frustrated by an inabilityto advance a NAFTA-like region-wide agreement. Therefore, it appears that Brazilwill continue to reinforce support for Mercosul, while biding its time on the FTAAand attempting to make headway with agricultural issues in the WTO.

Mercosul negotiates the FTAA as a bloc, which may gather strength ifVenezuela joins as a full member. (25) Interestingly, most analyses of the economiceffects of joining the FTAA point to differences in costs and benefits between Braziland the other three smaller members. The gains for Mercosul as a whole would comefrom its comparative advantage in agriculture vis-a-vis the United States, providedbarriers to trade in this sector are meaningfully lowered. For Brazil, opening up theU.S. market to agricultural products is critical, but the United States is also its majormarket for many value-added manufactured exports (frozen orange juice concentrate,steel, aircraft, petroleum). There is, it seems, the potential for considerablecommercial gains for Brazil should a far-reaching FTAA be completed. (26)

The cost and benefit calculus, however, is more complicated. For the smallerMercosul countries, an FTAA means giving up preferential access to the largeBrazilian market, which could mean a net loss in welfare for some sectors. TheFTAA would also mean greater access to the U.S. and other Latin American markets,and reduced costs for capital goods and other imports that no longer face a highMercosul CET (e.g. 35% in the case of automobiles). The smaller economies mightalso consider the effects of any future economic setbacks from potentialmacroeconomic problems in Brazil or Argentina. Brazil also is reticent to push foran FTAA precisely because with Mercosul (and more so with a functioning SouthAmerica Community of Nations), it is the hub and industrial center of a majorpreferential trade arrangement, which would certainly change in importance if theFTAA comes to be.

With an FTAA, Brazilian manufacturing industries that compete directly withmore efficient U.S. firms (e.g. machinery and chemicals) could lose in the short run. Combined with possible trade restructuring that other Mercosul countries might face,Brazil's comparative advantage might shift, to some degree, from industrial productsin a regional economic union to more agricultural goods in a hemispheric one. Giventhe economic and political strength of the United States, the FTAA might alter thebalance of power in the region, to the possible detriment of Brazil's regionalleadership. The potential for these relative changes, compounded by Brazil'sconcerns over its ability to conform to provisions covering enforceable intellectualproperty rights, services trade, and investor protection, point to why Brazil remainsreluctant to advance an FTAA, particularly if U.S. agricultural protection remainsrelatively untouched. Stated more succinctly, although an FTAA could providecommercial (and certainly consumer) gains to Brazil, it may come at a cost toindustrial and foreign policy priorities. (27)

For the United States, even a two-tier FTAA may make sense, particularly ifthe alternative is an FTAA without Brazil. With a two-tier FTAA, most of thehemisphere would be integrated, including Brazil, at least nominally. It may beviewed as a way to co-opt Brazilian reticence, or at least diminish the stalemateapproach that can also extend to other Mercosul countries. Given Brazil's deeplyheld concerns that reflect its "trade preferences," however, the status quo (impasse)seems to be Brazil's preferred position between moving ahead with the FTAAnegotiations or killing them outright. (28)

World Trade Organization (WTO)

Brazil has also been a vocal leader of the G-20 that represents developingcountry interests in the WTO. Even prior to forming the G-20 group, Brazil stoodup for including matters critical to developing countries in the WTO including themost pressing issue, barriers to agricultural trade, as well as, the treatment of rulescovering antidumping and pharmaceutical data protection, among others. (29) Inparticular, Brazil has insisted on addressing the reduction of barriers to agriculturaltrade, particularly export and production subsidies. The United States is working inthe WTO negotiations with Brazil to find a way to reduce agricultural subsidies,resists addressing antidumping rules, but is generally sympathetic to finding asolution to developing country concerns over providing drugs for HIV/AIDS andother emergencies. (30)

The implication for Brazil-U.S. trade relations is that the WTO is an arenawhere the two countries can find areas of both commonality and disagreement. Formany issues, the United States has indicated that the multilateral forum is thepreferred or only venue for issue resolution (domestic agricultural subsidies) and soprogress in addressing Brazilian concerns in the FTAA are contingent, at a minimum,upon success at the WTO. Brazil has taken similar stands with respect to servicestrade, intellectual property rights, and other issues. Hence, it is important to integratethe various factors that drive Brazilian trade priorities at the different levels ofnegotiation to be able to interpret Brazil's underlying intent and perhaps offer someunderstanding of why U.S. negotiators have been frustrated in their attempts to moveforward on some critical U.S. trade policy initiatives, especially the FTAA.

At the latest WTO ministerial in Hong Kong, Brazil played a leading role incontinuing to represent developing country interests in the Doha Round. It's voicewas prominent in becoming a member of the latest group of would-be brokers of aDoha Round agreement known as the Group of Six (EU, U.S., Japan, Australia,Brazil, and India). The WTO remains an important forum for Brazil, which couldbe a major winner if barriers to agricultural trade are significantly reduced. In thepost-Hong Kong period, Brazil has expressed a readiness to offer reductions inbarriers to trade in industrial goods and services, if the United States can convincethe European Union to move forward on agricultural barriers. The current level ofcooperation between Brazil and the United States bodes well for making headway inmultilateral talks that could "trickle down" to regional and bilateral accommodations. This outcome, however, is far from assured.

U.S.-Brazil Trade Relations

Brazil and the United States are two independent political and economicleaders in the Western Hemisphere, and is reflected in their trade relationship. First,unlike much of Latin America, Brazil does not have a preferential trade arrangementwith the United States such as NAFTA, the CBI, or the Andean Trade PreferenceAct, although it is protective of its U.S. preferences provided under the GeneralizedSystem of Preferences (GSP). Second, although there is consistent effort to maintainconstructive engagement between the two countries at all levels of negotiation, muchattention turns to areas of disagreement. Indeed, progress on the FTAA has crept toa halt, bilateral disputes have left some interests dissatisfied, including thoserepresented in the U.S. Congress, and key issues in the multilateral realm remainlargely unresolved. A look at U.S.-Brazil trade and the issues that confront the twocountries help explain this situation.

U.S.-Brazil Trade Trends

Brazil is the 15th largest U.S. export market, but a distant second to Mexicoas the United States' largest trading partner in Latin America. For economies of theirsize, Brazil and the United States actually trade rather little with each other. Totalmerchandise trade (trade turnover) in 2004 between the United States and Brazil was$35 billion, or 8.2% of U.S. trade with Latin America. The United States purchased21% of Brazil's exports and supplied 18% of its imports. The ebb and flow of U.S.bilateral trade with Brazil reflects a number of factors including their respectivemacroeconomic growth trends, Brazil's 1999 and 2001 devaluations (note rise in U.S.imports and fall in U.S. exports in Figure 4 -- data presented in Appendix 2 ), andafter 2002, Brazil's enhanced export promotion policy.

Figure 4. U.S.-Brazil Merchandise Trade, 1988-2004

Brazil and the United States are far from achieving their full bilateral tradepotential. It is clear that over nearly two decades, beginning before either NAFTAor Mercosul came into being, that the growth in U.S.-Brazil trade has laggedcompared to U.S. trade with Latin America and especially Mexico, a close traderwith the United States. As seen in Table 1 , in 1987 Brazil accounted for 1.8% oftotal U.S. trade, compared to 5.3% for Mexico and 12.4% for Latin America as awhole. U.S.-Brazilian trade grew by 195% from 1987 to 2004, a meager amountcompared to the 422% growth in U.S.-Latin American trade and the 665% growthin U.S.-Mexican trade. By 2004, Brazil had lost ground, making up only 1.5% oftotal U.S. trade compared to Mexico's 11.7% and Latin America's 18.7%.

Table 1. U.S. Trade with Brazil, Mexico, andLatin America

Source : CRS computations from U.S. Department of Commerce data.

Nonetheless, the United States is still Brazil's largest single-country tradingpartner, rivaling total trade with the European Union (EU) and exceeding Brazil'strade with Latin America. A simple analysis of Brazil's trade with the world suggeststhat the United States could play a more important role. This point is supported bymore sophisticated estimates as well. One study using a gravity model simulationsuggested that Brazil's trade with the United States in 1999 was only 44% of what themodel estimated it should have been. (31)

The United States exports mostly capital goods to Brazil; the top threecategories composing over half of U.S. exports are:

machinery (gas turbines used in the manufacture of Brazilianaircraft, computers, office machinery and engine parts);

electrical machinery (integrated circuits, radio, television, andtelephone parts); and,

organic materials (such as industrialchemicals).

The United States is also the largest market for Brazilian manufactured goods, whichare included in the top three U.S. import categories and compose nearly one-third ofU.S. imports from Brazil. These include:

aircraft (regional jet airplanes);

electrical machinery (cell phones, radio, and other transmissionapparatus); and,

machinery (automobile engine parts).

Other important U.S. import categories include mineral fuel, iron and steel,automobiles, and footwear (see Appendix 3 for bilateral services trade data, notdiscussed in this report). Treatment of Brazilian agricultural products, conspicuouslyabsent from top categories of U.S. imports, are among Brazil's major bilateral issues.

U.S.-Brazil Foreign Investment

Trade liberalization is also important because it tends to encourage increasedforeign direct investment (FDI). Permanent and predictable trade rules induce FDIbecause the flow of trade will be less likely to be interrupted by government actions. If a trade agreement also includes an investment chapter, which typically assuresforeign investors that they will receive national treatment and have recourse to animpartial dispute settlement process, there is further inducement for FDI. This animportant issue because the United States does not have a Bilateral Investment Treaty(BIT) with Brazil, another way to secure U.S. investor rights with developingcountries.

The stock of U.S. FDI in Brazil was $33.3 billion in 2004 (see Appendix 4 ). This figure actually declined from a peak of $37.8 billion in 1998. U.S. investmentin Brazil, the largest economy in Latin America next to Mexico, is relatively small,representing only 1.6% of U.S. FDI in the world and only 10.2% of U.S. FDI in LatinAmerica (Mexico has twice this amount). In addition, Brazil invests little in theUnited States, with the stock of FDI amounting to $1.3 billion in 2004. Althoughthis is double the previous year's level, it accounts for less then one-tenth of onepercent of FDI in the United States. Brazilian investment is growing, however,concentrated in industries of strategic interest to its economy that face formidableU.S. barriers to entry, such as citrus and steel.

U.S.-Brazil Bilateral Trade Issues and Disputes

Brazil and the United States have a number of specific trade issues that aretaken up at all levels of trade negotiations. As with all countries, the United Statesand Brazil practice some form of protection, although they are very different. TheUnited States is most concerned over Brazil's high average tariffs, particularly onindustrial goods, and multiple non-market access issues including intellectualproperty rights (IPR) enforcement, services trade, government procurement, andinvestment rules. The United States Trade Representative (USTR) considers thecommon external tariff (CET) a major barrier to U.S. agricultural exports, distilledspirits, and computer equipment. (32)

Brazil has raised its major concerns over broad U.S. policies such as the ByrdAmendment, which directs duties from trade remedy (antidumping) cases to affectedindustries, the calculation of antidumping margins, and what it considers to bediscriminatory treatment inherent in U.S. expansion of preferential trade agreementsin Latin America (NAFTA, Chile, CAFTA-DR). The Byrd Amendment was foundto be in violation of WTO rules. Although repealed by Congress on February 1,2006, the program remains in effect until October 1, 2007. The other two complaintsface no challenge in the WTO. Brazil also objects to product-specific barriers thatinclude restrictive tariff rate quotas (TRQs -- sugar, orange juice, ethanol, andtobacco), subsidies (cotton, ethanol, and soybeans), and trade remedy cases (steel andorange juice). The U.S. 2002 Farm Bill that effectively increased agriculturalsubsidies further aggravated the situation. As of January 1, 2006, there were 17 U.S.antidumping and countervailing duty orders in place against Brazil.

Tariffs Structures. One significantdifference between Brazil and the United States is their tariff structure. As shownin Table 2 , Brazil has comparatively high average tariffs. Although the differencein average agricultural tariff is small, Brazil's average tariff on industrial products isthree times that of the United States, the major product category of U.S. exports toBrazil. It follows that market access discussions between the two countries usuallyfind the United States focusing on reduction of industrial tariffs, whereas Brazilemphasizes U.S. peak tariffs on agricultural imports subject to TRQs. The highout-of-quota tariffs are meant to deter imports to protect U.S. producers, which are,for example, 350% for tobacco and 78% for sugar, and reflected in the comparativelylarge standard deviation in U.S. agricultural tariffs. Brazil notes that the U.S. averageagricultural tariff can mask the high cost Brazil faces from out-of-quota peak U.S.tariffs. (33)

Table 2. U.S. and Brazil Average TariffRates

Data source : Inter-American Development Bank via personal correspondence.

* Simple average tariff for calender year 2004.

# Standard deviation as measure of how much tariffs can vary from average.

Brazilian Complaints Against the United States. Brazil's major product-specific complaints are summarizedbriefly below.

Sugar. As part of U.S. support for thedomestic sugar growing and processing industry, quotas are set under U.S.commitments made under WTO rules to restrict the amount of sugar imports thatmay enter the country. The purpose is to maintain the domestic price of sugar abovea set minimal level. The United States Department of Agriculture (USDA) allocatesquotas among eligible countries, with Brazil receiving approximately 13% of theworld total. In-quota imports are subject to a very low duty. Amounts enteringabove the quota are subject to a tariff computed by the USITC to be 78% ad valoremin 2003. (34) Brazil has expressed concern over the smallincreases in quotas given to the Central American countries under the CAFTA-DR,suggesting it bodes poorly for future negotiations with the United States, given thatBrazil is the world's largest producer of raw and refined sugar.

Cotton. Cotton is a protected crop inthe United States, benefitting from direct payments, counter-cyclical payments,subsidized loans and other federal programs. Subsidies averaged $1.7 billion peryear for fiscal years 1991 to 2004. (35) Brazil successfully challenged portions of theU.S. cotton program under WTO dispute settlement rules, requiring the United Statesto change or withdraw these prohibited support programs. Although the UnitedStates missed the deadlines to correct these programs, Brazil, unlike some othercountries, did not take retaliatory measures. Congress repealed two of the offendingprograms as part of the FY2006 budget reconciliation conference bill on February 1,2006, but Brazil remains critical of remaining cotton support programs. (36)

Steel. The steel industry files moreantidumping and countervailing duty cases than any other U.S. industry, the subjectof repeated complaints by Brazil. (37) As of January 1, 2006, there were 16 such ordersin place against Brazil, some dating back to 1986. The steel issue was furtherexacerbated in 2002 when the United States imposed special safeguard duties of upto 30% on various steel imports, until successfully challenged in the WTO andwithdrawn. Brazil estimates that the total cost of these measures exceeds $2 billionin lost sales, and with the United States as one of its most important export markets,is eager to see restrictions reduced, if not eliminated.

Ethanol (corn). For years, both Braziland the United States subsidized heavily the development of ethanol production fromsugar and corn, respectively. Currently, Brazil's subsidy program has ended and itmaintains a highly efficient ethanol production process. Brazil's exports of ethanolface two barriers to the U.S. market. First, U.S. corn production is subsidized byvarious U.S. programs, and some 13% of total corn production is used for ethanol. Second, there is a U.S. import duty on ethanol plus an additional 54 cents per gallondesigned to offset a tax reduction all ethanol receives to offset the federal gasolineexcise tax levied at the pump on all fuels. (38) Brazil continues to press for changes in bothprograms.

Orange Juice. Brazil argues that theU.S. tariff on orange juice concentrate is equivalent to 65% on an ad valorem basisand 18.4% on non-concentrated juice. In addition, the most recent U.S. antidumpingorder against Brazil was placed on orange juice on January 1, 2005. In January 2006,the U.S. Department of Commerce made a preliminary finding of dumping againstBrazilian frozen concentrated orange juice, which Brazil has vowed to fight in theWTO.

Tobacco. Also subject to tariff ratequotas and very high over-quota tariffs, Brazil would like to see the U.S. market openmore to greater imports of the product from Brazil. Tobacco represents only 1% oftotal U.S. imports from Brazil on a dollar value basis.

Soybeans. Brazil, the second largestproducer of soybeans in the world, must compete against U.S. subsidies on soybeansranging from $1.5 to $3.2 billion annually between 2004 and 2006. Brazil isevaluating whether to challenge these subsidies in the WTO, as it did with cotton.

Shrimp. On January 27, 2005, theUnited States imposed an antidumping duty order on frozen or canned shrimp, andprawns from Brazil, decreasing imports from shrimp farmed in the poorer northeastportion of the country.

Beef and Chicken. U.S. sanitarycertification for Brazilian chicken has not been approved, and for beef was onlyapproved in 2005, subject to a TRQ.

U.S. Complaints AgainstBrazil. (39) The USTR lists a number of complaints againstBrazil, ranging from cumbersome import administrative procedures to outrightrestrictions on certain imports. Of equal importance is the inability to make moreprogress in areas where the United States is most competitive such as protection ofintellectual property rights and services trade.

High Tariffs. Between Brazil's higheraverage tariffs (especially on industrial goods) and Mercosul's CET (exacerbated bya surcharge from 1997 to 2004), Brazil's tariff regime hurts U.S. exports ofagricultural products, distilled spirits, computer and telecommunications equipment.

Prohibited Imports. Restrictions applyto various consumer goods, with a safeguard measure currently issued against certaintoys.

Intellectual Property Rights. AlthoughBrazil has numerous IPR laws on the books, the USTR is critical of many and notesthat enforcement issues are a serious problem. (40) There isa 5-6 year backlog in processing patent applications, and data confidentialityprotection for pharmaceuticals is not covered by law. Brazil lacks copyrightenforcement leading to significant piracy losses for U.S. businesses (particularlyvideo and audio cassettes). Despite Brazilian attempts to rectify the problem with anew task force and other initiatives, it lacks the resources to tackle the problem fullyat this point in time. Brazil, therefore, is reluctant to sign on to an FTA that containsenforceable IPR provisions. The United States held up review of Brazil's eligibilityfor benefits under the Generalized System of Preferences (GSP) because of concernsover piracy issues, but the United States decided against taking action in recognitionof Brazil's attempts to address piracy. Still, Brazil acknowledges its piracy problem,realizing the implications for its own producers and tax revenues as well. TheBrazilian Congress conducted a study on the issue in 2004, which noted that piracyconstituted nearly 60% of music sales and that Brazil had failed to close legalloopholes and counteract the problem more effectively, including its lack oforganizational capacity and resources. (41)

Onerous Licensing and RegulatoryRequirements. Importers complain of the high costsassociated with meeting business registration and other requirements in Brazil.

Sanitary and Phytosanitary (SPS)Barriers. The USTR argues that SPS restrictions, includingthose that apply to beef, the prohibition of poultry imports (also a reciprocity issue),and certain types of wheats from various U.S. states are unfounded.

Government Procurement. Brazil isnot a signatory to the WTO Agreement on Government Procurement and there aremultiple preferences given to local businesses.

Export and Financing Subsidies. Through various programs at the National Social and Economic Development Bank(BNDES), Brazil promotes the purchase of domestic equipment and machinery andhelps finance export activities.

Services Trade and Investment. Thereare restrictions on industries such as audio visual, telecommunications, financial(insurance), and express delivery services. Brazil has expressed concern overinvestor-state provisions, standard language in U.S. free trade agreements, andpossible U.S. reaction to some of its subsidized financing programs conducted underBNDES. Brazil has not signed a bilateral investment treaty with the United States.

Outlook

Brazil trades relatively little for an economy of its size and diversity andwould benefit from trading more. It has embraced export promotion, whichgenerates foreign exchange and can contribute to growth in economic output, but hasshied away from deeper commitments to lowering barriers to imports, which are keyto gains in productivity, per capita income, and development. This strategy isconsistent with Brazil's short-term financing needs and its trade preferences, whichare driven by a combination of macroeconomic, industrial, and foreign policypriorities.

For the United States, this presents a delicate policy conundrum becauseeconomic reciprocity may not be the only key to successful trade negotiations withBrazil. For example, even if significant progress could be made on agriculturalissues in the Doha round, and Brazilian trade complaints could be ameliorated inbilateral working groups with the United States, Brazil may still choose not toliberalize areas where either it cannot easily fulfill the provisions of an FTA(enforcing protection of IPR), or where the United States has a distinct comparativeadvantage or particular interest (industrial goods, services, investment). This hasbeen made clear in statements by Brazilian officials and by formal trade negotiationpositions.

To illustrate, in speaking on the FTAA, a former Brazilian Ambassador to theUnited States and noted trade expert wrote:

The Brazilian position is not merely atactical reaction to the U.S. negotiating strategy regarding the so-called systemicissues. In fact, Brazil has a clear interest in preventing hemispheric disciplines ontopics such as investment, intellectual property, government procurement, andservices from curtailing its ability to formulate and implement public policies that arein its highest national interest. (42)

This attitude is reinforced by evidence questioning the economic logic of Brazil'santi-FTAA position based on the U.S. preference for addressing subsidies in theWTO. For example, studies point out that ending agricultural subsidies wouldincrease FTAA agricultural trade little compared to a far bigger gain for Brazil fromeliminating tariffs. (43) Brazil seems to realize this on some level or itwould not continue to offer the "4+1" market access talks as an alternative to theFTAA.

As such, U.S. trade negotiators may be frustrated because there is perhapslittle they can do to nudge Brazil off its course of continuing to advance Mercosul,where the marginal gains from expansion are likely small, and pursuing selectivepriorities in the WTO, while leaving the FTAA to flounder indefinitely. Brazil mayactually have more to lose, however, because as much as both countries couldimprove their economic well-being from greater trade liberalization, as a developingcountry, Brazil seems to have the most to gain from not only reducing foreignbarriers to its exports, but unilaterally opening its economy further, particularly aspart of completing its ongoing economic reform agenda.

Appendix 1. Brazil: Top 15 Exports andImports

(calendar year 2004, $ millions)

Data Source : Boletim do Banco do Brasil, September, 2005.

Appendix 2. U.S.-Brazil Merchandise Trade

($ millions)

Data source : U.S. Department of Commerce.

Appendix 3. U.S.-Brazil ServicesTrade

($ millions)

Data Source : U.S. Department of Commerce. Bureau of Economic Analysis(BEA).

* Trade turnover = total trade or exports plus imports.

Appendix 4. U.S.-Brazil Foreign DirectInvestment

(in millions of U.S. dollars, historical costbasis)

Source : U.S. Department of Commerce. Bureau of Economic Analysis (BEA).

Note: historical cost data measures the stock of FDI reflecting prices at the time ofthe investment.