On March 26, 1991, Brazil, Argentina, Uruguay, and Paraguay signed the Treaty of Asunción, establishing the Common Market of the South (Mercado Común del Sur—Mercosur) with the intention of strengthening sub-regional development and cooperation through economic integration. Since then, Mercosur has struggled to achieve deep economic integration, but has maintained a cooperative economic and political framework, which has also become an influential voice in determining the fate of the hemisphere's regional integration initiatives. In particular, the U.S. vision for hemispheric integration, the Free Trade Area of the Americas (FTAA), has stalled largely because of opposition from within Mercosur. Venezuela's July 2006 signing of an accession agreement only reinforces Mercosur as the undisputed economic counterweight to the United States in the region and raises further doubts over the prospects for a hemispheric-wide trade agreement. This report examines the evolution of Mercosur as it relates to U.S. trade policy in Latin America. It will be updated periodically. The Mercosur countries are experiencing an extended period of strong economic growth after a deep recession caused by financial crises in Brazil (1999) and Argentina (2001). They currently have competitive exchange rates, stable macroeconomic conditions, and strong growth in exports and foreign direct investment largely because of the global commodity price boom. Commodity prices, however, cut two ways. Although strong agricultural prices have fueled export growth, the rising price of oil has offset some of these gains for the net oil importers (Venezuela being the exception), contributing to deteriorating current account balances over the past year. Within Mercosur, Brazil dominates the trade relationship, running a sizable and growing trade surplus with the rest of the pact. Mercosur has a well-diversified trade relationship with the world. In 2006, the European Union (EU) was Mercosur's largest trade partner, capturing 25% of total trade, followed by Asia with 22%, and the United States with 19%. By contrast, the four Mercosur countries together accounted for only 3.0% of total U.S. trade. With the recent addition of Venezuela, the "Mercosur 5" make up 3.6% of total U.S. trade, the increase accounted for almost entirely by U.S. imports of Venezuelan oil. Collectively, the "Mercosur 4" would rank 9 th for U.S. exports and 14 th for U.S. imports, slightly ahead of Brazil by itself, the largest economy in South America, responsible for 80% of total Mercosur trade with the United States. Patterns in U.S. merchandise trade with the "Mercosur-4" appear in Figure 1 (country data for all five appear in Table A -1 ). Note that trends are heavily skewed by Brazil's large economy. U.S. imports of Mercosur goods rose steadily from 1996 to 2006, paralleling growth in the U.S. economy. Expansion of U.S. exports, by contrast, was flat from 1996 to 2001 and then fell as import demand collapsed around deep recessions in Brazil and Argentina. U.S. exports rebounded in 2004 as the Mercosur economies recovered, and by 2007, the U.S. trade balance turned from deficit to surplus for the first time since 2001. The U.S. trade surplus reflects growth in demand in all four Mercosur countries. For Brazil, U.S. imports actually declined slightly in 2007, as U.S. exports rose by 28%. U.S. exports have been helped by Brazil's strong economic growth resulting in increased demand for U.S. inputs such as aircraft engines and parts, as well as the strong appreciation of Brazil's currency relative to the U.S. dollar. Major U.S. exports to Mercosur include mostly capital and high technology goods such as mechanical and electrical machinery (computers, vehicles, aircraft, medical equipment, and pharmaceuticals). The primary U.S. imports are components for machinery and vehicles, agricultural products, and oil if Venezuela is included. Specifically, the United States imports primarily machinery and mineral fuel from Brazil, mineral fuel and processed foods from Argentina, sugars and woods from Paraguay, and meat and woods from Uruguay. Despite being a relatively small U.S. trade partner, Mercosur contains two of South America's largest economies, and so prospects for growth in trade and investment drive, in part, ongoing U.S. interest in maintaining cordial and cooperative relations, as does the expectation for deeper Western Hemisphere integration, perhaps including, at some point, the FTAA. Mercosur evolved from a series of 1980s bilateral agreements between Brazil and Argentina. It was conceived as a way to foster new levels of political and economic openness and cooperation following a prolonged period of mutual distrust, much of it taking place under military dictatorships in both countries. In addition, as the South American economies moved away from an import substitution model of development to one based increasingly on trade openness, a regional trade agreement made sense given the four countries were "natural trade partners," sharing geographical, cultural, and economic complementarities. In fact, Uruguay and Paraguay pressed hard to expand the arrangement to a four-country common market to improve their trade prospects, or at the least, ensure that they would not be isolated by a bilateral economic pact between their two largest neighbors. Mercosur, therefore, evolved from economic and political circumstances that emphasized the need to preserve and enhance the Brazil-Argentine bilateral relationship, while fostering cautious ambitions for sub-regional economic integration that could also serve as a platform for the four countries' insertion into the global economy. Ultimately, as one scholar has observed, meeting expectations is critical, and Mercosur's success rests on the provision of consistent reciprocal market access and a "framework for cooperation" that promotes mutual economic growth and development. It is the difficulty in achieving this standard, as shall be seen, that has been at the root of persistent discontent within Mercosur. Formally, the Treaty of Asunción established Mercosur as a common market among Brazil, Argentina, Uruguay, and Paraguay for the stated purpose of accelerating economic development and social justice. The goal envisioned improved living conditions for all member countries through "balanced and managed growth in trade flows." The treaty followed guidelines compatible with the Latin American Integration Association (Asociación Latinoamericana de Integración—ALADI), a regional trade organization that provides a common, yet flexible framework for establishing sub-regional trade pacts that encourages inclusiveness and minimal harm to non-members. These pacts may be both "regional and partial in scope," in contrast to the U.S. free trade agreement (FTA) model that tends to be comprehensive. For example, Mercosur adopted as basic tenets "gradualism, flexibility, and balance," and allows for the negotiated accession of other countries. Mercosur followed an incremental path to a common market, beginning with a transition period (1991-95) in which it operated as an increasingly comprehensive free trade agreement (FTA) based on a schedule of automatic tariff reductions. The formal jump to a common market was made on January 1, 1995, but in reality, Mercosur became (and remains) only a partial customs union. It adopted a common trade policy and a schedule of common external tariffs (CETs) that applies to 80% of tariff line items, but with some very important exceptions for sensitive sectors such as sugar, automobiles, capital goods, computers, and other technology products. The exceptions were to be phased out by 2006, but many have been extended to 2011, requiring a set of complex rules of origin. In addition, there are weaknesses with the CET, a core requirement of a true customs union. The CET can be levied twice, first when a good initially enters a Mercosur country, and again if it crosses into another member country. Between the double taxation and multiple exceptions problems, resolving application and uniform enforcement of the CET remains an important unaddressed issue. The double taxation issue is a particular problem for Paraguay, which will suffer significant revenue losses without some type of comprehensive customs revenue sharing plan because most goods enter the Mercosur area through one of the other three countries. The incompleteness of the customs union fosters asymmetry issues (discussed below) that are at the root of Mercosur discontent, and that also suggest that the achievement of a full common market remains a distant, if not illusory goal. The Treaty of Asunción also provided for macroeconomic policy coordination and harmonization of policy legislation at the sectoral level (e.g. energy, agriculture, industry, technology). Some macroeconomic policies, such as exchange rates, have been forced toward complementarity by economic events, but differences remain significant and full coordination of policy is not currently feasible. The rationale for sectoral cooperation rests on inter-country factor mobility being pursued gradually, allowing comparative advantage to work, while easing the integration adjustment process. Nonetheless, sectoral issues and disputes remain a continuing challenge, especially between Brazil and Argentina, as does cross-border movement of goods both within Mercosur and to third country markets. All parties were required to accept a common set of rights and obligations (Article 2), with little allowance for special and differential treatment for smaller economies. There were many follow-on protocols. Among the most important was the December 17, 1994 Protocol of Ouro Preto, which formally established the common market and extended the institutional framework accordingly. Mercosur adopted a democratic commitment clause in 1996, and there were two protocols that clarified and expanded the dispute settlement process, the last being the Olivos Protocol signed on February 18, 2002, and implemented two years later.