BRAZIL´S CRISIS -- AND OPPORTUNITY / THE WALL STREET JOURNAL OP EDITORIAL ( VERY HIGHLY RECOMMENDED READING )

THE AMERICAS
.
July 22, 2012, 6:20 p.m. ET
.
Brazil's Crisis—and Opportunity
.
The breakdown of the customs union with Argentina could free it to seek better trade opportunities elsewhere.

By MARY ANASTASIA O'GRADY
.

Associated Press

Argentina's president, Cristina Kirchner and Brazil's president, Dilma Rousseff pose at the opening of the Mercosul leaders summit.

The adolescent crush that money managers had on Brazil is wearing off. As economic growth has underperformed expectations, this big hunky Latin object of investor affection is beginning to look unsophisticated and immature.




.Now the country's most important trade relationship, with neighboring Argentina, is breaking down. This is likely to give the economy more headaches.





.
Brazil still has plenty of promise, thanks mostly to its human capital. Its institutions have held up in recent years even as the Workers' Party (PT) government's closest ideological allies—in power in Venezuela, Ecuador, Bolivia, Nicaragua and Argentina—have destroyed institutional checks and balances in their own countries. A Supreme Court trial alleging corrupt practices by the ruling PT party staff of former president Lula da Silva, slated to begin next month, demonstrates a healthy separation of powers. Low inflation has also fostered a middle class.




But then there is the monster state, which intervenes everywhere, gobbles up resources, and makes bottom-up entrepreneurial-led growth impossible. Especially disturbing, these days, is the aggressive expansion of credit channeled to chosen national champions by the Brazilian development bank.

Argentina is in even worse shape. It flirted with markets in the 1990s. But ever since the 2002 peso devaluation, successive Argentine governments have behaved like jilted lovers, hostile and vengeful toward investors. Contracts and property rights are now largely meaningless in an Argentine court of law.

Things could easily go downhill further for people living in both countries if, as seems likely, the Southern Cone customs union known as Mercosur, which also includes Paraguay and Uruguay, falls apart. In the long run, the end of Mercosur will be a good thing if it drives its members to open trade with the rest of the world. But in the short run, with so many industries heavily invested in the rules of the Mercosur game, a breakup is certain to be disruptive.





The most recent trouble for Mercosur started last month when the Paraguayan congress lawfully impeached President Fernando Lugo. Mr. Lugo was an acolyte of Hugo Chávez. For the Venezuelan dictator, it was a further sign that his regional Bolivarian movement has peaked and that opponents are having increasing success at pushing back against it—as they did with the removal of Manuel Zelaya from the presidency in Honduras in 2009. So when Mr. Lugo was voted out, Hugo sprang into action, mobilizing his allies, through diplomatic channels, to punish by isolation the new Paraguayan government.


.
One material effect of Mr. Chávez's activism was the decision by Mercosur to "politically" suspend Paraguay, which had opposed Venezuelan membership, from the group. Once it was suspended, Brazil joined Argentina and Uruguay in a vote to admit Venezuela.



.
Former Brazilian ambassador to Washington Rubens Barbosa had harsh words for the decision. As the president of the board of foreign trade of the powerful Industrial Federation of the state of Sao Paulo, Mr. Barbosa pointed out that the vote violated the Mercosur treaty. Paraguay, he said in an interview in Rio de Janeiro, has only been suspended but is still a member and was entitled to block the Venezuelan accession. He also warned that Venezuela would create political problems: How to deal with "the question of Israel, for example, which has an agreement with Mercosur but does not maintain relations with Venezuela?"

 

The Venezuelan fiasco was only the latest irritant in the trade relationship with Argentina. A bigger problem described by Mr. Barbosa is the casual manner in which Buenos Aires violates the agreement of free trade inside the union and its common external tariff. "The ministers and Brazilian technocrats travel to Argentina [and] reach agreements but later those agreements get stuck in the hands of [the Argentine secretary of trade] because everything [in Argentina] becomes a political question." Argentina, he predicted, "will be responsible for the end of Mercosur."



.
According to the Venezuelan daily El Universal, Mr. Barbosa also criticized the nationalization of the Argentine oil company YPF, which formerly belonged to the Spanish oil company Repsol. That decision, he said, has been damaging to the Mercosur bloc because it has increased the sense of investor insecurity in the region.

 

.

Argentina's noncompliance is also driven at this point by a shortage of foreign exchange. Despite its increasing efforts to suppress imports and employ strict capital controls, it risks a balance of payments crisis.




.
Nevertheless there is opportunity here as well. Mercosur creates more cross-border trade within the union, but thanks to the union's external tariff this is at the expense of trade with nonmembers that could provide better value. This matters less to Brazil, with its large internal market, than to the smaller members. If Paraguay is smart it will take advantage of its suspension to bolt the union and pursue free trade with the rest of the globe. For that matter, it wouldn't be a bad idea for Brazil either.

.

Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved