Uruguay: little kid on the bloc

As Mercosur expanded this week, Uruguay still feels the effects of its neighbors' woes.

Asked what he would advise Uruguay to do in order to boost its sluggish economy, a Latin American economist once replied: "Move!"

The story may be apocryphal, but it sums up this tiny South American country's dilemma. Uruguay is a small kid living on a tough block.

The two big kids on that block are Argentina and Brazil, and as they go, so go their neighbors - and they haven't gone so well lately. Moreover, with Uruguay linked to the two behemoths through Mercosur, the world's third-largest trade bloc, the problems in the neighborhood have had Uruguay on the edge of economic meltdown for the past year.

Now as Mercosur expands - Peru joined as an associate member this week - with hopes of creating a continental trade bloc à la European Union, Uruguay provides a cautionary tale of what can happen when a small country hitches its wagon to big stars that ultimately fall. While trade blocs can provide small countries with huge new markets, analysts say they must proceed with care.

Last August, a collapse of Uruguay's financial system was narrowly averted thanks to a $1 billion emergency-aid package from the US. But despite follow-up aid from the International Monetary Fund, Uruguay remains in the doldrums, its economy listing, and more and more of its people looking to emigrate from this land of immigrants.

In 1991, Uruguay joined Brazil, Argentina, and Paraguay to form Mercosur, as a means of bolstering regional trade and exerting greater influence in the global market. Since then, Bolivia, Chile, and now Peru have joined as associates. Brazil's President, Luiz Inacio Lula da Silva, said the accords signed in Lima this week "may be ... the first step in building here what was built in the European Union." He traveled to Venezuela as well, signaling it may be next to join.

But some of Uruguay's benefits have yet to be realized. Mercosur lacks blue-chip anchor members. The North American Free Trade Agreement (NAFTA) has the United States and Canada while the EU has Germany, France, Britain, and Italy. These countries provide the economic muscle that has helped bring stability and sustained growth to countries like Mexico and Ireland.

By contrast, Uruguay has Brazil and Argentina, two countries that have suffered a mix of debt default, currency devaluation, recession, and an inability to sustain growth.

"[Uruguay] was very divided on joining," says Ana Maria Rodriguez Aycaguer, a lecturer in international relations at the University of the Republic in Montevideo. "Many people opposed membership, worried that Uruguay was too small and that all decisions in the bloc would be made by Brazil and Argentina,"

Initially, trade within the bloc bloomed. But in 1999, fallout from the Asian financial crisis reached the region, hitting Brazil and Argentina hard. When Argentina's economy eventually tanked last year, it nearly took Uruguay down with it.

In part, the cause was the financial integration spurred by Mercosur. Argentines have long held bank accounts in Uruguay, known as the Switzerland of South America. When Argentina imposed a freeze on domestic bank accounts at the beginning of 2002, many Argentines took the short boat trip to Uruguay. Soon, a run on the banks in Argentina had been exported to Uruguay.

Because of its location, Uruguay probably would have been hit hard even if it had not joined Mercosur. But integration exacerbated things, especially in the financial sector. The financial system has now been secured, but the economic fallout continues. Last year, Uruguay's economy contracted 10 percent and has yet to start growing again.

"One of the questions for Uruguay is: 'Does Mercosur bring it the kind of stability that the US brought to Mexico through NAFTA?' And obviously it does not," says Claudio Loser of the Inter-American Dialogue, a Washington based think tank.

But experts say the country's problems are not solely a consequence of membership.

"Uruguay needs to reinvent itself," says Larry Birns of the Council of Hemispheric Affairs, a think tank based in Washington. "It needs to come up with a miracle product away from agriculture - much the way Ireland did by developing a high-tech sector in the last 10 years. Until it does, it will be a country permanently foundering."

Still, Uruguay sees a big upside to membership in Mercosur coming down the pike.

Currently, the US and EU are both engaged in talks with Mercosur about prospective free-trade agreements, giving Uruguay bigger markets for its meat and leather. The US wants to see a Free Trade Area of the Americas by 2005.