European Union-Mercosur Agreement: A Partial Equilibrium Analysis for the Milk Powder Production Chain in Brazil

Milk is one of the few agricultural products in which Brazil is not competitive. The domestic market is served by domestic production and imports from Argentina and Uruguay. The Mercosur-European Union Bi-regional Association Agreement provides for the elimination of tariffs and the harmonization of non-tariff measures (NTMs) between the parties. Because the EU is one of the most competitive regions in the world market for powdered milk, this study analyzes the effects of the agreement on the links in this production chain in the Brazilian market. A constant, nested, multisectoral, and vertically integrated elasticity of substitution model is structured incorporating uncertainty in the estimates of Armington elasticities through Monte Carlo simulations, as in Hallren and Opanasets (2018). The model allows projecting the price effect (Armington) and the preference effect in the market shares of Brazil, Mercosur, and the EU on the domestic market. The results, in the most ambitious scenario of the agreement and in the most conservative estimate, show that Brazil would lose 71.7 percentage points in the domestic market. This means reducing Brazilian production by 475 thousand tons of powdered milk. The national agricultural link in this scenario would lose 15% of the current dairy demand. This loss benefits the EU, which would participate in the national market with a market share of 58.75%. Mercosur would add 13.41 percentage points to its current share of the Brazilian market.