By Guido Nejamkis
BUENOS AIRES (Reuters) - The South American trade group Mercosur welcomes Venezuela as its newest member this week but growing protectionism in the bloc's leading economies and political posturing have reduced it to a shadow of its former self.
When regional heavyweights Argentina and Brazil teamed up with Paraguay and Uruguay to form the customs union in 1995, they hoped to boost regional trade and investment by forging a bigger market along the lines of the European Union.
Trade within Mercosur has since quadrupled to $51 billion in 2011 but with economic growth slowing and Argentina and Brazil locked in a series of trade disputes over everything from cars to olives, analysts expect it to fall this year.
"Argentina is seen as hostile to foreign capital, Paraguay is fragile and unstable, Uruguay has an open economy but it's very small, and Brazil continues to draw investment. Mercosur, as a whole, does not," said Jose Botafogo Goncalves, a former Brazilian diplomat and representative to the bloc.
The decision last month to allow Venezuela's entry into Mercosur stirred further controversy within the group and fueled criticism that it has become little more than a political club for left-leaning leaders who harbor ambitions of Latin American unity.
Venezuela's socialist President Hugo Chavez shares such ideals but his country's membership, pending since 2006, had been blocked because it did not have the support of Paraguay's Congress, dominated by rightist parties.
When the same Congress ousted leftist President Fernando Lugo in a lightning-quick impeachment trial in June, the other Mercosur countries suspended Paraguay from the trade bloc and took advantage of its absence to let Venezuela in.
Mercosur will formally welcome Venezuela into the fold at a presidential summit in Brasilia on Tuesday.
GRUMBLING AND REPRISALS
When Mercosur got its start, the only products that were exempted from free trade were automobiles and sugar.
All other goods were supposed to be traded freely within the bloc or gradually stripped of duties, a goal that was largely met until Argentina expanded the use of non-automatic import licenses in 2011 and imposed a new system to pre-approve nearly all purchases abroad in February.
Last month, Brazil and Argentina got Mercosur's approval to raise import tariffs on up to 200 products of their own choosing, further diluting the objective of a common tariff, on the grounds that each nation must protect its industry as economies get hit by fallout from Europe's debt crisis.
Trying to safeguard its cherished trade surplus, Argentina has used the non-automatic licenses and new approvals system to block imports, affecting goods such as farm machinery and textiles from Brazil and shoes and food products from Uruguay.
It is a clear violation of Mercosur norms, but the response from within Mercosur has been muted grumbling and a raft of reprisals by Brazil's government, which like Argentina is under pressure to revive flagging local industry.
Brazil has sporadically restricted the entry of some Argentine goods, including fruit, olive oil and cookies.
The decision by Argentina and Brazil to virtually abandon the common external tariff - the backbone of Mercosur - allows individual members to raise tariffs as high as 35 percent, compared with current levels of about 10 percent to 12 percent.
"Argentina has a protectionist model, taking tariffs to 35 percent. It doesn't allow imports and it's methodology differs greatly from the original spirit of Mercosur," said Sergio Abreu, a former government minister in Uruguay.
For international companies using regional bases to supply the Mercosur market, the protectionist hurdles among member states are wreaking havoc.
"In the new Mercosur, foreign investment is discouraged," Abreu said.
Canada-based McCain Foods, the world's largest producer of French fries, laid off hundreds of workers at its Buenos Aires plant last month because Brazilian trade barriers were preventing it from supplying Burger King and McDonald's branches across the border.
"They had to supply the Brazilian market from Canada and Europe and rent warehouse space to store some of the production that they couldn't sell," a spokesman in Buenos Aires said.
The squabbles between Mercosur's two heavyweights have also proved a headache for the bloc's smaller members.
All three of Uruguay's car assembly plants - run by Chery Socma, Nordex SA and Effa Motors - have threatened to close and have laid off hundreds of employees since October, when import restrictions in Argentina and Brazil began taking a toll on their shipments.
McCain set up shop in Argentina in 1995 with an eye on the lucrative market in Brazil, Latin America's biggest economy with a population of about 200 million.
Access to Brazil's market once allowed Argentina to attract investment that would not have landed there otherwise, particularly in the food-processing and automotive sectors.
"But the way things are now, Argentina will probably have more trouble getting investments that were aimed at tapping a bigger market," said Mauricio Claveri, a trade expert at Abeceb consulting group in Buenos Aires.
Last year, Brazil received $66.66 billion in foreign direct investment compared with Argentina's $7.24 billion. In the 1990s, when Mercosur was created, Argentina received one dollar for every four dollars that entered Brazil, U.N. data shows.
"Argentina would never have been able to become a top 20 automobile manufacturer if it hadn't belonged to Mercosur," said Marcelo Elizondo, an international trade specialist at Argentine consulting firm DNI Negocios Internacionales.
For the first time since Mercosur's creation, the new protectionist measures are hitting trade flows. Trade between Brazil and Argentina slumped 12 percent in the first half of the year and shrank 32 percent in June alone.
And while Venezuela's Chavez hails his country's membership in the bloc after a six-year wait, producers in the Caribbean nation are skeptical about the potential benefits.
The target dates for reducing tariffs that were set in 2006, when Venezuela's incorporation was first agreed in principle, must be overhauled and details governing its membership will take a long time to hash out.
Trade between the Caribbean country and the bloc totaled $8.76 billion in 2011, with Mercosur tallying a roughly $5 billion trade surplus.
"From the point of view of manufacturing or agriculture ... we can't compete," said Manuel Heredia, president of Venezuela's National Federation of Ranchers, or Fedenaga.
(Additional reporting by Alejandro Lifschitz in Buenos Aires, Eyanir Chinea in Caracas and Hugo Bachega in Brasilia; Writing by Helen Popper and Hilary Burke; Editing by Kieran Murray; Desking by Vicki Allen)