* Latin American, European leaders meet to deepen trade ties
* Europe says time to wrap up long-stalled Mercosur deal
* Merkel will ask Brazil's Rousseff to revive negotiations
By Robin Emmott and Alexandra Ulmer
SANTIAGO, Jan 26 EU leaders told Argentina and Brazil on Saturday to open up their markets and push ahead on a free-trade deal that would be a major prize for Europe as it tries to emerge from three years of economic crisis.
Treading carefully in a region whose fortunes are markedly better than Europe's, German Chancellor Angela Merkel warned Buenos Aires and Brasilia not to revert to the kind of protectionism of the 1930s that deepened the Great Depression.
Five years after the global financial crisis and with the euro zone in its second recession since 2009, the European Union needs Latin America's buoyant economies. But it is frustrated by Brazil and Argentina's policies to protect local markets.
At a two-day summit in Santiago, Merkel led EU leaders' efforts to win a breakthrough on the long-stalled negotiations for with the South American trade bloc Mercosur that is made up of Argentina, Brazil, Paraguay, Venezuela and Uruguay.
"We need to have open markets in terms of free trade and not protectionism," Merkel told a meeting of business leaders. "History has taught us that in the '20s and '30s," she said, flanked by the pro-free trade presidents of Mexico and Chile.
Negotiations on a trade pact with the South American trade bloc Mercosur began in the 1990s and were relaunched in 2010.
They have yet to make real progress due to disputes over European farm subsidies and moves by Brazil and Argentina to shield local industry from cheaper, foreign-made imports.
In the meantime, Brussels has signed free-trade deals with a number of Latin American countries, including Mexico, Peru and Chile, revealing a split between the free-trade advocates on the Pacific side and the more closed economies, such as Brazil, Argentina and Venezuela, on the other side of the continent.
Merkel said she would discuss the issue with Brazilian President Dilma Rousseff and Argentina's Cristina Fernandez on Saturday at a time of growing impatience in Brussels, which has one of the world's most ambitious free-trade agendas.
"It is time to reach a deal with Mercosur," Jose Manuel Barroso, the head of the European Commission, said in his speech to loud applause from business leaders.
According to a draft of the summit's final statement seen by Reuters, EU and Latin American leaders will indeed commit on Sunday to more open trade and to avoid protectionist policies.
Europe wants to retain its influence in a region it conquered 500 years ago and where it remains the biggest foreign investor as China steps up its investment in mining and energy.
'LATIN AMERICA'S DECADE'
After decades of hyperinflation and financial crises, Latin America's economic fortunes are now better than Europe's.
Latin America's economic output is expected to grow almost 4 percent this year, as the 17-nation euro zone will probably contract.
Latin America's per capita gross domestic product could double by 2030, according to the InterAmerican Development Bank, meaning Europe will have more potential buyers of its cars, luxury goods, banking services and pharmaceuticals.
Gathered at a luxury hotel in a part of the Chilean capital dotted with newly-built glass skyscrapers, the mood was certainly celebratory, with Colombian President Juan Manuel Santos declaring it was "Latin America's decade."
But tense relations with Argentina and Brazil represent a new hurdle to a Mercosur deal, one that Germany as Europe's top exporter is especially keen to see resolved.
Argentina's fiery, left-leaning Fernandez, slapped sweeping controls on imports in February 2012 in a bid to prop up the trade surplus and keep industry competitive as labor costs soar.
Fernandez met Brazil's Rousseff on Saturday in Santiago and called for Mercosur to establish a committee to "discuss and re-elaborate new proposals and a new offer to present in the last quarter of the year to the EU."
It was not immediately clear if this signalled a breakthrough or a move to buy time.
According to Global Trade Alert, an independent body monitoring commerce, Argentina is the world's worst offender when it comes to protectionist measures because the policies affect so many industries and sectors all over the world.
Neighboring Brazil - Latin America's largest economy - has also raised import barriers on goods from European steel to powdered milk. In the first 10 months of 2012, Brazil opened 47 trade defense cases, more than double the number in all of 2011.
EU Trade Commissioner Karel De Gucht acknowledged that the 27-member European Union could do more to reduce its trade barriers in a region that guards its agricultural sector from U.S. and Latin American imports it regards as unsafe or a threat to its local products ranging from Parma ham to Bordeaux wine.
But he said it was time for Argentina and Brazil to act. "We need to bring the negotiations with the Mercosur countries to a conclusion," De Gucht said. "It is no secret that Europe would like to have made more progress in these talks by now."