12 for 2012: Brazil’s import substitution industrialisation 2.0

As
the third quarter of 2011 brought a pause to Brazil’s recent long
stretch of growth, many have been asking: is this a temporary
contraction or is Brazil facing a more troubling halt, in line with its
historical pattern of boom and bust?

More than anything, Brazil’s slowdown is a sign that caution
vis-à-vis the eurozone crisis is felt in all quarters. The country is
taking a breather but it will continue its domestic, market-led growth.
Given the reasons why Brazil is growing, however, this may not leave
much to celebrate in the future.

Growth in the past eight years is a result of the benign confluence
of Brazil’s competence in biofuels, banking, mining, offshore oil, and
especially the expected benefits of its vast deep-water “pre-salt” reserves. Brazil will turn out more than 6m barrels of crude a day by 2020. To reach that goal Petrobras plans to spend over $1tn in coming years in pre-salt projects.

The company’s yearly capital spending of $45bn far exceeds NASA’s annual budget at the height of the Space Race (in current dollars). Petrobras is also the main force behind the remaking of Brazil’s naval industry. From 2012 to 2022, the company will buy more than 250 large oil tankers at an average price of $125m each – and 65 per cent of its components have to be “Made in Brazil”.

That says a lot about the country’s growth model. Contemporary Brazil is seeing the quiet rebirth of policies formulated by Raul Prebisch (1901-1986), the Argentine economist, and Celso Furtado (1920-2004), Brazil’s leading advocate of Dependency Theory. We may call this renaissance “Import Substitution Industrialisation 2.0″ or ISI 2.0.

From the early 1950s, Brazil used import substitution to change the DNA of a country historically attached to agriculture and mining. Its most spectacular periods of growth in the 20th Century – President Juscelino Kubitschek’s “50 Years in 5” (1956-61) and the “Brazilian Miracle” (1967-73) – were largely the result of ISI. It produced annual growth rates in excess of 10 per cent and indeed converted Brazil into a large industrial economy targeted at a vibrant domestic market. However, inarticulate exchange-rate policies, a lack of vertical industrial integration and unfavourable international junctures have made inflation and foreign debt the “twin sisters” of ISI.

ISI 2.0 can be easily identified in the way state-owned enterprises, official banks, municipalities, states and the Federal Government interpret and implement Brazil’s interests in the global economy. Today, ISI 2.0 is the parameter of how government in Brazil protects domestic companies from foreign competition, fosters local content and goes about procurements.

Prebisch and Furtado – still the patron-saints of policy-makers at BNDES (Brazil’s powerful government-owned development bank) and the economic departments in Brasília – argued that only those countries performing massive indigenous industrialisation could become “cyclical centres” of the global economy and therefore endogenously trigger their own development.

Present day ISI 2.0 has two faces. It continues to apply high import taxes and other barriers to protect national groups and foster Brazil’s chosen industrial priorities (semiconductors, software, electronics, automobiles and others).As the country’s currency is clearly overvalued, its trade deficit in manufactured goods would be even larger if it were not for tariff shields – which contribute to the outrageous prices paid by Brazilian consumers for many foreign goods.

Much like its 1950s prototype, ISI 2.0 is clearly “nationalistic”. It nonetheless updates the concept of “economic nationalism”. Rather than merely sheltering Brazilian entrepreneurs, ISI 2.0 calls for the “Brazilianisation” of companies wishing to harness the potential of Brazil’s domestic market. An entire set of incentives is put to the service of those who decide to create jobs in Brazil. Its most powerful tool is the robust policy of government procurement which has found expression in the Lula-Dilma administrations (of Luiz Inácio Lula da Silva, president from 2003 to 2010, and Dilma Rousseff, president since January 2011).

Brazil is operating under what we could call “the pre-salt hedge”. According to this notion, multiplier effects of new oil discoveries for those who decide to invest in Brazil will be so huge during the next 30 years that they “anchor” the decision to set up long-term operations in the country. That is why 2011, in spite of the global crisis, sees Brazil receiving $65bn in foreign direct investment, 5 per cent of the world’s total.

Is all this good news for Brazil? No. It may become an underperformer among the Brics and other EMs as it continues to sweep urgently-needed labour, tax and political reforms under the carpet. And Brazil’s ISI 2.0 is inherently vulnerable. It relies on heavy, non-stop flows of FDI pouring in over many years. For all this to work smoothly, ISI 2.0 must generate shorter learning cycles to boost rapid and voluminous productivity gains – conspicuously absent in Brazil.

Making matters worse is the fact that over the past quarter century
Brazil has failed to implement a strategic project for power or
prosperity. Today, it confuses the concept of such a project with the
so-called “PAC” (the Portuguese-language acronym for Brazil’s Growth
Acceleration Programme, centred on updating the country’s poor physical
infrastructure). Welcome as it is, the PAC is not about building the
future. It is the search for lost time: ports, airports, paved roads –
the past catching up with the present.

Brazil’s comparative advantages of today (bioenergy, mining, oil,
pre-salt and so on) must foster the knowledge-based competitive
advantages of tomorrow. This will be a long road for a country that
directs less than 1 per cent of its GDP to research and development.

The future for Brazil lies in making its companies tech-intensive in
various industries. There is nothing more strategic for Brazil than the
challenge of transforming its creative people into a society of
entrepreneurship and innovation.