NS4540 Winter Term 2019 Brazil: Reindustrialization Oxresearch “Brazil: Reindustrialization faces formidable hurdles” December 29, 2016

Overview The relative decline in the manufacturing industry’s weight in the Brazilian economy started 25 years ago. However the pace has picked up in the last decade The loss of industrial competitiveness behind this latest contraction results from An overvalued and unstable exchange rate for most of the period A poor business environment and Increasing competition from Chinese industrial goods Economists and policymakers of different political persuasions agree on the need to reindustrialize the economy, but no clear action plan for achieving that objective.

Brazil: Decline in Manufacturing

Poor Competitiveness Multiple reasons explain the long-term loss of competitiveness of Brazil’s manufacturing industry For most of the period since the mid-2000s an overvalued exchange rate has persisted increasing the competitiveness of imports Despite recent depreciation, the instability of the exchange rate – which reflects Brazil’s political and economic environment – remains an inhibiting factor for production and investment decisions.

The “Brazil Cost” The loss of industrial competitiveness also reflects from the “Brazil cost” a long standing list of problems facing businesses in the county. These include A heavy tax burden on businesses coupled with a Byzantine tax- system Excessive bureaucracy High interest rates for companies unable to access funding from the National Development Bank (BNDES) Rising wages and production costs in the last 10-15 years, and Poor infrastructure As has happened elsewhere, competition with cheaper Chinese goods both in the domestic and foreign markets has also contributed to a decline of Brazilian competitiveness across several manufacturing sectors.

Brazil: Policy Response I Brazil government responded to the global financial crisis with various policies aimed at boosting domestic demand Tax breaks and Credit expansion While policies succeeded in creating higher demand for manufacturing goods – largely met by foreign production Rising industrial imports contributed to The weakening of domestic inter-industry linkages and The deterioration of the trade balance of manufactured goods Since 2014 manufacturing GDP has been shrinking consistently more than total GDP However as a result of the country’s long and deep recession imports have dropped sharply and the trade balance has started to show signs of improvement

Manufacturing/GDP Growh

Brazil: Industrial Capacity Utilization

Brazil Trade Balance

Brazil: Policy Response II Exports could represent an alternative for the manufacturing industry. However their potential is limited by The unstable exchange rate The low competitiveness of most Brazilian manufacturing segments The poor performance of the international economy Stagnant global trade levels, and Growing protectionism

Limited Policy Leeway Most economists agree the country requires a new strategy for its manufacturing industry. However Severe fiscal constraints and High public and private indebtedness Limit the government’s room for manoeuver The government has abandoned the industrial policy based on subsidized credit and tax exemptions Moreover Temer administration is inclined to promote greater economic openness and to seek bilateral and regional trade agreements This is a move away from Brazil’s long-standing prioritization of multilateral trade liberalization under the WTO framework

Limited Policy Leeway II While these moves in line with government’s objective of strengthening Brazil’s relatively weak links to global value chains, their potential effectiveness is unclear. Some additional disruption provoked by increased consumption could deliver another blow to industry’s attempt at integrating into international production networks as a key supplier. Unintended consequences? There is further uncertainty regarding the impact on manufacturing industry of government’s plan to freeze its own expenditure in real terms for at least ten years. Measure expected to restore investor confidence by signaling a clear and predictable path to reducing public debt However, could also lower aggregate demand temporarily if prove sector does not offset the moderation in government spending

Industry 4.0 I New technologies such as the Industrial Internet of things (LLoT),3D printing and artificial intelligence are already revolutionizing global manufacturing For Brazil they represent both an opportunity to catch up with leading manufacturing economies and a considerable risk Brazilian infrastructure is not suited for a massive adoption of LLoT in the short term 3D printing may favor the on-shoring of manufacturing activities by firms headquartered in developed countries, potentially threatening an economy whole industry is largely composed of foreign multinational companies

Industry 4.0 II The longer the Brazilian manufacturing sector takes to adjust to this “new industrial revolution” The higher the risk that it may have to rely solely on Protectionism, and The health of domestic and regional markets Or shrink even further

Assessment Numerous short-term constraints and structural challenges undermine Brazilian reindustrialization In a context of: Fiscal crisis High private and public indebtedness and Unemployment An eventual industrial recovery would first meet demand increases by elevating capacity utilization before expanding productive capacity through new investments Longer term reindustrialization will require further action, particularly to embrace technologies such as 3D printing and the Industrial Internet of Things