Chinese Investment Flows Continue to Aid Brazil's Ascendency

Chinese Investment Flows Continue to Aid Brazil's Ascendency
Faizaan Sami

1. Brazil has been able to avoid a major setback from the global financial crisis, due largely to its burgeoning trade relationship with China.

2. The terms of trade with the Asian nation have been reassessed by the Brazilian administration, especially after domestic industries have been suffering from the competitive impact of Chinese manufactured goods.

3. Dilma Rousseff's administration has responded by implementing protectionist measures and pursuing trade diversification initiatives.

China's unstoppable emergence and influence as an economic super power has led to one of the most important changes to the global economic framework in the modern period. In the 1990s, the nation sought to consolidate its position regionally by nurturing bilateral trade relations with its neighbors and utilizing soft power to build state legitimacy. Gradually, after the rapid growth of its manufacturing sector, China's resource-intensive economy has influenced the global expansion of its economic ties in order to sustain its growth pattern.

To meet the rising demand for agricultural and mineral commodities, China has developed trade relations with Latin America, particularly Brazil, which has both sets of resources in abundance. The trade statistics tell the story of a relationship that has developed at an exponential rate. Brazil's exports to China have increased by USD 28.8 billion since the turn of the millennium, while imports have increased by USD 24.3 billion during the same period, helping the Latin American country to obtain an advantageous USD 5.2 billion trade surplus in 2010. Trade between the two countries has more than tripled in the past five years to USD 56.4 billion[1], solidifying China's position as Brazil's largest trading partner for some time to come; right now China's share of Brazil's exports is not far below that of the entire European Union.[2] The major trade items -- iron ore and soybeans, account for 83.7 percent of Brazil's exports to the Far East, while 90 percent of the imports from China consist of manufactured goods, which are helping to satisfy the demand of Brazil's expanding consumer class.[3] Consuming up to half of the world's annual output of iron ore, China has found the perfect partner in Brazil, the biggest supplier of the mineral in the world.[4]

It has been widely considered that China's large investments in Brazil's raw materials have helped the South American nation avoid any long-term effects from the 2009 global financial crisis. However, it was also the favorable domestic conditions that created the opportunity for growth. As a result of the country's conservative fiscal and monetary policies adopted in the late 1990s, Brazil has been able to maintain a strong banking system, a steady growth rate, manage debt, and boast large foreign currency reserves. So while Brazil's economic stability has been built by its conservative economic practices, its rapid growth has been significantly attributable to China's demand for basic commodities that happen to be Brazil's special forte. The positive outcomes of Brazil's economic growth have included greater employment, higher wages, as well as upward social mobility, illustrated by the expansion of the lower middle class and with it, greater consumer demand. However, in light of increased consumer as well as foreign demand -- both of which have outgrown supply levels, Brazil's market has experienced steady inflation and overheating for over a year.

Currency Appreciation & Speculative Investment

One of the dilemmas the central bank of Brazil (BCB) is facing is how to deal with the influx of speculative capital into the economy. As emerging markets like Brazil have become some of the main drivers of growth, foreign investors have been borrowing money in advanced economies with low interest rates and then proceeding to pour such capital into Brazil -- an investment strategy that boosts money supply and further leads to inflation. So when Brazil chose to raise interest rates three different times since the start of the year in order to curb inflation, it attracted investor inflows that pushed up the currency value. This in turn somewhat countered the tightening measures. With little success in curtailing inflation and avoiding the effects of speculative investment, the central bank has now turned to the unorthodox approach of reducing interest rates to twelve percent, even as the economy is growing. Since the interest rate cuts, the real has weakened by six percent against the dollar although it still remains up by thirty six percent in comparison since January 2009.[5] After a consistent period of inflation, the nation is gradually coming to the realization that the real currency could remain strong for the long-term future.

Dangers in the Terms of Trade

In 2000, Brazil was exporting more manufactured goods than commodities. Primary commodities now, however, account for nearly half of Brazil's exports, while manufactured goods account for only a third of sales, revealing a significant shift in the composition of exports, one which has helped increase the nation's trade surplus by nine hundred percent in the same period. While Brazil wants to maintain its trade relationship with China, the issue lies with the other face of the terms of trade. There is discontent among Brazilian manufacturing industries of being undermined by the influx of cheap imports from the Far East, which have risen by sixty percent from 2009 to 2010, a rate that is showing no signs of abating.[6] The influx is due primarily to the high cost of domestic manufacturing, labor and transport prices, which have become so unfavorable that certain industries would rather seek parts or entire consumer goods from China rather then sourcing them domestically. The trend could not be more apparent than at the heart of Brazil's most illustrious carnival festival, where some eighty percent of the clothes worn were made in China.[7] Such new occurrences have thrown caution to the wind and the terms of trade are now being reassessed.

Protectionist Measures for Domestic Industries

As a result of the country's currency appreciation and the relative isolation of its manufacturing industry, an estimated seventy thousand jobs and USD 10 billion have been lost.[8] In response, the government has begun to implement protectionist measures on a consistent basis since the turn of the year. It has been the responsibility of Brazil's President Rousseff to help protect the nation's key domestic manufacturers from competition and be able to deal with the potentially damaging outcomes of a trade relationship with China that was left unchecked by Brazil's previous incumbent, President Luiz Inácio Lula da Silva. Upon assuming the presidency, Dilma Rousseff directly addressed the issue stating, “We will act decisively in multilateral forums in defense of a healthy and balanced economic policy, protecting the country from unfair competition and from the indiscriminate flow of speculative capital.”[9]

Efforts to protect Brazil's manufacturing sector began as early as January 2011 when tariffs on toy imports from China were increased.[10] The government has also stated it will allow any new anti-dumping tariffs retroactively for ninety days to prevent importers from stocking up on goods.[11] Local industries fear that China is practicing a dumping policy, whereby its manufacturers are selling goods below their domestic price and forcing out competitors. Brazil is not alone in its suspicion of China's dumping pricing policy; nearly four hundred cases around the world have been filed involving anti-dumping, countervailing surcharges and potential punitive measures against Chinese imports.[12] Concerns over the prospect of deindustrialization have been allayed by further protectionist measures from the state. Aimed at protecting steel producers who have been desperately dropping prices in order to attract demand, a five-year anti-dumping tariff of USD 743 per ton on steel pipe imports has been instituted to prevent oil companies from importing the material.[13]

The latest source of discontent is now coming from the domestic automakers industry, which predicts that a quarter of the automobiles sold in 2011 will be imported.[14] Even more problematic, both domestic and foreign automobile manufacturers in Brazil have been importing car parts from abroad, which has caused the state administration to react in September 2011 by raising the industrial tax on cars that consist of more than thirty-five percent foreign content. Due to Brazil's currency appreciation, the costs of production for automobiles are sixty percent higher.[15] These conditions, similar to the ones in the other industries mentioned, have significantly reduced the importing of car parts. However, now that the government has applied the tax measure, manufacturers and suppliers will be primarily confined to the MERCOSUR region, forcing them to manage with higher costs of production, a burden that is likely to trickle down to the consumer.

State Led Trade Diversification Initiatives

Like her predecessor, Dilma Rousseff has sought to maintain strong trade relations with China. However unlike Lula da Silva, she has been cautious about the developing terms of trade and advocated the necessity for trade diversification. Rousseff hopes that expanding and diversifying exports will reduce the market's dependency on any single state investor or specific commodity demand. Since her visit to Beijing in April 2011, a number of bilateral investment deals have been reached with long-term expectations of improving the manufacturing sector. ZTE, China's second largest telecommunications equipment manufacturer, has agreed to build an industrial plant in Hortolândia that will employ two thousand workers; in addition to production, it will include a research and development center, with around two hundred Brazilian-based employees.[16] It is anticipated that the establishment of the plant in Brazil will provide the local labor force with essential training and the necessary conditions to increase productivity and efficiency in the communications sector.

Incidentally, once again it was the enactment of protectionist measures that influenced a change in the company's operations. If not for the implementation of high import tariffs, the telecom manufacturer would otherwise pursue the more cost efficient strategy of making its products from home. Similarly, Foxconn, a Taiwanese company whose operations are based in mainland China, has promised to invest USD 12 billion in building a manufacturing plant in Brazil to make Apple products, introducing just the sort of high-end goods that Brazil fervently wishes to inject into its manufacturing sector.[17]

As well as facilitating the ongoing sophistication of the manufacturing sector, Brazilian authorities have urged Beijing to purchase more Brazilian value-added goods and make every effort to diversify trade. In April 2011, Brazil announced the sale of twenty Embraer E-190 jets with an option to sell an additional fifteen to China in a deal worth USD 1.4 billion.[18]

Substandard Labor Productivity & Misguided Protectionism

Linked to the absence of a strong, competitive and sophisticated manufacturing sector is Brazil's somewhat poor total factor productivity (TFP), which is "the ratio of the total goods and services [an] economy produces to the factors of production such as capital, labor, and human skills."[19] Problematically, low TFP rates in both the service and manufacturing sectors have weakened the incentives for innovation and growth. In addition, since only twenty percent of the labor force works in the manufacturing sector compared to over sixty percent in the service sector, the Brazilian administration has been justifiably criticized for misguiding its efforts of trying to protect and promote the manufacturing industry.[20] Instead of focusing on industrial competitiveness, an arena where Brazil cannot match India or China, critics argue that the administration's policy should instead be devoted to increasing the TFP in the service sector.

Infrastructure Deficit As a Barrier to Advancing Economic Growth

Apart from a scarcity of productive labor as well as the lack of an adequate domestic industry for technological products, Brazil's infrastructure deficit is stifling the opportunity for growth and efficiency. Since only a quarter of Brazil's cargo is transported by rail, the need for expanding railway networks has become essential as exporters are usually forced upon inadequately maintained roads. The costs for transporting materials like soybeans overland can be three times more expensive in Brazil than in the U.S.[21] In light of this, the Brazilian mining company Vale has been investing in infrastructure development; its iron ore shipments are transported through its own rail network spanning nine of Brazil's twenty-six states, which also contributes to the transportation of sixteen percent of Brazil's total shipments.[22] Currently under construction, the Trans-Oceanic highway traversing Latin America is another infrastructure investment that is not only likely to improve Brazil's export practices but allow other emerging markets like Chile and Colombia access to export destinations on the Atlantic, an investment that could encourage better regional economic relations with Brazil.

As Brazil continues to ship greater masses of commodities out of the country and gets accustomed to new levels of demand from China, it will need sizeable and well-equipped ports to arrange to ship such exports efficiently. With growing demand for steel and aluminum among other metals, the country's ports were handling eight hundred million tons of freight in 2010, expected to rise to a billion tons by 2015.[23] With the combination of private sector and state funds, USD 17 billion will be used to finance port infrastructure development, to both expand and create new ports to handle bigger ships.[24] Confidence in the country's infrastructure revitalization is so strong that the International Finance Cooperation has made its largest investment in port development, with an allocation of USD 670 million for Brazil to build a new container terminal at the Port of Santos.[25]

The Uncertainty Surrounding Future Growth

So far Brazil has done remarkably well in the last two years to create jobs for six million people and noticeably increase its standard of living. The administration's current focus on social programs and poverty reduction will bode well for the economy; reducing poverty will mean greater participation in the country's economic structure and the sustainability of consumer demand, which will be imperative for Brazil's economic stability for its forthcoming, potentially tumultuous year. However, with the new benefits of growth, the expectations of the new middle class have risen. People will now expect a higher quality of life, with the desire for better healthcare, infrastructure, and technological sophistication. Achieving quality of life will be possible only if the government can control its current account deficit, sustain its growth pattern, and combat rising inflation. Already GDP growth is expected to slow to 3.7 percent from 7.5 percent last year, and the forecast for global growth next year is pronouncedly weak.

Only by investing in self-improvement will Brazil be able to mitigate its reliance on Chinese demand and establish long-term growth. This implies becoming more productive, principally by investing in its deficient infrastructure, which takes years of work to alleviate. In order to become competitive, Brazil's administration will also need to work towards slashing the costs of production, increasing labor productivity and developing a skilled workforce, particularly for sophisticated manufacturing. Protectionist measures for manufacturing industries can only be short-term solutions for fending off the mass imports of cheap manufactured goods coming from China. Additionally, Brazil might need to consider realigning its focus away from manufacturing, not only because much of its labor force is presently engaged in services but also because the manufacturing sector is slowly declining with no reversal likely.[26]

As a commodity export nation, the cards being dealt are strongly in Brazil's favor; the rise in commodity prices as a result of surging demand from growing economies will hurt advanced economies like the United States, which will have to realize they no longer have the luxury of cheap access to raw materials. It is up to the central bank to continue to find an economic balance by countering inflation and leading the nation in a positive direction by maintaining a healthy GDP growth. A lot of uncertainty is involved with the outcomes of Brazil's reactionary measures amidst a global economy that's going through dynamic changes. However, the persistent activity from Rousseff's administration and the central bank already reflect a determination to get things right.

- Provided by the Council on Hemispheric Affairs (COHA)