Natural resource booms are a mixed blessing. Economists often point to the example of the Netherlands in the 1960s, when a natural gas bonanza brought a windfall tax take for the government, but also drove up the value of the currency and decimated local export manufacturers. Some in Brazil now fear that their country, surging on the back of a soy, oil and iron ore rush, is becoming the next victim of this “Dutch disease.”
The ramifications would be especially destabilizing for Brazil, an upper-middle-income country. Economies usually transition up the value chain from a manufacturing-oriented to services-oriented economy as they develop. But analysts fret that Brazil is prematurely de-industrializing for all the wrong reasons, which could stunt its long-term growth.
Another threat is the potential that China’s economy will slow. In recent years, Brazil’s economic growth – along with other South American nations – has been fueled in large part by China’s investment and construction boom. With that growth cooling, some fear Brazil’s economy might freeze. For every 1% China’s growth slows, Brazil’s GDP will fall by 1.2%, according to estimates by credit ratings agency Fitch.
A farewell to factories
Brazil has exported natural resources since colonial times, but its most recent boom took off only in the past decade. The inflow of capital has put huge upward pressure on the value of Brazil’s currency. Earlier this year the value of the real was up around 45% against the US dollar from 2008 levels. It has since cooled somewhat, but remains 25% above its 2008 value, making it one of the most overvalued currencies in the world by some measures.
A stronger currency has clearly damaged Brazil’s manufacturing export industry. Manufactured goods accounted for over half of all Brazilian exports in 2001, but a decade later the figure had fallen to just 35%, according to data from the WTO. The country’s purchasing managers’ index indicated that the industrial sector shrank in April, May and June, and anecdotal reports of layoffs abound.
Natural resources overtook manufactured goods as Brazil’s biggest export in 2007, and the country now runs a persistent manufactured goods deficit with most countries. China is a particularly extreme case; in 2010, some 83% of Brazilian exports to China were natural resources, while an overwhelming 97% of Chinese exports to Brazil were manufactured goods.
Rule-bound
But a strong, commodity-fueled currency is only partly to blame. A backwards regulatory regime has also burdened Brazilian companies. “Labor costs and administrative costs make the cost of doing business in Brazil very high,” said David Clearly, strategy director of agriculture for non-profit organization Nature Conservancy.
Brazil ranks a paltry 126 out of 183 countries on the World Bank’s annual “Ease of Doing Business” survey. It scored particularly poorly on taxes. Payroll taxes are “ridiculously high,” Clearly said; state and federal rates combined can add up to about 37% of salaries. Brazil’s value-added tax (VAT) hits products like manufactured goods but not raw materials, effectively punishing industry and subsidizing commodities industry, noted Carlo Lovatelli, president of the Brazilian Vegetable Oil Industry Association (ABIOVE), a trade body.
“We have a very awkward fiscal policy in Brazil. We have to work on that,” Lovatelli said. He said his organization is lobbying to streamline and reduce the red tape and has meetings “almost every week” with federal regulators in the capital, Brasilia.
There are signs of progress. In March the government announced a transition from a 20% federal payroll tax rate to a 1% levy on gross revenue for certain industries most affected by international competition. Officials cut taxes on industry again in April, saving companies around BRL5.8 billion (US$2.85 billion). They also announced new measures, such as more government purchases from local suppliers and BRL45 billion (US$24.6 billion) in new lending to the manufacturing sector from the state development bank.
However, the government has also resorted to openly protectionist measures, such as a tax on currency conversion, local content rules for the oil industry and new tariffs on auto imports. Such policies may be politically attractive, but they hardly reduce Brazil’s dependence on Chinese demand for commodities, or strengthen the competitiveness of Brazilian exporters internationally.