Brazil/China economy: Rebalancing the relationship
The Economist, April 13th 2011
FROM THE ECONOMIST INTELLIGENCE UNIT
Sino-Brazilian commercial ties have expanded rapidly in the last decade, and China is now Brazil’s top trading partner—and was its biggest foreign direct investor in 2010 (with FDI worth around US$15bn). However, the relationship is seen as unbalanced, with Brazil exporting mostly commodities and importing manufactured goods from the Asian giant. President Dilma Rousseff took a step towards correcting this imbalance during a five-day visit to China that began on April 11th. She signed 22 co-operation agreements, some designed to open China’s market to higher-value-added goods.
The Rousseff administration wants to diversify Brazil’s exports and convince China to lower its substantial formal and informal barriers to the import of manufactured and processed goods. For example, China buys huge quantities of soybeans from Brazil, but does not import much processed soy products. Of Brazil’s US$56bn in sales to China last year, around 75% was commodities, with iron ore being the top export item. Similarly, some 90% of Chinese FDI in Brazil is in natural-resources sectors.
Accompanied by a large contingent of Brazilian businessmen and officials, Ms Rousseff was clear in her message to her Chinese hosts: she wants a “qualitative jump” in what Brazil sells to the Asian powerhouse, with a major increase in value-added and processed goods. The government also wants Chinese investment in Brazil to be more diversified, to include not just extractive industries but also high-tech manufacturing.
Range of deals
The president got some of what she wanted. The accords cover areas ranging from defence co-operation to joint development of agricultural technology and biofuels, as well as sports and education initiatives. The two sides also agreed to do research and development in the areas of nanotechnology, electricity and oil. Brazil’s state-controlled oil company Petrobras, for instance, will work with China’s Sinochem and Sinopec to develop new technologies for geological and deep-water prospecting.
China also said it would lift barriers to the import of pork products and agreed to purchase 25 additional regional jets for its state companies (Beijing had already agreed to buy 10) from Embraer, the Brazilian aircraft manufacturer. These orders are worth US$1.2bn. As a follow-up, the Chinese will send a commercial mission to Brazil in May to identify other potential suppliers of manufactured goods.
In the high-tech area, a major announcement came from the chief of Taiwan-based Foxconn, who said the company was considering an investment of US$12bn over five years in Brazil to manufacture Apple products, including the popular iPad tablet computer.
Looking for reciprocity
At the core of the discussions was the concept of “reciprocity”. This underscores growing concerns that, although Brazil has reaped rewards from its closer ties to China in terms of trade and investment—Chinese demand has been a driver of Brazilian exports and economic growth for years—the long-term benefits seem to favour the Chinese. Critics warn that Brazil and other Latin American commodity exporters are returning to a commodity-driven export path resembling that of the 17th and 18th centuries.
This carries the risk of an over reliance on commodity exports at the expense of sectors such as manufacturing and services exports. This not only makes Latin American countries vulnerable to a crash in commodity prices (or a sharp drop in Chinese demand), but also to “Dutch disease”, whereby local currency values rise in line with commodity prices, making it even more difficult for their manufactured and non-commodity exports to compete. This could contribute to potential “deindustrialisation” of Latin American economies—whereby manufacturing sectors shrink as natural-resource sectors continue to grow. This could eventually lead to rising imports and decreasing exports, balance-of-payments difficulties and negative impacts on overall economic growth.
The risk of deindustrialisation is compounded by the fact that China captures the bulk of value-added production from the commodities it buys, while discriminating against imports of value-added goods. Further, thanks to China’s low labour costs and a government policy designed to keep the Chinese currency undervalued, China outcompetes many Latin American manufactured goods in global markets and increasingly within Latin America’s home markets as well.
China is a competitor
According to one analysis, 94% of manufactured exports from Latin America and the Caribbean face a partial or direct threat from China. The direct threat is most acute for Mexico and the countries in Central America and the Caribbean, which are not net commodity exporters but export many light manufactured goods that directly compete with exports from China. Such countries have been losing market share to more competitive Chinese goods for some years.
Yet even in Brazil there is worry about potential deindustrialisation. Manufacturing competitiveness is being hurt by the strong local currency, the Real (which has been appreciating for two years owing to strong capital inflows), as well as by China’s own currency policy. Given Brazil’s diversified productive sector, the short-term risk of deindustrialisation is limited. However, industrial growth has been slower than that of commodity exports, and many sectors—notably clothing and footwear—have already suffered loss of market share at home and in neighbouring markets.
Active industrial policy
The Rousseff administration’s desire to reset commercial relations with China forms part of the left-leaning government’s broader industrial policy designed to promote industrial leaders (“national champions”), boost competitiveness and use industry as a tool of economic development.
Besides assisting local businesses with state financing and other incentives, the government is trying to steer certain strategic companies towards more production of value-added goods. One example is Vale, Brazil’s second-largest company and one of the world’s biggest mining companies. Vale extracts iron ore and other base metals, and exports them mostly to China. The previous government of President Luiz Inácio Lula da Silva tried to strong-arm the management of Vale for years to invest in steel production and other value-added projects at home. Ms Rousseff earlier in April finally succeeded in pressuring Vale’s shareholders to oust its president, who had resisted such government interference.
Challenges ahead
With regards to China, the recent bilateral agreements, while notable, are not likely to fundamentally change the nature of the relationship. Not only will China continue to import primarily raw materials, it is also becoming a bigger player in the direct production of such resources, particularly oil. Energy security and access to primary metals and foodstuffs will remain China’s overriding strategic interest in Brazil.
As China also continues to penetrate the Brazilian market with its lower-cost electronics, clothing and other goods, domestic producers may display more resistance to Chinese competition, and may pressure the government for more direct assistance (even protectionist measures) or to initiate anti-dumping complaints. Yet even commercial tensions of this nature are unlikely to turn back China’s expansion in Brazil, whether via trade or direct investment.
The challenge for Brazil and other commodity exports will be to figure out how best to profit from the Chinese connection to ensure that it contributes to more equitably distributed, diversified and sustainable growth. Besides agreements of the type signed in Beijing, more will have to be done on the domestic side to channel income from the commodities windfall to improvements in education, infrastructure and innovation, which will help to improve competitiveness over the longer term. Progress in implementing structural reforms in areas such as labour laws, fiscal policy and taxation, which keep business costs high, will also be needed.
The Economist Intelligence Unit
Source: ViewsWire
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