Month: February 2023

Brazil and the Return of Neomercantilism

The principal challenge of emerging markets policy makers is to provide the business environment for private enterprise to invest in activities that generate sustainable and equitable growth.

When they fail to do this they face the crippling flight of both financial and human capital. The ease  of communications, travel and capital movements make it easier than ever for wealthy and cosmopolitan elites to move their families and capital abroad.

Human and financial  capital drain can be devastating for emerging markets. Some 4.5 million Indians,  generally well-educated, have immigrated to the U.S. and the U.K. since 1980, contributing greatly to these developed economies. Venezuela has lost most of its educated elite and middle class over the past 15 years, leaving the country with dire prospects of ever recovering the middle-income status it once enjoyed. The past decade of slow growth and political unrest in Latin America has caused massive  capital flight from historically more stable countries like Brazil and Chile.

Brazil, which in the past largely avoided the drain of human and financial capital, now faces an exodus, with Portugal and the U.S. as the favorite destinations. With the return to power of the leftist Lula — reenergized, more bitter and radical after his two-year prison confinement — this flight from Brazil is sure to accelerate.

Ironically, the policies proposed by Lula are no longer on the ideological extreme. On the contrary, the new government’s policy proposals – government support through subsidies and credit for industrial onshoring and green technologies, all justified under the banner of national security and sovereignty – are a carbon copy of those promoted by the Biden Administration in the U.S. Moreover, the quote below, which was made this week by President Biden, could have come out of Lula’s mouth

“What it’s about is giving working folks a chance. I’ve never been a big fan of trickledown economics. In the family I was raised in not a lot trickled down to our table. When the middle-class does well, everybody does well. I campaigned on build from the bottom and middle out and when that happens the poor have a chance up, the middle class does well, and the wealthy always do well.”

In many ways, Biden’s quote applies even more to Brazil than it does to the U.S., as Brazil’s has suffered more deindustrialization than the U.S., and its inequality is one of the worst in the world and worsening.

Brazil desperately needs a new policy framework which promotes investment in productive activities with jobs that provide a middle-class lifestyle, not the service jobs (e.g. food delivery) that have been the only source of jobs in recent years. Or else, it will continue deeper into a peripheral role as a  supplier of commodities, mainly to China. The core of any economic strategy has to be to improve the income of the mass of Brazilians that currently barely participate in the productive economy.

According to the World Inequality Database, the poorest 50% of Brazil’s populations have about 8% of the country’s income and none of its wealth.  The consequence of this is that Brazil is really two countries: one country of some 20 million people  who have the income level of southern Europeans and are genuine consumers; and another country of 200 million people – including  a large poor segment relying extensively on government handouts – that has little purchasing power. The charts below compares Brazil to other countries in this regard. With a little over 20% of its population able to consume, Brazil’s consumer market is small. Worse, it hasn’t grown much over the past twenty years, increasing only during commodity booms.

Given the size of its available market, Brazil does not underproduce. For example, production of motor vehicles per potential consumer is comparable to other countries. Given current circumstances opportunities for capturing foreign demand are scarce, so the only opportunity for growth would come from an increase in the population of consumers.

Brazil’s new government understands Brazil’s challenges and has ambitious plans to relaunch the economy through an active promoter-state. Unfortunately, it maintains its traditional penchant for doing this through state companies and a big-state mentality.

However, Lula’s main problem is that his Labor Party lacks credibility. Lula pretends that the rampant corruption and incompetent management of the last PT government (2002-2016) never happened, but for most Brazilians the memory of that period is still vivid. No one has forgotten that the previous PT government’s (2002-2016) efforts to implement similar policies were crippled by graft and poor execution, and expectations are high that the same will occur again.

The tragedy of Brazil is that it is likely to miss the boat again. It was a major loser of the past 40 years of neoliberalism and globalization (starting the process at its end with Finance Minister Paulo Guedes) and now, as the world turns to neomercantilism, it is unprepared to respond adequately.

 

 

 

 

 

China’s Existential Threat to Emerging Market Economies

The model of development followed by most developing countries has been to gradually move up the value chain of manufactured goods while at the same time establishing control of the production of the basic inputs of industrialization which are steel, cement, ammonia, and plastics.

This model of development worked well for many of the current middle income emerging market countries. Brazil and Mexico, for example, developed its steel, cement, ammonia and petrochemical industries in the 1950s and 1960s while it concurrently dominated the process of mass production of motor vehicles, capital goods and many other basic consumer goods. Those years were the golden years for these countries and were broadly perceived as economic “miracles.” Most middle-income Asian countries (Thailand, Malaysia, Indonesia) repeated this process in the 1960s, 1970s and 1980s with similar success, now followed by Vietnam.

This process of basic industrialization was achieved with foreign investment and the transfer of mature technologies from the U.S. and other developed countries. The technologies were easy to transplant to developing countries and had the advantage of being scalable to different markets and often  large generators of low-skill “quality” jobs. Generations of Brazilians were integrated into the modern economy and learned the skills of industrialization and the routines of modern enterprises by working in manufacturing, and they entered into the middle class and became consumers (e.g., Brazil’s current president, Lula, worked in an auto plant in Sao Paulo in the 1960s as a metalworker before becoming a union leader).

Two things happened to dramatically undermine this trend. First, the neoliberal revolution of the 1980s spawned the “Washington Consensus” for free trade and capital movements and the great wave of hyper-globalization of the past decades. Second, in the 1980s,  China entered the phase of rapid development, following the path set by Brazil and others: exploiting foreign investment and technology transfer to dominate the production of the basic inputs of industry (steel, cement, ammonia and plastics) and the mass production of consumer and capital goods.

While the mass production technological cycle (“Fordism”) was exhausting itself in both the industrialized world and middle-income emerging markets, giving way to the Information and Communication Technology revolution (ICT), China gave it new life. With abundant cheap labor and clever incentives, China became the dominant global producer of most basic industrial goods,  replacing production capacity in both developed and developing markets. In a neoliberal era of free markets, multinationals gladly offshored the mature mass production function to China, to gain access to cheap labor, subsidies and lax environmental rules. The combination of a large and growing domestic market and access to international markets gave China a scale advantage which previous fast-growing developing countries had never enjoyed during this period of learning to dominate the mass production process.

The degree to which China has taken over the mass production paradigm is shown in the following charts: 1. Global Primary Energy Consumption; 2. Global steel production; 3. Global cement production; 4. Global ammonia production; 5. Global plastics production. The growth of output that China has experienced in all of these areas is astonishing in a historical context. China consumed one third the primary energy consumed by the U.S. in 1980 and 1.7 times as much in 2021; it produced about the same amount of steel as the U.S. in 2000 and now produces 10 times more; China’s cement output in 2020 was 27 times the U.S.’s peak production year; China produced 2.5 times more ammonia than the U.S. did in 2021; and China now produces 1.5 times the plastics made by the U.S.

 

As China moves up the manufacturing value chains, it now seeks to dominate global markets for consumer durables, such as computers, televisions and cars. The charts below show the astronomical growth of China’s car production and its recent progress in tapping export markets. China’s growth in auto production over the past decade is greater than the entire growth of the industry on a global basis. And now, China’s auto firms, as the economist Brad Setser recently noted, are ramping up exports. In a few years’ time, Chinese passenger car exports have grown to surpass those of the U.S. and Korea and match those of Germany. Most of these highly subsidized exports are finding their way to developing countries.

The extension of the mass production technology cycle was an unequivocal boon for China but a mixed blessing for developed countries and the middle-income emerging markets. In exchange for cheap consumer goods and high corporate profits, manufacturing sectors were decimated, jobs were lost and income inequality and political rage increased. Moreover, while the mass production cycle was extended, with dire consequences for CO2 emissions, the potential benefits of the ICT revolution were delayed. Instead of focusing on making industry more productive and greener, Silicon Valley has channeled most of ICT investments into social networking, search, delivery and gaming applications.

For developing markets, China’s rise is an existential threat. Unless they can defend themselves with tariffs, they are condemned to handing over their consumer demand for manufactured goods to China in exchange for commodities.