A New Path for Industrial Policy in Brazil

In recent decades, very few developing countries have reduced the income gap with rich nations, and those that have are either in East Asia or Eastern Europe. The successful “climbers” have prospered by integrating themselves into an increasingly globalized economy, gradually increasing the volumes and complexity of their exports. The “laggards” across the developing world have typically suffered from economic and political instability and shunned the competition of global markets. Brazil, the “poster child” for the laggards, has been stuck in a “middle-income trap” for over thirty years, caused by public policy errors resulting from political dynamics.

Since the 1980s “lost decade” Brazil’s politicians have pursued “distributional politics” aimed at correcting wealth disparities between regions and social classes. The previous model (like China’s current model), which for three decades (1950-1980) had been aimed at building mass production manufacturing and infrastructure, was largely discarded as inefficient and costly.

The new development model for Brazil, still very much extant today, has been driven by the “Welfare” Constitution of 1988 that imposed an extreme form of federalism which gives scarcely populated states enormously disproportionate representation in both chambers of Congress.

Unlike the successful economies of Asia and Easter Europe, since the 1980s Brazil’s industrial policy has been inward looking and aimed directly at achieving social objectives instead of economic results. The main goal of industrial policy has been to relocate industrial activity from rich states to poor states by providing abundant tax incentives to investors. The result has been the hugely wasteful Manaus Economic Free Zone and some uneconomic and nonproductive relocation of manufacturing facilities from the south to the north. Consequently, since 1980, Brazil has gone from being the prominent industrial nation in the developing world to a minor player undergoing large-scale deindustrialization.

The major winner from federal political dynamics has been the farm sector which is broadly diffused geographically in states with low population density. In this case the policies have led to massive increases in output and productivity.

In essence, Brazil’s farm sector is a disguised “Asian Tiger.”  Like in Asia, government support for Brazil’s farmers has been broad and extensive and consistent for decades. In addition to substantial fiscal, credit and export subsidies, the sector has benefitted greatly from the work of the national Brazilian Agricultural Research Corporation (Embrapa), which is widely recognized as a global leader in tropical agriculture research and has been instrumental in boosting crop productivity. Furthermore, the farm sector benefits from two more characteristics integral to the “East-Asian” development model. First, domestic competition is acute, therefore, even though state support is available to all, only the most productive farmers can thrive.  Second, because agricultural commodity markets are global in nature, the sector is export driven. This means that Brazilian farmers compete with American farmers and must remain at the forefront of technological innovation.

Unfortunately, the farm sector is not a good substitute for industry. In contrast to the job creation, work training and other multiplier effects that are integral to Asian industrial policy, the farm sector in Brazil is highly capital and technology intensive and does not generate many jobs or ancillary economic activity. Also, its success has significantly increased the commodity dependence of the Brazilian economy and led to a structural appreciation of the Brazilian real. Finally, this commodity dependence generates economic and currency instability which further undermines the competitiveness of the manufacturing sector.

The challenge for Brazil is to find new growth sectors which can secure sustainable political support and lead to productive investments that generate quality jobs. The markets are very skeptical that this can be done.

A brief effort at industrial policy during the first Lula Administration collapsed under mismanagement and corruption and was followed by an equally brief romance with neoliberal policies under Bolsonaro.

Lula’s return to power this year has revived talk of industrial policy in Brazil, abetted by a shift away from neoliberalism in the United States and China’s aggressive state-led push to achieve industrial self-sufficiency in all “strategic” industries. Unsurprisingly, given Lula’s track record, market skepticism is high. Initial signs from the new government do not give much hope. The best that the new administration has come up with so far is a hare-brained scheme to provide temporary subsidies for purchases of automobiles.

Any viable industrial policy will need broad and sustainable political support in Congress. This means that the benefits must be broadly distributed geographically. Unfortunately, Lula’s atavistic vision of development is rooted in the state-led, capital-intensive model of the 1970s (e.g. Petrobras leading investments in refining and infrastructure).

A better approach would be to focus on strategies that have been successful in other countries: tourism and “green” energy, for example. Building a national consensus with political support to provide long-term  incentives for private businesses to invest in tourism and alternative energy could set Brazil on a new growth path. Policies should be structured so that  investors face both domestic and foreign competition to weed out the weaker players.

These are two sectors that are labor intensive and with potential for broad geographical dispersion of benefits. Brazil’s woefully underdeveloped tourism industry can learn from countries like Mexico and the Dominican Republic. In the case of alternative energy, the policies pursued by the Biden Administration in the U.S., the roll out of wind and solar capacity in Texas and initiatives pursued in many other countries can be copied. The roll out of wind and solar energy in Texas is highly relevant, as Brazil has outstanding conditions  to do this, with many locations in poor states. 150,000 well-paid clean energy jobs have been created in Texas over the past eight years and the sector is growing fast.