Brazil: Embracing Globalization?

BRAZIL: EMBRACING GLOBALIZATION?

Background

This case focuses on Brazil's development strategy since World War II and on the change of the economic model following the debt crisis of the 1980s. At the time of the case Brazilian officials are deciding whether regional integration or globalization offer the best route to economic prosperity and development. This case illustrates the challenges that developing countries face in defining trade policy. It also introduces the role of regional trade blocks as an alternative to globalization. At the current time regionalism seems to be very much in vogue and seems to be much more likely to be the basis for future trade system changes than comprehensive trade treaties.

Brazil's Import Substitution Strategy

After the Great Depression of the 1930s, Brazil followed an import substitution strategy characterized by massive government investment, targeting of key industries, and protection against competition with high tariffs walls. Brazil's import-substitution strategy initially appeared to be a success, creating a temporary boom in the 1960's and 1970's that masked the strategy's longer-term implications.

Import substitution industrialization also called ISI is a trade and economic policy based on the premise that a developing country should attempt to substitute products, which it imports, mostly finished goods, with locally produced substitutes. The theory is similar to that of mercantilism in that it promotes high exports and minimal imports to increase national wealth.

As a result of import-substitution industrialization, the Brazilian economy experienced rapid growth and considerable diversification. Between 1950 and 1961, the average annual rate of growth of the gross domestic product exceeded 7 percent. Industry was the engine of growth. It had an average annual growth rate of over 9 percent between 1950 and 1961, compared with 4.5 percent for agriculture. In addition, the structure of the manufacturing sector experienced considerable change. Traditional industries, such as textiles, food products, and clothing, declined, while the transport equipment, machinery, electric equipment and appliances, and chemical industries expanded.

However, the strategy also left a legacy of problems and distortions. The growth it promoted resulted in a substantial increase in imports, notably of inputs and machinery, and the foreign-exchange policies of the period meant inadequate export growth. Moreover, a large influx of foreign capital in the 1950s resulted in a large foreign debt.

The lower increases in the shares of the intermediate and capital goods industries reflect the lesser priority attributed to them by the import-substitution industrialization strategy. In the early 1960s, Brazil already had a fairly diversified industrial structure, but one in which vertical integration was only beginning. Thus, instead of alleviating the balance of payments problems, import substitution increased them dramatically. This is shown in Exhibit 2-7.

Mercosur - Regional Integration Initiative

Between 1981 and 2000 Brazil faced various problems. As shown in Exhibit -7a current account balance and trade deficits persisted as a result of higher increase in the imports than exports. Exchange-rate stability and external perception of the country depended on the current account balance. Problems were classified into two sets: internal and external factors. High tax burden and inadequate infrastructure were internal problems. External factors such as wide variety of trade barriers that kept Brazilian products out of the world market existed. "Brazilian cost" - internal factors negatively affected Brazilian producers' competitiveness in the global arena. Tax burden was estimated to be 29% of GDP. Due to Brazil's highly regulated labor system, there was a very high cost to employ workers. Compulsory benefits to wages of full-time employees were said to almost double the cost of labor. To bring Brazil to the prosperity and achieve the top priorities goal, reduction in trade barriers and increase in exports, the government had to overcome these problems. One way to meet these goals was to use WTO forum to fight against practices that damaged Brazilian interests. Due to the failure of WTO's 1999 Seattle Conference, Brazil's hopes were dimmed. Brazil could try to negotiate bilaterally with the US and Europe or it could use the alternative of strengthening the Mercosur union. Brazil went on Mercosur way negotiating with Argentina to diminish traditional geopolitical rivalries, to weaken respective military establishments, and to consolidate the emerging democracies.

Mercosur project is called the common market of South America. It is a trading zone, regional integration, between Brazil, Argentina, Uruguay, and Paraguay, founded in 1991 by the Treaty of Asunciуn, which was later, amended and updated by the 1994 Treaty of Ouro Preto. Its purpose is to promote free trade and the fluid movement of goods, people, and currency among member states. Mercosur was seen as giving the capability to combine resources to balance the activities of other global economic powers such as the United States and the European Union. By January 1, 1995, 90% of the intra-regional trade circulated free of tariffs and quotas. The member countries adopted a common external tariff (CET) and quotas with nonmember countries. After the creation of Mercosur, trade among the member countries increased rapidly despite the differences in the member countries, making Mercosur the fastest growing trade region in the world. During 1991 and 1997, exports within the region increased fourfold. Argentina became Brazil's second trading partner after the US. Bilateral trade between Brazil and Argentina represented approximately 75% of the total trade flows in the region. Intra-regional trade had created opportunities for economies of scale mostly in the manufacturing sectors without a major displacement of local production in the Brazilian economy. The