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date: 21 October 2019

Trade Policy from the 1930s to the Present

Abstract and Keywords

This chapter analyzes Brazilian trade policies over the course of nearly a century and their effects on trade performance, competitiveness, and growth. Historically, Brazilian trade and investment policies have been characterized as highly protectionist to foster inward industrialization growth. At an aggregate level, Brazil lost ground in world markets for most of the products categories, except commodities. In particular, in agriculture trade and iron ore, the country became a “large player.” The chapter analyzes the links between the current account balance, capital flows, and the real exchange rate. Developed countries agreements with Latin American countries eroded the Brazilian position in developed countries’ markets. This is one of the challenges facing Brazil in the near future: how to increase market access in a world that is segmented by regional agreements, new competitive players, and laggard multilateral trade negotiation to open agricultural markets.

Keywords: Brazil, trade policy, trade performance, inward industrialization, balance of payment crisis, exchange rate policy, exports

19.1. Introduction: Trade Policy Background

The objective of this chapter is to analyze Brazilian trade policies, over the course of nearly a century, and their effects on trade performance, competitiveness, and growth. The period covered, from the 1930s to the present, is rich with episodes that changed the profile of the Brazilian economy, and where a more integrated world economy opened new trade and investment opportunities. It has also been a turbulent century, with recurrent crises ranging from the Great Depression to the 2008 financial crisis. The chapter analyzes Brazilian trade policy changes against this backdrop of large swings in the world economy, as well as numerous critical domestic factors influencing trade policy design.

In the second section (19.2) of the chapter we discuss Brazilian trade policy regimes, divided into four periods, and the section ends with a discussion of the trade liberalization policy of the 1990s, a radical departure from the previously inward-looking import policies. The results were important in terms of slashing tariffs and nontariff controls that fostered increased competition, modernization of the industrial sector, and significant productivity growth (Kume, Piani, and Souza 1988). Historically, Brazilian trade and investment policies have been characterized as highly protectionist to foster inward industrialization growth. A large array of tax and credit subsidies for industrial investments and high tariffs and nontariff barriers (NTBs) protected the domestic market from import competition, leaving for export-promotion policies to mitigate the anti-export bias of trade policies (Cardoso and Fishlow 1990). Even the liberalization attempts of the late 1980s and early 1990s were partial and not enough to change the domestic market focus of the Brazilian development model. Brazil is almost an autarchy in terms of trade flows.

(p. 395) The third section (19.3) is devoted to analyzing trade performance and comparing with world trends. The composition of world exports has evolved gradually in the direction of high-technology manufactured goods, but the Brazilian trade structure has moved in the opposite direction during the last decade. At an aggregate level, Brazil lost ground in world markets for most product categories, except commodities. In particular, in agriculture trade and iron ore, the country became a “large player” in several markets, and the increased exports contributed to the large trade surplus during the last decade.

In the fourth section (19.4), we analyze the links between the current account, capital flows, and the real exchange rate. In the Brazilian case, we found empirical evidence that high foreign liabilities triggered large exchange rate devaluation to correct balance of payments disequilibrium.

The final section (19.5) summarizes some main conclusions and discusses future challenges in trade policy.

19.2. Brazilian Trade Policy Regimes

The events that shaped the world economy in the twentieth and twenty-first centuries can be roughly divided into two periods. In the first, ranging from 1914 to 1945, there was a strong setback in trade and international capital flows due to two world wars and the Great Depression. This phase can be considered the end of the first great wave of globalization begun a century earlier during the Pax Britannica. In the second period (1945–2015) came a gradual opening of the world economy to international flows that lasted for 70 years and—again—the world economy became highly interdependent. This section covers Brazilian trade policy changes, having as a background these large shifts in the world economy, and domestic factors influencing trade policy design.

19.2.1. The Great Depression and World War II: 1930–1945

At the outbreak of crisis in 1929, the coffee sector was the most important of the Brazilian economy. It was responsible for more than 60% of export revenue and had an almost monopoly position in the world market. Since 1830, the rapid expansion of coffee production had been an important factor behind the expansion of the domestic market and for an incipient industrial growth in sectors isolated from foreign competition by transport costs. Prior to 1930, the most important industrial sectors were textiles, apparel, and food processing. Coffee exports were the engine of growth of the Brazilian economy, representing 9% of gross domestic product (GDP) at the end of the 1920s.

The international demand and supply for coffee are price inelastic, and since 1906 government intervention in the coffee sector had been successful in exploiting the Brazilian monopoly position in the international market, sterilizing excess supply (p. 396) through government purchase and stocks. It is well known in trade theory that a country with monopoly power in international markets can turn relative prices in its favor by restricting supply in the world market and maximizing short-run profits. This “rent-seeking” policy for coffee growers was not accompanied by production controls, and there was a strong incentive to increase production and sell it to the government. The country started to reap large crops when external demand shrunk sharply after 1929 and foreign loans dried up for the following 20 years. Nominal coffee prices fell by 63% between 1928 and 1931 and export revenue by 49% in the same period. Imports fell even more sharply by 70%, due to the domestic recession (GDP fell 5.3% in 1930 and 1931), high import duties, and rationing of scarce foreign exchange to essential imports. Since the imperial period, Brazil had adopted a system of specific tariffs that were very high at the outbreak of the 1929 crisis. According to Mata and Love (2008), at the outset of the 1930s the average tariff was above 30% of the import value. High tariffs were an essential tool to repress the demand for imports and maintain an overvalued exchange rate, favorable to coffee interests. It is worth mentioning that tariffs were the main item in the government revenues, representing half of total receipts.

With a large production surplus, the federal government started an important support program for the coffee sector, through massive purchases and destruction of excess supply. This program lasted up to 1937, and it is estimated that the equivalent of three annual crops were burned during the period (Abreu, Bevilaqua, and Pinho 1996b). This is typically a case of expansionary fiscal policy that was followed, after 1933, by credit expansion by Banco do Brasil to finance coffee purchases by the government. Even so, terms of trade worsened dramatically during the 1930s: between 1929 and 1940 Brazilian terms of trade fell by 52%. Starting in 1941, there was a gradual terms of trade recovery that lasted up to 1954, due to reduced coffee crops and the increase of demand for commodities during World War II and the Korean War. This was the golden age for terms of trade gains. A complete picture of terms of trade performance in the long run (1920–2015) is shown in Figure 19.1. It is worth mentioning that there is no statistically significant tendency of worsening of terms of trade in the long run as postulated by the ECLAC (Economic Commission for Latin America)-originating “dependency theory” of center and periphery economic growth asymmetries.

Given the collapse of foreign exchange markets, Brazil quickly abandoned the gold exchange regime in the mid-1930s, followed by a sharp devaluation of the Brazilian currency. The estimated real exchange rate devaluation between 1929 and 1931 was 83%.1 After this initial devaluation, the real exchange rate saw minor fluctuations in the 1930s. It is now well documented in the Brazilian empirical economic history literature that exchange rate devaluations have a downward pressure in international price of commodities, when the country has market power in the world market (Abreu and Bevilaqua 1996a).

This was the Brazilian case up to the mid-1960s, when coffee was still the main source of foreign exchange and the country a major player in world markets. The government used extensively overvalued exchange rates to maximize export revenue, and import controls depended increasingly on tariffs and non-tariff barriers (NTBs). Additional (p. 397) factors to explain exchange rate controls were the burden of government debt service in foreign currencies and the exchange rate as a nominal anchor to control inflation (Abreu and Bevilaqua 1996b). High tariffs, real exchange rate devaluation, and expansionary fiscal and monetary policies were essential to changing the level and composition of demand in favor of domestic industrial production. Average industrial growth in the period 1930–1945 was 6.1% per year, and GDP growth averaged 3.9%. This period can be considered the first stage of import-substitution industrialization (ISI). But Brazil remained a rural country, with 69% of the population in the countryside in 1940. It had become clear to the government that to tie the economy to commodities exports would leave the country vulnerable to balance of payment crises, foreign debt service defaults (like that of 1937), and radical downturns in economic growth. There was room for additional stages of inward-looking ISI based on shifting underemployed supply of cheap labor from agriculture to the industrial sector, typical of the Lewis development model.

Trade Policy from the 1930s to the PresentClick to view larger

Figure 19.1. Brazilian terms of trade, 1920–2015.

Note: (2006 = 100).

Source: IPEA DATA.

19.2.2. The Heyday of Import Substitution as Explicit Policy: 1946–1963

Industrial growth and trade surplus during World War II was a consequence of new export possibilities and unavailable manufactured goods for imports. Brazil’s exports (p. 398) became more diversified, including products such as beef, cotton, rice, and textiles and clothing. Manufactured exports to Latin America and Africa were substitutes for Northern Hemisphere exports, and foreign reserves increased. Industrial production increased 5.7% per year between 1939 and 1945. Two years of import liberalization (1946 and 1947) were enough to dry up the convertible reserves, and import licensing controls were imposed once more. Import licensing was chosen, since the specific tariff of 1900 was completely eroded by inflation.

In 1946—within the Bretton Woods regime—Brazil adopted a fixed exchange rate of Cr$/US$18.50,2 equal to the 1939 level, even though domestic inflation was 153% during the war years. Inflation increased due to government expenditure during the war, lack of imports, and increased exports of staples. It was the chosen anchor to control high inflation, which reached 15% in 1945. Overvalued exchange rates and import controls favored domestic industrial production through access to intermediate and capital goods imports at lower exchange rates. Additionally, the overvalued exchange was an important device to reduce coffee supply, and there was a strong recovery of coffee prices and terms of trade that lasted up to the Korean War.

In 1953, SUMOC3 enacted a foreign exchange reform, through Normative Instruction 70, establishing a more flexible regime with multiple exchange rates for exports and imports, even though the official exchange rate remained fixed at Cr$/US$18.50. Auctions of foreign exchange were the instruments to ration imports instead of the outmoded specific tariffs of 1900. There were five categories of exchange rates for imports and US$ were allotted according to essentiality: oil, wheat, and newsprint could be imported at the fixed “official rate” of Cr$18.50, and luxury goods had the highest exchange rates. There were preferential exchange rates for intermediate and capital goods (Abreu and Bevilaqua 1996b).

The 1957 Tariff reform eventually introduced escalating ad-valorem duties that could reach 150% and became an important instrument by which to restrain foreign competition to domestic industrial production, while the “Law of the Similar” gained a new status to prohibit imports with domestic industrial production.

The rationale for the ISI growth strategy during this period can be summarized as follows: an overvalued exchange rate was decisive in keeping coffee prices higher, and thus maximizing foreign exchange revenue. An overvalued exchange was also the nominal anchor to control inflation. The rationing of imports through small amounts of foreign exchange in specific auctions of finished consumer goods isolated the industrial sector from international competition, and the preferential access to import intermediate and capital goods created a very favorable environment for investments and high profits in the industrial sector. Foreign direct investment (FDI) inflows increased in the second half of the 1950s, attracted by oligopoly profits and subsidies inaugurated in 1955 by SUMOCs Normative Instruction 113, which allowed the direct import of capital goods without foreign exchange outlays (Cardoso and Fishlow 1990).

In the second half of the 1950s, the auto industry was the main target for industrial promotion in Brazil. A vast array of protective devices, ranging from prohibition of imports of “similar to nationals,” high import tariffs, requirement of 95% of domestic (p. 399) content, credit, and imports of capital goods subsidies, created a domestic oligopoly isolated from international competition. Strikingly, 60 years later the same sector is still the most protected sector of the Brazilian economy; while the 1950s saw the invoking of the “infant industry argument” in favor of protecting the auto industry, we can perhaps say that today this should be updated to the “senile industry argument” to protect the same sector. Trade policy was inward looking, with a strong anti-export bias due to the overvalued exchange rate and strong incentives to divert production into domestic absorption. During the first decade after the war, terms of trade increased, relaxing the constraint of foreign private and official financing shortage. In the second half of the 1950s, balance of payment deficits were financed mainly by FDI.

Industrial growth was at its peak between 1946 and 1960, when industrial GDP grew at an average annual rate of 9.3%. Even with this impressive industrial growth, exports of commodities still represented 85.4% of the total exports in 1964 and manufactured goods only 6.2%, as shown in Figure 19.2. Coffee exports represented 50% of the total. At the beginning of the 1960s, the burden of distortions of ISI was high, and Brazil experienced a period of reduced economic growth, increased inflation, and balance of payment crises. An overvalued exchange rate led to stagnant exports and trade deficits; FDI diminished after a wave of investments in the protected domestic market, and government deficits were increasingly financed by inflation tax. In the 1961–1963 period, annual industrial growth was down to 2.6% and inflation up to 50%. The 1964 military coup was a consequence of these economically and politically turbulent years.

Trade Policy from the 1930s to the PresentClick to view larger

Figure 19.2. Composition of Brazilian exports.

Note:

(*) Exports of semi-manufactured goods excluded.

Source: Ministério do Desenvolvimento Indústria e Comércio.

(p. 400) 19.2.3. Export Promotion, Oil Shocks, and Foreign Debt Crisis: 1964–1987

At the outset, it is worth mentioning export performance prior to 1964 to highlight the challenge facing policymakers in the early 1960s. In 1946, export revenue reached US$1 billion; it went up to US$1.4 billion in 1963—a dismal annual increase, in nominal terms, of 1.2%. In real terms, exports fell on average 1.3% per year. In this period, exports fell from 12% to 6% of GDP. After the Korean War, terms of trade worsened by 35.3%, and the balance of payment deficit increased after 1960. The big government challenge was the design of new trade policy instruments to boost exports of manufactured goods.

The chosen trade policy target was manufactured export promotion, through fiscal and credit subsidies and a new “crawling peg” regime to avoid the frequent overvaluation of the Brazilian currency. The instruments to foster manufactured exports were exemptions of manufactured exports from the domestic tax burden and subsidies through tax rebates on domestic sales based on export performance and a more predictable exchange rule (see, for example, Cardoso and Fishlow 1990). According to the government, tax and credit subsidies were compensation for the overvalued exchange rate, the consequence of high tariffs that repressed the demand for foreign exchange. It was a kind of “second best” policy to correct the distortion of reduced imports. Export subsidies were a very explicit and transparent feature of export promotion, and a typical case of “unfair trade policy” that aroused increasing opposition from developed countries, mainly the United States. This policy was discontinued during the 1980s due to fiscal deficits and international trade disputes, and was replaced with two “maxi-devaluations” of the Brazilian currency in 1979 and 1983. The results were impressive: in 1964, manufactured exports represented 6.2% of the total, and in 1980, 44.8%, as shown in Figure 19.2.

Another feature of trade policy during this period was the timid and short-lived 1967 tariff liberalization reform, followed by a radical reversal in 1974, after the first oil shock. Between 1974 and 1976, import duties were doubled for consumer goods and a sharp increase occurred for intermediate and capital goods. In 1976, imports of 1,300 superfluous goods were “temporarily prohibited,” but this restriction remained effective for 14 years. There was also an extensive use of the “law of the similar” to ban imports. Import restraints were so binding that by the end of the 1980s the Brazilian economy was close to autarchy, with an import/GDP ratio of 4.4%. Instead of using the conventional devaluation cum contractionary fiscal and monetary policy to face balance of payment deficits, the Brazilian government decided to postpone the adjustment and rely on external debt (with floating interest rates) to finance the adverse supply shocks and maintain a higher GDP growth rate, with an additional round of ISI in intermediate and capital goods. The literature points out that one of the consequences of this policy was the increase of the relative price of capital goods that became an important drag on further growth (see, for example, Bacha and Bonelli 2012). (p. 401)

Table 19.1 Brazilian Economic Performance, 1967–1980

Yearly Average Growth

1967/1973

1974/1980

GDP

11.1%

6.8%

Industrial GDP

13.2%

6.6%

Inflation (GDP deflator)

21.9%

49.7%

Current account (%GDP)

0.8%

–4.5%

Foreign Debt, US$ billion,1973 and 1980

14.9

64.3

Source: Elaborated by the author from data provided by IBGE.

Prior to the oil and interest rate shocks, Brazilian economic performance had been outstanding, attaining the nickname of the “economic miracle”: between 1967 and 1973, the yearly average GDP growth was 11.1%, and industrial growth was at a record rate of 13.2% per year. Even with the oil shocks, the growth cum foreign debt strategy did work up to the end of the 1970s. GDP growth was 6.8% and industrial growth 6.6% per year, but balance of payment deficits reached an annual level of 4.5% of GDP in the period 1974 and 1980. Foreign debt skyrocketed from US$14.9 billion in 1973 to US$64.3 billion in 1980, as can be seen in Table 19.1.

The real exchange rate was overvalued, and in 1979 the government abandoned the crawling peg rule with a maxi-devaluation, followed by prefixing the exchange rate correction in 1980, as a nominal anchor to control inflation. It did not work, and the country entered into a three-digit level of annual inflation. After a second large devaluation in 1983, inflation jumped from 100% to 200% per year, and during the next decade the country was haunted by the risk of hyperinflation. The Cruzado Plan (1986) used a general price freeze, including the exchange rate, to curb inflation, and as a consequence foreign exchange reserves were exhausted and the government declared a unilateral default on foreign debt in 1987.

In 1979, inflation reached double-digit levels in developed countries, and then came the final act ending the period of cheap money for developing countries: Volcker’s disinflation tight monetary policy—followed by other developed countries’ central banks—caused a deep world recession in the early 1980s, worsened terms of trade for commodities exporters, led to higher interest outlays on foreign debt, and, in September 1982, came the Mexican default. Brazil entered a phase of balance of payments adjustment under the International Monetary Fund (IMF) conditionality, economic growth vanished, and the country entered into the “lost decade.”

19.2.4. Import Liberalization Reform and a Comeback for Protectionism: 1988–2015

By the end of the 1980s, high tariffs and NTBs became dysfunctional and thus one important impediment to investment, productivity growth, and competition in the (p. 402) Brazilian economy. Brazil was so isolated from the world market that clearly the first move had to be a unilateral opening up of the domestic market to foreign competition. The costs of near autarchy were very high, distorting resource allocation, reducing economic welfare, and hindering economic growth. Starting in 1988, a series of measures were undertaken reducing the level and the variance of import controls. Import duties were reduced, and the government agency for NTBs was discontinued (Kume, Piani, and Souza 1988). During six years tariffs fell sharply, but after 1995 no additional progress was made in terms of trade liberalization, and a reversal occurred after the mid-1990s.

The opening up of the economy was implemented in three steps: between 1988 and 1989 the reform eliminated tariff redundancy (water in the tariff), leaving untouched the NTBs controls by CACEX (the state agency responsible for administrative import controls); the period 1990–1993 saw the elimination of the 42 special import regimes, quotas, and a list of 1,300 forbidden import items, while CACEX was discontinued and a new Tariff Law was approved, reducing import duties scheduled in a period of four years; finally, in 1994, after the inauguration of the Real Plan, there was one additional round of tariff reduction, anticipating the tariff levels of the Ouro Preto Protocol that instituted Mercosur’s common external tariff (CET). By the mid-1990s, trade policy reform moved import controls to market instruments (tariffs and exchange rate) instead of using the unpredictable, informal, and nontransparent bureaucratic controls of previous decades prone to rent-seeking activities. The results were impressive. Prior to reform, the most favored nation (MFN) effectively applied import tariff rates on manufactured goods was 54.9% (UNCTADSTAT), one of the highest in the world; in 2014, the tariff was one-quarter of the initial level, reaching 12.7%, accompanied by the removal of important NTBs. Even though this represents one important step in trade reform, the resultant scheme still resembles the structure of the previous regime: high tariff rates by international standards and a large variation in nominal and effective protection, discriminating against imports of capital goods, essential for productivity growth (Moreira 2009). The same sectors that had the highest protection at the peak of import substitution remain sheltered from international competition.

There is plenty of empirical evidence on the effects of the Brazilian trade reform on productivity growth and competitiveness. Hay (2001), using panel data for the period 1986–1994 for large manufacturing firms, found important total factor productivity (TFP) gains, and reductions in market share and profits. The supply shock from import liberalization forced firms to improve their efficiency. Cavalcante and Guillén (2002) using panel dada for 16 industrial sectors in the period 1985–1997, found that trade reform increased average TFP in the majority of Brazilian manufacturing industry sectors, although they did not find significant changes in domestic market power associated with increased import competition. Productivity growth was attributed to access to imported inputs and technologies, not to competitive pressures from abroad. Córdoba and Moreira (2003) concluded that total factor productivity increased in the (p. 403) manufacturing sectors of Brazil and Mexico after the unilateral and regional trade integration. With opposite results, Muendler (2004), using firm level statistics for the period 1986–1998, found that competition in product markets had an important role in boosting TFP growth, but access to inputs in world markets and the elimination of inefficient firms had no significant effect on productivity growth. Tyler and Gurgel (2009), using a computable general equilibrium model to simulate the effect of the trade liberalization of the 1990s, found favorable effects: an increase of 1.9% in welfare, measured by the increase in consumption, a 9.1% real exchange rate devaluation, and income redistribution in favor of Brazilian relative abundant natural resources. The model also simulated increases in trade flows and changes in production composition in the direction of agriculture, mineral products, and light manufacturing, sectors where the country’s comparative advantage lies.

But Brazilian trade liberalization is rather limited when compared with the average world pattern, and the relative price of capital goods is still high. The following statistical data illustrate the challenges facing trade policy for the future. Compared with a large sample of countries, Brazil stands as a country of high nominal tariffs. The weighted manufactured goods tariff of 12.7% in 2014 appears in the upper quartile of the distribution, well above (72%) the average tariff (UNCTADSTAT). It is worth mentioning that the present Brazilian tariff is above the 2006 level, and the last 20 years have seen no further effort to liberalize trade and reap the advantages of better resource allocation and productivity growth.

Macroeconomic imbalances since the mid-1990s, linked with overvalued exchange rates and international financial turbulence, gave new strength to protectionist demands and tariff hikes, and NTBs were implemented. The Brazilian anti-dumping and unfair trade practices agency became very active. According to the latest DECOM (2015) report, in the period ranging from 2005 to 2015, 274 anti-dumping investigations have been conducted, and in 58% of the cases countervailing duties have been imposed. As pointed out by Tavares and Miranda (2008), in most cases the decisions protected domestic monopolies or oligopolies. According to the World Trade Organization (WTO), there are only two countries in the world with a higher number of anti-dumping investigations in 2016: India and the United States. Similar results appear for unfair trade practices (subsidies) and safeguard measures, protecting domestic firms with monopoly power.

There is a large variation in nominal and effective protection, according to the latest empirical calculations as given by Castilho (2015). The nominal tariff ranges from 0% for oil and natural gas to the level of 32% for trucks and buses, but the great variance occurs with the effective tariff rate. It ranges from –3.1% for oil and natural gas to 132.7% for trucks and buses. The average nominal tariff in 2014 was estimated at 12.2%, and the effective rate at 26.3%. Compared with the tariff levels of 1988, where the average nominal tariff was 38.5% and the effective rate was 50.4%, there was a significant reduction in tariff levels, but there is room for further trade liberalization.4 There is no economic rationale for the present tariff structure. Why protect the truck and bus (p. 404) industries with an effective rate of 132.7% and penalize the production of alcohol and oil with negative rates? The only answer is the vested interests of protected sectors consolidated in the tariff structure and in NTBs. But the costs for the country are high in terms of distorted resource allocation, employment, welfare loss, and reduced rates of growth.

The high protection given to the machinery and equipment sectors is one important burden for investment in Brazil. There is convincing empirical evidence showing that high relative prices of capital goods have a negative impact on a country’s investment and growth rates. Using a selected sample of developing countries (UNCTAD 2016), it is possible to point out that the Brazilian applied weighted tariff on machinery is relatively high. The Brazilian tariff of 13.84% in 2014 is the highest of representative countries of Latin America, Asia, and the BRICs (Brazil, Russia, India, and China).5 One stylized fact of the Brazilian economy is the low rate of investment. In the last five years the average gross investment/GDP rate was 19.2%, and there is no sound economic argument to penalize investment that is badly needed to increase productivity and growth.

Brazil was one of the latest countries to embark on trade liberalization and did not go far enough from its autarchic model, taking as a yardstick the average degree of trade openness of developing countries. After the unilateral trade reform and the MERCOSUR initiatives of the beginning of the 1990s, no significant move can be identified in terms of trade policy liberalization. Domestic and international turbulence, inconsistent domestic macroeconomic policies with recurrent exchange rate overvaluations, the strengthening of protectionist lobbies, and a different government strategic view after 2003 can all be invoked to explain the paralysis in trade policy reform and the increase in protectionism.

After the 2008 financial crisis there was a strange increase in technical barriers to trade6 and the definition of a “new industrial policy” with preferences for domestic suppliers in government procurement (overprice up to 25%); tax rebates for the auto industry to increase national content; ambitious national content requirements (65%) in “Pre-Salt” investments; BNDES credit subsidies for capital goods and selected “national winners” in industrial targeting.

Particularly, there was a revival of South-South integration initiatives. The abandonment of trade negotiations in the Western Hemisphere and with the European Union eliminated the possibility of preferential access to high per capita income markets. The trade agreements with India, the Southern African Customs Union, and Latin American countries were very limited in scope and did not significantly increase bilateral trade flows. Even though it is not possible to blame the retreat of liberalization as the only factor explaining poor economic performance, recent years have witnessed a GDP growth slowdown without parallel in 115 years. In the period 2011–2015, average annual GDP growth was down to 1% and industrial output fell by 3.2%, on average, per year. Balance of payment deficits increased to 4.3% of GDP in 2014, and a huge nominal devaluation in 2015 (50%), coupled with a deep recession, reduced foreign deficit.

(p. 405) 19.3. Brazilian Trade Performance and the Exchange Rate

It is a stylized fact that the degree of openness of the Brazilian economy has been historically low, and during the 1970s and 1980s the country followed the opposite path of the rest of the world, reducing the share of its trade in GDP (UNCTAD 2016b). Following trade liberalization there was a gradual increase in export and import flows. After the first oil shock of 1973, the share of imports declined steadily up to the end of the 1980s. Tight import controls and an additional round of ISI in intermediate goods, petrochemicals, and capital goods explain the path to near autarchy. Imports fell to 6% of GDP, one of the lowest of the world and incompatible with any criteria of comparative advantage. Since 1990, imports have had an increased share in domestic supply, and this is explained by the opening up of the economy. With a decade lag, exports followed the same downturn trajectory, being reversed only in the first decade of the twenty-first century.

Exports fell from 14% to 7% of GDP as a consequence of overvalued exchange rates, associated with various attempts to control inflation, the discontinuity of tax subsidies to exports, and isolation of world-class technologies embodied in imports and FDI flows. In 1999, Brazil adopted a floating exchange rate regime followed by three large devaluations of the real (1999, 2001, and 2002), and this was the first factor behind export expansion. Compared with the pattern globally, Brazilian insertion in world markets is still modest, calling for additional steps in trade liberalization policies. In the last half-century, international economic integration advanced steadily. In the early 1960s, exports represented 12% of world GDP. With trade liberalization through multilateral and regional agreements, exports now represent 30% of world GDP. Brazil, however, did not follow the same track. In 2015, the Brazilian export/GDP ratio was similar to the world ratio of 1973.

Taking a long-run perspective, the price competitiveness of Brazilian exports has fluctuated widely, and this had been a hindrance on exports, mainly of manufactured goods. During the period 1985–2015, the real exchange rate became several times highly overvalued as a consequence of various attempts to use the exchange rate as an anchor against inflation and large inflows of foreign capital attracted by high domestic interest rates. With a 33% appreciation of the real exchange rate during the first period of the Real Plan, balance of payment deficits increased sharply and the country was on the verge of an additional default on foreign debt in 1998. In January 1999, after an acute speculative attack against the real, the Central Bank had no choice but to move to the floating exchange rate regime. After 1999, there were four large real devaluations of the Brazilian currency, but after 2004 the exchange rate appreciated again up to 2014.

There are two major factors explaining this exchange rate behavior in the short run. The first one is Brazilian sovereign risk. Since the 1980s, inconsistent macroeconomic policies led to increased foreign and government debts, and risk fluctuated wildly, (p. 406) determining the path of the exchange rate. The huge devaluations of 1999, 2001, 2003, and 2014 are explained by risk averse-behavior with respect to Brazilian financial assets. With the consolidation of three pillars of the macroeconomic policy (inflation targeting, floating exchange rates, and fiscal responsibility) Brazil reached in 2008 the status of “investment grade” and risk and the exchange rate embarked on a consistent downturn up to 2014. After 2011 macroeconomic policy became increasing inconsistent with the so called New Macroeconomic Matrix, based on expansionary fiscal and monetary policies, and followed by higher inflation, price and exchange rate controls, and huge balance of payment and fiscal deficits. This macroeconomic disarray led to the “Great Recession” of 2015–2016, when GDP fell by 7%, as opposed to the 5.3% reduction of 1930–1931, during the Great Depression. Brazil lost investment grade status in 2015, and the government is proposing fiscal adjustment and reforms to avoid an explosive path of government debt. There is a major chance that the country is entering a new “lost decade.”

The second factor to explain lower exchange rates is the inappropriate mix of macroeconomic policy. It is a well-known result in macroeconomic models that—with floating exchange rates and integrated financial markets—the combination of expansionary fiscal policy with restrictive monetary policy produces higher equilibrium interest rates, lower exchange rates, and balance of payment deficits. Price competitiveness in world markets depends crucially on the exchange rate, and the present macroeconomic policy represents an important constraint to export performance. The main factors behind the export recovery after 1999 were exchange rate devaluations, rapid world demand expansion, and the sharp increase in commodity prices associated with the emergence of China as a major player in world markets.

Finally, structural reforms and support policies by government agencies must be mentioned as favorable factors affecting export performance. Import liberalization and privatization were responsible for important productivity gains, increasing the competitiveness of Brazilian companies. Cases like Embraer and Vale are vivid examples of success in world markets after privatization. The role of the state agricultural research body EMBRAPA (see, in this volume, Bacha, Chapter 13; Martha and Alves, Chapter 15) is essential to understanding the increased share in world agricultural markets through innovations in seed varieties and production techniques. But the Brazilian share in the world’s exports increased only modestly. According to UNCTAD (2016) data, in 1981 the Brazilian share in world exports was 1.15%; in 2015 it reached 1.16%. Increasing market share is a measure of dynamic export competitiveness, and by this criteria Brazil offered a dismal performance.

The following analysis covers the last three decades, the period of import liberalization, stabilization of inflation at lower levels, changes in the exchange rate regime, and increased world demand for commodities that lasted up to 2011. Over this period, both the product composition and direction of Brazil’s trade have experienced considerable changes, and the long-run response of exports and imports to the exchange rate has varied according to product types. The stylized facts that emerge are as follows. (p. 407)

Table 19.2 Composition of World Exports (Percentage), 2014

Agricultural Products

Fuels and Mining Products

Manufactures

Africa

11.5

62.9

21.3

Asia

6.7

11.3

80.0

Brazil

39.0

24.4

33.3

Europe

10.6

11.1

74.8

Middle East

2.3

64.9

20.7

North America

11.1

16.7

67.6

South and Central America

30.6

39.9

25.5

World

9.5

20.5

66.2

Source: WTO (2016).

The volume of world exports grew at an annual rate of 5.1% and Brazilian exports at 4.8%. In nominal terms, world exports expanded 8.1% per year and the Brazilian exports by 7.8%. The composition of world exports has evolved gradually in the direction of manufactured goods, but the Brazilian trade structure moved in the opposite direction during the last 15 years. The present structure of world exports can be depicted by the data of Table 19.2. The share of Brazilian agricultural exports are almost four times the world average; on the other side, manufactured exports are 50% below the world average. There is no region of the world with a higher share of agricultural exports than Brazil. The proportion of manufactured goods exports has declined during the last decade, with an increased share of primary products.

The composition of Brazilian exports has changed in the direction of primary products (see Silva e Silva, Chapter 31 in this volume). At the end of the 1990s, the share of commodities was 22.8%; in 2015, it had increased to 45.6%. The main exports of this group are iron ore, petroleum, meat, soybeans, sugar, and coffee. The opposite move was observed in manufactured goods, with its share diminishing from 59% to 38.1%. In this group the main exports are vehicles, iron and steel, airplanes, organic chemicals, and machinery. The changes in Brazilian exports are shown in Figure 19.2. With respect to imports, the opening up of the economy substantially increased the share of manufacturing, from 57% in 1989 to 84.4% in 2015.

The more important changes in the composition of Brazilian trade were, on the export side, the increased share of commodities and the reduced share of manufacturing in export flows. In the case of commodities, increased world demand and comparative advantage of the Ricardian type are the factors behind the observed tendency in the last two decades. The declining share of manufacturing is explained by the increasing competition from Asian countries and overvalued exchange rates. According to UNCTAD (2002), primary products and resource-based manufacturers have lost share in world (p. 408) exports during several decades, and in those sectors Brazil had increased export concentration. For developing countries as a whole, the fastest-growing export was of high technology sectors, where Brazil had a minor share of its exports. The UNCTAD study defineda “winner” in world markets as a country that increased its share in world markets for manufactured goods. The striking result during the period 1985–2000 is that Brazil does not appear once among the top 20 “winning” countries for all categories of manufacturing industries. The positive results for commodities are associated with the rapid growth of trade during the last decade, the effect of China in particular, and domestic supply factors like the rapid increase in productivity associated with import liberalization, privatization (Embraer and Vale), and new technologies developed by EMBRAPA.

Brazil has not been able to change its comparative advantage toward the new technological sectors. To increase competition of manufactured goods, it is necessary to reduce the level of import protection to enhance modernization and efficiency gains, particularly diminishing tariffs on imported capital goods. Another important task is the elimination of the domestic tax burden on exports. Brazil has a complex tax system with a high tax burden (33% of GDP in 2015), imposing large administrative costs and indirect taxation on exports, and this is a significant constraint on Brazilian firms’ competitiveness in world markets. The current policy of rebates for state and federal value added tax is not enough to eliminate taxes levied on exports being part of the so-called Brazilian cost. It is also fundamental to control government current expenditure to commit higher government resources to investment in education, research, and infrastructure essential to the competitiveness of the industrial sector in the long run. Brazil has one of the more diversified industrial bases among developing countries, but is not able to reap this advantage in world markets due to the heavy burden of inappropriate government policies.

Two final subjects on trade issues: the first one is regional market diversification, and the second is the outstanding agribusiness performance. One distinguished feature of recent export performance has been the increasing sales to new markets, as pointed out by Bonelli and Pinheiro (2007). All developing regions increased purchases from Brazil, as can be seen in Table 19.3. The share of MERCOSUR more than doubled between 1989 and 2015, as a consequence of preferential regional agreements and lower transport costs associated with lower distances and infrastructure improvements.7 Developed countries declined in importance as major trade partners, the United States in particular. In 1989, 65.3% of Brazilian exports went to the European Union, the United States, and Japan; this share fell to 32.7% by 2015. The major change is the emergence of China as the major trade partner. Brazil is a “global trader.” Brazilian exports are distributed among all regions of the world. This does not come as a surprise. The size of the country, different climates (ranging from tropical to temperate), a large endowment of natural resources and labor, and a highly diversified industry all influence the composition and regional distribution of Brazilian exports.

Another distinctive feature of the present Brazilian trade profile is the regional specialization of exports. Manufactured exports are dominant in only two regions: Latin (p. 409) (p. 410) America and the United States. With the exception of MERCOSUR, in all other markets the country’s exports followed the uniform pattern of reduced importance of manufactured goods.

Table 19.3 Destination of Brazilian Exports (Percentage)

1989

2015

Basic

Semi- manufactured

Manufactured

% Total Exports

Basic

Semi- manufactured

Manufactured

% Total Exports

Africa

16.5%

13.8%

69.7%

2.8%

36.7%

23.1%

40.2%

4.4%

ALADI excluding MERCOSUR

6.4%

6.5%

87.1%

6.4%

17.0%

4.3%

78.7%

7.7%

MERCOSUR

14.2%

4.0%

81.8%

4.0%

12.2%

2.1%

85.6%

9.6%

China

11.7%

27.5%

60.8%

1.8%

80.4%

13.2%

6.4%

19.1%

Japan

40.4%

34.6%

24.9%

7.2%

66.8%

18.4%

14.8%

2.6%

United States

10.7%

11.6%

77.7%

24.2%

19.2%

19.1%

61.7%

12.0%

Middle East

26.7%

11.1%

62.2%

3.3%

61.6%

9.9%

28.5%

0.5%

European Union

46.9%

15.4%

37.8%

33.9%

48.7%

16.2%

35.1%

18.1%

Russia

0.0%

0.0%

0.0%

0.0%

73.7%

15.0%

11.3%

1.3%

total

28.1%

17.1%

54.8%

46.8%

14.2%

39.0%

Source: Ministry of Development, Industry, and Trade statistics.

This is the result of one important pitfall in the Brazilian trade policy strategy. When multilateral trade negotiations waned, the country moved to South-South agreements with minor effects on trade flows. The international trade specialization with developing countries is limited by market size and similarity in factor endowments. A smaller market does not permit exploration of the comparative advantage of a larger array of manufactured products and the benefits of economies of scale. Similar factor endowments impose very high adjustment costs for a full-blown free trade agreement. The adjustment costs of a bilateral agreement with India or China would not be trivial in labor- and capital-intensive industries.8 On the other hand, the absence of preferential access to developed countries’ markets explains the falling share of Brazilian exports in those markets. Developed countries have been very active in regional trade agreements. The North American Free Trade Agreement (NAFTA), the European Union enlargement, and their agreements with Latin American countries explain, at least partially, the eroded Brazilian position in developed countries’ markets. The competition in the manufactured goods world market increased sharply in the last three decades with the entry of new and major players. China, with its aggressive trade and exchange rate policies, is the great novelty, becoming in one generation the largest exporter in the world. This is a challenge facing Brazil imminently: how to increase market access in a segmented world through regional agreements, new competitive players, and laggard multilateral trade negotiation to open agricultural markets.

One distinctive aspect of the Brazilian insertion in world trade is the outstanding performance of agribusiness. From the early 1960s, the share of agribusiness in total exports fell steadily as a consequence of the import-substitution policy and government export incentives for manufactured goods exports. In 1990, agribusiness exports were reduced to 28% of total exports and remained at this level up to 2005; in the past decade it has increased to 46.2% (2015). Agribusiness has always been an export-oriented sector, and presently its share in exports is five times bigger than its share in GDP. There are several factors behind export growth during the past decade: the high growth rate of world demand; price increases of commodities in world markets; increased competitiveness of agribusiness; regional diversification of exports; and the elimination of the anti-export bias of trade policy after import liberalization.

Agribusiness’s exports upsurge has had two basic characteristics: changed composition of exported products, and regional diversification in the direction of developing country markets.

With the increased importance of meat and sugar, today agribusiness exports are diversified within tropical products, temperate products, and meat. During this decade there was a relative decline of exports to developed countries, and developing country markets are becoming increasingly important. Within developed countries, the reduction was across the board: diminishing share to all relevant markets; for the developing countries, China appears as the most dynamic market for agribusiness exports (see (p. 411) Table 19.2). There is not a unique factor to explain regional diversification, but clearly rapid per capita growth in Southeast Asia and highly protected markets in the developed countries can be pointed to as some of the key factors explaining the observed tendency in agribusiness trade. The “China effect” and Vale’s privatization also explain Brazil becoming a large exporter of iron ore.

One stylized fact of the world economy after World War II was the diminishing share of agriculture in world production and trade. The opposite movement happened with Brazilian agriculture. In 1990, Brazil had 2.4% of the world’s agriculture trade; by 2014, the Brazilian share was double that at 5%. Brazil is the third-largest exporter in the world, behind the European Union and the United States. Brazil is now a “major player” in several markets, ranking as the largest exporter for orange juice, sugar, poultry, coffee, and second place in soybean products, corn, and beef. The degree of openness of the agribusiness sector to exports is the largest of the country. According to recent FIESP (2016) data, Brazilian industry exported 17.3% of its production in 2015, clearly inferior to the agriculture sector figures of 37.7% in the same year.

The increased competitiveness of Brazilian agriculture has depended on a series of factors. The most important to explain output expansion was productivity growth. There are several empirical studies showing that total factor productivity growth was impressive. Avila and Evenson (2005) data show that TFP in Brazilian agriculture, in the period 1981–2001, grew on average 3.2% per year—the largest among all developing countries. Gasques (2006) estimates that between 1975 and 2005 total farm productivity doubled. Productivity growth is linked to government policy decisions to invest in EMBRAPA’s research in new agricultural technologies, and also to investment in human capital. Public universities graduated a large number of forestry engineers and veterinarians necessary for high-tech production in agriculture. The main competitors in agriculture world markets are the developed countries, and their exports depended on subsidies, modern agriculture technologies, and large-scale production. As the world’s third-largest exporter, Brazil was able to overcome unfair trade practices and became a major player in the world agriculture market.

Trade liberalization had also a positive impact in agribusiness export performance. In the period of import substitution, the agriculture sector was penalized by trade policies through overvalued exchange rates, tariffs in final products and imported inputs, quotas, licensing, and domestic taxation of exports. Trade reform during 1987–2004 eliminated export licensing and quotas, reduced tariffs and NTBs for agriculture imports, and in 1996 the value added tax on exports of agriculture and semi-manufactured goods was abolished. During this period the domestic government program of credit subsidies and price support was phased out, forcing the agriculture sector to compete in an open world market environment.

Finally, the rapid increase in international demand should be mentioned to explain the success of agricultural trade. The results have been impressive, and the agribusiness sector was responsible for changing the Brazilian trade balance during the last 25 years. In 1989, agribusiness trade surplus reached US$11 billion, or 67% of total trade surplus; in 2015, with a trade surplus of US$88.2 billion, the agribusiness sector was the only (p. 412) sector with trade surplus and compensated the trade deficits of the manufacturing and services sectors.

A summing up of Brazilian trade performance: the country continues as a global trader, with an increasing relative share of new developing markets, a decreasing share of manufactured goods exports, and an increasing share of agribusiness and mining. The main factors to explain export performance are productivity growth, economic reforms, diversification of markets, and natural resources. Brazil experienced an export boom after 2002, with two main characteristics: new markets, and a change in export composition.

19.4. The Balance of Payments and the Real Exchange Rate in the Long Run

With the advantage of hindsight and almost a century of economic literature and statistical data, it is possible to give a comprehensive explanation of the links between the current account, capital flows, and the real exchange rate. For the balance of payments, the picture that emerges is recurrent and long-lasting current account deficits, as shown in Figure 19.3.

Trade Policy from the 1930s to the PresentClick to view larger

Figure 19.3. Brazilian balance of payments, 1930–2015 as percentage of GDP.

Sources: IBGE and Brazilian Central Bank.

(p. 413) Given the structural low level of domestic savings, Brazil used extensively foreign capital to finance domestic investments. Balance of payment surplus occurred only in exceptional periods such as the Great Depression and World War II, when capital inflows collapsed, or during the early 1970s and the first decade of the 2000s, when commodities prices boomed with a very favorable external environment. But the dominant feature was four long cycles of balance of payment deficits, followed by increased foreign debt and crises. The largest came after the oil shocks of the 1970s, followed by the debt crisis and default of the 1980s: current account deficits peaked at 6% of GDP, financed by a similar size of inflows of petrodollars. During the Real Plan, with a fixed nominal exchange rate for four and a half years, came another period of large deficits, and Brazil almost went into foreign debt default again. Starting in 2008 came the most recent period of increased balance of payment deficits, followed by a large devaluation of the Brazilian currency in 2015.

This chapter has stressed that the Brazilian government has always been cautious with exchange rate devaluations due to the impacts on terms of trade, inflation, and the government budget. How can the large real devaluations be explained in the long run? The answer is the foreign budget constraint. Current account deficits over time increase foreign liabilities that have to be served in foreign currency. This is the famous “original sin” in international economics theory. This cash flow problem is depicted in Figure 19.4 through the gross foreign debt/export ratio and the real exchange rate.

Trade Policy from the 1930s to the PresentClick to view larger

Figure 19.4. Index of the real exchange rate and Brazilian gross foreign debt/export ratio, 1920–2015.

Source: IBGE and Brazilian Central Bank.

(p. 414)

As foreign debt increased, a higher proportion of export revenues was committed to interest payments and other foreign exchange remittances, like profits and dividends. In the Brazilian case, when the foreign debt/export ratio exceeded 3 (right-side scale in Figure 19.4) it became increasingly difficult to serve foreign liabilities, and the country became more vulnerable to terms of trade and capital inflow reversals that triggered large exchange rate devaluations to correct balance of payments disequilibria. The statistical correlation between the two statistical series is 0.53% over a period of 95 years.

19.5. Concluding Remarks

Historically, Brazilian trade and investment policies have been characterized as highly protectionist to foster inward industrialization growth. A large array of tax and credit subsidies for industrial investments and high tariffs and NTBs protected the domestic market from import competition, leaving it for export-promotion policies to mitigate the anti-export bias of trade policies. Even the liberalization attempt of the late 1980s and early 1990s was partial and insufficient to change the Brazilian development model’s focus on the domestic market. Brazil is almost an autarchy in terms of trade flows.

During this period, Brazil implemented important trade policy changes, going from ISI to export promotion, trade liberalization, and ultimately a return of protectionism in the last two decades. Booms and busts in the world economy are important factors shaping Brazilian trade policy in the twentieth and twenty-first centuries. Protection to foster industrial growth has been of paramount importance. Most of the time, trade policy was inward looking with a strong anti-export bias due to overvalued exchange rates and strong incentives to divert production into domestic absorption and industrial growth. The results were impressive during the half a century from 1930 to 1980, when industrial average annual growth was 8.1%. But in the last 35 years, industrial growth has almost vanished, to a dismal annual rate of 0.7%. There was no room for additional stages of inward-looking ISI based on shifting underemployed supply of cheap labor from agriculture to the industrial sector, typical of the Lewis development model.

Brazil is a typical case of a country caught in the “middle-income trap,” with an annual per capita growth rate of 1% since 1980. By this pace, per capita income will double after 70 years. Trade policy alone cannot be blamed for this poor performance, but the country is still very isolated from the world market, and trade liberalization is one of the big challenges for the near future.

The benefits of the trade and investment liberalization of the 1990s were blunted by international crisis and inconsistencies in domestic macroeconomic policies. After 2002, the world economy boomed for six years, with important consequences for the Brazilian foreign sector. The country’s exports quadrupled in nominal terms, with important composition and regional changes. The benefits of more trade and FDI (p. 415) were clear, and the country moved to a higher growth rate plateau. In a certain way, the twenty-first century resembles the nineteenth century. The similarity is that the most dynamic economies had a scarce endowment of natural resources, and their growth irradiated to the world by increasing demand for staples, oil, and mining products, with very favorable effects on Brazilian exports. This was the case with Great Britain in the nineteenth century, and is the case with China today. This period also witnessed the resurgence of world FDI. By the end of the 1980s, FDI was less than 1% of world GDP and rose to 4.7% in the period 2012–2014. In 2014, Brazil ranked sixth in world FDI stock.

During this period, Brazil implemented important economic reforms, ranging from trade liberalization, the stabilization of inflation, an aggressive privatization program, to moving to the floating exchange rate regime. Trade and foreign investment policies have always been decisive in Brazil, given the frequent balance of payments crises and their restrictive impacts on economic growth. In which direction has trade reform and international demand changed the composition of trade? In which sectors has Brazil been more competitive in world markets? What were the consequences of “getting the fundamentals right” on trade flows? What is the direction of trade policy reform? These are the some key questions to be answered. By the middle of the second decade of the twenty-first century, trade policy is still inward looking: the country presents an export/GDP ratio of 13% and a modest share of 1.16% of world trade, similar to 40 years ago. According to OECD (2015) statistics on foreign value added share in gross exports, Brazil stands with the second-smallest share in the world of foreign value added in exports, higher only than Saudi Arabia.

Brazil implemented an important trade reform during the 1990s, compared with its historically inward-looking policies. Tariffs and NTBs were removed, new opportunities were open for FDI, and the country became more integrated in the world economy. A more open economy was able to reap the advantages of international specialization, and the gains in efficiency, productivity, and competitiveness in the Brazilian case are well documented empirically. The structure of foreign trade moved in the direction of the increasing share of commodities in exports and high technology manufactured goods in the import side, reflecting present comparative advantages. Three decades after of the beginning of economic reforms, Brazil still faces important unsettled issues in trade.

The first challenge for policymakers is to choose the appropriate mix of macroeconomic policies. Price competitiveness in world markets depends crucially on the exchange rate. The present combination of loose fiscal policy with restrictive monetary policy produces higher equilibrium interest rates, lower exchange rates, and balance of payment deficits. A more restrictive fiscal policy and an expansionary monetary policy will be suitable to promote exports through a devalued exchange rate and lower interest rates without jeopardizing inflation control. It is also fundamental to control government current expenditure to commit higher government resources to investment in education, research, and infrastructure, essential to competitiveness in the long run. This has been an important constraint on export performance during the three previous (p. 416) decades, and is one important part of the “Brazil cost” (overvalued exchange rate, high tax burden and interest rates, and costly infrastructure). One additional side effect of a sound fiscal policy is to improve the business environment for investment, attracting both the domestic and foreign capital essential for brighter growth prospects. Higher domestic savings are fundamental to avoid the recurrent balance of payment crisis that constrained Brazilian growth in the post–World War II period.

Important fiscal controls have been approved by Congress in 2016: an amendment to the Constitution will restrict government expenditure growth over the next 20 years and the social security reform is being seriously discussed in the Congress today. New rules for concessions in infrastructure and Pre-Salt could boost investment in the near future. With a more restrictive fiscal policy and inflation close to the target, there is room for reducing the policy interest rate and a more devalued currency. If the United States implements an expansionist fiscal policy with the Federal Reserve increasing interest rates, there will be an additional pressure for US dollar strength.

Even though nominal and effective tariffs had been reduced, by international standards, they are comparatively high and with a large variance. There is no economic rationale for the present tariff structure. Nominal tariff rates range from zero to 32%, and the effective exchange rate from –3.1% to 132.7%. The only explanation for this outcome is the strength of special interest groups consolidated in the tariff structure. High tariffs on capital goods penalize investments, badly needed in a country where the investment rate is low. The costs of the present tariff structure for the country are high in terms of distorted resource allocation, less employment, welfare loss, and reduced rates of growth. The direction of tariff reform is clear: reduce the level and the variance of the present tariff schedule. Ideally, a Chilean-style homogeneous tariff would eliminate privileges and rent-seeking activities. An additional advantage of a reduced tariff rate is to increase the demand for imports contributing to the devaluation of the exchange rate, reinforcing the results of the previous proposal. It should be noted that the proposed round of trade liberalization is a completely different case compared with the opening process of the 1990s. Then, the country was so isolated from the world market that the first task depended only on domestic will and the move for more trade was unilateral. Now, market access is of paramount importance. This leads to the final challenge: market access at the regional level.

During this decade Brazil moved to South-South agreements with minor effects on trade flows. The international trade specialization with developing countries is desirable but is limited by market size and similarity in factor endowments. On the other hand, the absence of preferential access to developed countries’ markets explains the falling share of Brazilian manufactured exports to those markets. Developed countries have been very active in regional trade agreements. NAFTA, the European Union enlargement, and their agreements with Latin American countries eroded the Brazilian position in developed countries’ markets. This is one of the challenges facing Brazil in the near future: how to increase market access in a world that is segmented by regional agreements, new competitive players, and laggard multilateral trade negotiation to open agricultural markets.

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Notes:

(1.) The BRL$/US$ real exchange rate was calculated using data from IBGE (1990 and 2006) and FED (2016). The deflators chosen were GDP deflator for the Brazilian economy and CPI for the United States.

(2.) Cr$ was the symbol of the Brazilian currency, the cruzeiro, used in the period 1942–1967.

(3.) Acronym for the government agency for money, credit, and exchange rate guidelines created in 1945, a precursor of the Brazilian Central Bank opened in 1964.

(4.) According to Kume’s (1996) calculations for 1988.

(5.) For capital goods without a domestic counterpart, there is the possibility to reduce the tax burden through a bureaucratic and nontransparent import regime called ex-tarifário.

(6.) Probably the most bizarre recent technical barrier to trade is the globally very rare three-pin socket for electrical appliances in force since 2010.

(7.) MERCOSUR signed trade agreements with Chile and Bolivia (1996), the Andean Community (2003), India (2004), Southern African Customs Union (2008), and Lebanon and Tunisia (2014). Brazil and Mexico (2002) signed a bilateral agreement within the LAIA initiative granting free trade status for 800 tariff lines, even though trade is heavily concentrated in autos and auto parts.

(8.) Silber (2004) finds that trade liberalization with India would increase Brazilian imports of apparel, textiles, chemicals, and pharmaceutical products. DECOM (2015) reports that—in the two previous decades—26% of all anti-dumping countervailing duties were applied on Chinese exports of manufactured goods.