Over the past 30 years, China has turned itself into the world’s largest factory region, concentrating no less than 28 percent of global industrial output. While other countries, namely the U.S., have criticized this concentration of production for some time, it took the Covid-19 pandemic to prove that having nearly all medical supplies produced in one place is not a good idea. That realization, coupled with a slowdown in the flow of people, should lead to a reorganization of global value chains with countries seeking to bring production closer to home.
Could that be an opportunity for Brazil to make a leap in development?[restricted]
For people such as long time investor Mark Mobius, founder of Mobius Capital Partners, this is a real possibility. In an interview with CNBC, he said companies were keen on reorganizing their supply chains, and while Canada and Mexico would be more logical locations for U.S. companies, “there’s going to be diversification where these supply chains get moved into places like Vietnam, Bangladesh, Turkey, even Brazil.”
Changing a system that has been building up for so many years is no easy task, and will not happen overnight. But the first signs that the so-called “decoupling” of U.S. firms from China is here to stay are already popping up, with Apple moving part of its production to India and Vietnam. Also, as political tensions between the U.S. and China continue to boil over on issues such as trade and Beijing’s Hong Kong takeover, decentralization may be the new order of business.
Meanwhile in Brazil, the economy is still feeling the impacts of Covid-19, with factories closing for good and industrial production falling 22 percent in May year-over-year. But industry experts believe that the country may be in a good position to become an attractive destination for investment — if it deals with its own internal challenges.
And that is a big if.
Brazil is better than it was, but not where it should be
In the past few years, Brazil has approved several reforms that aimed at reducing red tape and costs — such as the 2017 labor reform — or at balancing public accounts, as was the case of the 2019 pension reform. However, the country still languishes in the 124th position in the Doing Business ranking, which measures how business-friendly a market is, suggesting that there is still a lot to be done in order to make Latin America’s top economy more competitive.
For Thomaz Zanotto, director of International Relations and Foreign Trade at São Paulo’s Industries Federation (Fiesp), the local priority must be Brazil’s long-delayed tax reform.
“If we manage to approve the tax reform, we’ll be able to enjoy this regionalization, especially with the U.S. There is no doubt that we can win back Latin American markets that we lost to China,” he told The Brazilian Report, pointing out sectors such as apparel, machines, and vehicles as potential areas to benefit from the trend, despite being among the hardest-hit by the Covid-19 crisis.
Mr. Zanotto is not the only one to support this vision. According to Patrícia da Silva Gomes, executive director of Foreign Markets, and Maria Cristina Zanella, executive director of Statistic Economy and Competitiveness, both from the Brazilian Association of Machine and Equipment Industries (Abimaq), Brazil is in a prime position to reach Latin American countries, an potentially go further. “The Brazilian machine and equipment industry exports to over 150 countries. In 2019, roughly 30 percent of the sector’s exports went to the U.S. market, which shows international diversification,” they wrote in an emailed statement to The Brazilian Report.
They add that trade deals between South American trade bloc Mercosur and the European Union and members of the European Free Trade Association are set to open more demanding markets for Brazil. However, “in order to attract productive investments amid the reorganization of global supply chains, it is necessary to fight the variables that make up the ‘Brazil Cost,’” they say, including poor infrastructure and the heavy tax burden.
This demand is not new, as Brazil’s complicated and onerous tax system is considered one of the main obstacles for the development of the productive sector in the country. The extent of the problem becomes evident when we consider that taxes gobble up to 45 percent of the transformation industry’s output, while agriculture and extractivism sectors pay roughly 6 percent, as shown in a study by Rio de Janeiro’s Industries Federation (Firjan).
This loss of competitiveness eventually takes a toll on the sector’s contribution to the economy. While the industry accounted for 21 percent of the Brazilian GDP in the 1980s, it now makes up around 11 percent.
Unlike the pension reform, which was forged in consensus, tax reform is a source of controversy, starting with the fact that at least five proposals have been considered in Congress — and the Ministry of the Economy is yet to assemble its own bill.
Industry also depends on political abilities
Reforms are not the only issues that will require a better strategy from the Jair Bolsonaro administration. Besides infrastructure woes and an entangled tax system, Brazil’s image has not been cast under a favorable light recently — not only due to a poor response to the pandemic but also due to numerous environmental scandals, including record levels of deforestation in the Amazon rainforest. The alarming data comes two months after Environment Minister Ricardo Salles was caught on tape saying the government should use the pandemic as a diversion to further deregulate environmental rules in the country.
The international community’s reaction is strong, with calls to suspend the Mercosur-EU trade deal, and a meeting held between foreign investors and Vice President Hamilton Mourão — including Mr. Salles, Foreign Minister Ernesto Araújo, and Agriculture Minister Tereza Cristina — to discuss combatting deforestation in the Amazon.
For Mr. Zanotto, “Brazil has to deal with [international pressure] politically, to be intelligent in its message. If we change the message and agree with the media’s greener view, moving forward with the reforms, investments won’t be a problem in Brazil,” he said.
Mr. Salles himself acknowledged in an interview that he needs to “improve communication and bring people to the debate,” signaling that the pressure is starting to produce some effects. However, the country is still far from achieving the material results necessary to prove to foreign investors that Brazil is making actual environmental progress.
Fighting over scraps
Brazil will need to do its homework do overcome competition that is getting increasingly tough. On its newest World Investment Report, the United Nations Conference on Trade and Development (UNCTAD) expects global foreign direct investment to fall between 30 and 40 percent in 2020, plunging another 30 to 50 percent in 2021, depending on “the extent of the economic damage and the effectiveness of extraordinary measures that governments around the world are implementing to support businesses and households.”
Latin America and the Caribbean is set to be hit hardest, with a projected drop in FDI of between 40 and 55 percent in 2020. That’s because the region’s investments are highly concentrated in commodities such as oil, of which consumption has been severely affected by social isolation measures.
This blow is particularly hard for Brazil, where the oil industry accounts for 32 percent of FDI. The sale of assets such as gas pipeline network TAG to French group Engie helped to put the country on the map as one of the top 5 largest FDI destinations in the world in 2019, attracting USD 72 billion.
Privatizations of assets such as energy holding Eletrobras would be useful to foster investments once more, according to the report, and Economy Minister Paulo Guedes aims to carry out four such privatizations in the next 90 days. However, with market conditions unfavorable and the recent political skirmishes between the Executive, Congress and the Supreme Court also frustrating the sale of state-owned assets, the promise seems unrealistic.
In a recent article, Fernando Santiago, Industrial Policy Officer from the United Nations Industrial Development Organization (Unido) and Fernando Vargas, Specialist in Competitiveness, Technology and Innovation at the Inter-American Development Bank, support the view that Latin America needs to foster innovation funding and the digitization of the economy to foster industry investments in the post-pandemic scenario.
“The challenge of digitizing will vary according to the level of technological sophistication of each firm,” they wrote. “Those with more technologically mature systems, and which are operating in countries with greater levels of industrial development — such as Argentina, Brazil, and Mexico — may target a recovery strategy incorporating more advanced technologies such as those associated with Industry 4.0.”[/restricted]