ISI and SOEs
The effects of heavy state involvement in the Brazilian economy
From my make shift hostel kitchen office I’ve been battling Mosquitos and struggling to type on my iPad for the past weeks. Which, combined with all the travel and partying exploring I’ve been doing explains why I’ve been slow to post content. Although the constant onslaught of mosquitos certainly is a nuisance it fails in comparison to the torture of having to write lengthy content with two fingers at a time. First world problems, I know. To bad my laptop decided to die the day before I left for Brazil.
This post will highlight a couple of the unique historical aspects of Brazil’s economy as well provide a brief analysis of their current and future prospects. While it would be prudent to write a post analyzing each subject (which I may do in the future) I plan to just stick to the meat and potatoes for now.
Import Substitution Industrialization (ISI) 1950s-1978
ISI can be traced to the early 20th century; however, its heyday came thanks to a prominent Latin American economist by the name of Raul Prebisch in the 1950s. Prebisch called for high import taxes to promote domestic consumption and protect/grow infant industries as a means of fostering economic growth. The idea was domestic industries and infrastructure would develop holistically and in turn keep both money and resources domestically. This was an easy sell for Latam governments, especially Brazil, weary of international intervention (think Cold War era) and safety from the exploitation faced during the colonial times. Most importantly, regimes were desperate for jobs to appease their voter base.
While the extent to how successful ISI was in achieving its goals of economic growth and infrastructure development has been well examined, one thing is for sure: Brazil received little external investment. Both Foreign Direct Investment (FDI) and modern goods were largely absent due to the isolationist economic policies and as a result, most of the industries were under grown. Perhaps the most important downside of the policy was without either competition or incentives, inefficiencies developed. Domestic goods were (and still are) expensive and inadequate to the point their export value was nearly negligible. Lacking an adequate education system the country had very little human capital, further adding to the lag in innovation which resulted in subpar domestic goods. ISI did help serve some of its tertiary goals of employment, keeping money within the economy, and maintaining a Brazilian stamp. But, such accomplishments weren’t available without heavy state involvement.
State Owned Enterprises (SOEs) 19XX-present
In conjunction with ISI Brazil employed a joint government-enterprise model for many of its major industries. Utilities (Electrobras, Furnas, Electronuclear), petroleum (Petrobras), aviation (Embraer), banking (Banco do Brasil), and telecoms (Telesp) are of notable mention. While Telesp and Embraer have been spun off into private entities many State Owned Enterprises still exist to this day and account for a large chunk of the countries jobs. Historically. SOEs have more or less been a part of Brazil’s inception depending on how you look at it. First in the form of colonial trading companies and later the entities which we witness today. While the same can be said for many colonial countries (including the U.S.) the difference is cultural.
SOEs are looked at from either a bane or boon standpoint. Because the government has skin (plus often an arm and a leg) in the game investors are provided security. Furthermore, added benefits in regards to subsidies, government legislative support, and monopolism make SOEs in some cases unfairly competitive on the world market. However, with government comes bureaucracy, regime interests, corruption, and patronage. Thus, their effectiveness is variable and dependent per regime. More times than not this relationship is problematic due to the variability of the ruling party and of course pathway for corruption. Furthermore, executive and managerial hiring are much more politicized and less based on merits or qualifications.
Conclusion
While Import Substitution Industrialization is over some of its policies have endured. High import taxes make electronics, among other things, incredibly expensive. For example, the most expensive Apple iPhones in the world are found in Brazil coming in at $1,234 (USD). For a comparison the average wage is about R$2200 a month or $725 USD. This poses a problem because Brazilians, like Americans, are very much consumers and end up financing expensive imported tech such as iPhones and laptops. Domestic competitors are often nonexistent or still fail in comparison to their North American competitors. Thus many spend an unnecessary amount of their disposable income on said goods because the high taxes sometimes create as much as a 60% markup!
State Owned Enterprises also haven’t faired well the past few years. In 2007-2008 high commodity prices allowed Petrobras to become the poster child of the powerful potential the fusion of both public and private sectors could bring. Since, oil prices have reached 6 year lows and analysts predict the price could continue to drop. Even more alarming is the recent scandal engulfing many of Petrobras’ exec and potentially even President Rouseff herself, a one time Chairman of the oil giant. Dubbed Petrolão due to its size and scope, as much as $20bn is estimated to have been grafted over the past decade. The names of multiple politicians and contractors have since come to the surface as the investigation continues. Petrobras stocks are down from $22 a share to $8 and the Brazilian Real dropped to R$3.30 to the dollar both due in large part to the scandal.
Both ISI and SOEs are classic examples of outdated economic policies which continue to survive due to precedent rather than progress. While each certainly served their place, such policies prove Brazil is still lagging as it’s becoming more obvious that the time has long passed where SOEs should have been spun off and import taxes lowered. In fact, both are now hindering economic progress because they don’t allow either Brazilian consumers or businesses to behave naturally without paying for it. Getting the government off the back of companies would be a large first step allowing companies to operate more focused on profits and be less effected by political means (i.e. artificially low oil prices). The country doesn’t suffer from the human capital constraints it once faced in the past and the policies shouldn’t reflect this either. Without a doubt corruption would still exist but it would be much harder as the avenue is less obvious and the incentive riskier. Further trade liberalization is also necessary to increase trade and job growth as multinationals are attracted by the large Brazilian consumer base, immense infrastructure, and relatively cheap labor (made possible by exchange rate differences). The reason why they aren’t there already? The famous Custo Brasil (Cost of Brasil) only made possible by these outdated economic policies (ISI, SOEs) where the government has its hand in everything but mostly the pockets of the consumers and businesses. Until either policies are done away with Brazil will never truly reach its full potential.