At first sight Brazil and China look strikingly complementary in terms of trade and investment. China needs commodities to fuel its rapid economic growth. Brazil has abundant natural resources, ranging from iron ore over soy to oil. (Recent oil finds could turn Brazil into a major exporter in the coming years.) Brazil suffers from low savings and investment rates. China generates “excess” savings. The savings ratio is a paltry 17% of GDP in Brazil and a massive 45% of GDP in China, and China exports its “excess” savings as reflected in its huge current account surplus. The Brazil-China pairing looks like a compelling story, except maybe for the fact that China will become an increasingly important commercial competitor in manufacturing. This has some sectors of Brazilian industry wondering about how beneficial Brazil’s economic relationship with China really is (or will be).
Brazilian exports to China have been booming, but Brazil registered a bilateral trade deficit for the first time in many years. Structural factors drive resource-intensive economic growth in China, mainly urbanisation, demographic transition and industrialisation. This is good news for Brazil’s commodity-intensive export industry. Not surprisingly, bilateral trade has been booming, growing very rapidly from a low base. Last year Brazilian exports to China accounted for only 7% of total exports. But this made China Brazil’s third-largest trading partner (or second-largest if one does not count the EU as a single partner) and the country with which trade grew fastest. But last year Brazil also registered a trade deficit with China despite record-high commodity prices, and Brazilian manufacturing exports to China have basically stagnated in recent years.
Chinese overseas direct investment (ODI) in Brazil has thus far disappointed. China has largely “recycled” its huge capital and current account surpluses in the form of official FX reserve accumulation, the recent establishment of a sovereign wealth fund notwithstanding. Given the huge domestic demand for commodity imports, political, strategic and even economic logic would seem to make it attractive for China to invest directly in overseas (Brazilian) commodities sectors. Indeed, during his 2004 trip to Latin America, President Hu allegedly promised USD 100 bn in Chinese foreign direct investment until 2010. So far, Chinese ODI in Latin America, let alone in Brazil, has been disappointing. Chinese ODI data record average annual ODI in Brazil of USD 10 m! Even under the assumption that some of the Chinese FDI flows to Brazil are routed through off-shore centres, Chinese ODI in Brazil remains disappointing.
The key question is whether Brazil can afford to rely on an essentially commodity-based export model. Will China not become a threat to Brazil’s manufacturing sector and future economic development? No doubt, Brazil’s labour-intensive, low-tech manufacturing sector will increasingly come under pressure and even some of the tech-heavier parts of the economy may face increasing competition from China over time. China registered a staggering increase in high-tech exports in the past few years. Already in 2005, 31% of Chinese manufacturing exports consisted of high-technology products compared with 13% of Brazilian exports. Brazil will find it difficult to pursue a development strategy based on a rapidly expanding, broad-based, export-oriented manufacturing sector. First, China combines rapid productivity growth, low-cost labour and the fact that it has already built up a competitive export-oriented manufacturing sector with the help of foreign direct investment. Occupying a favourable position in the Hausmannian “product space”, China will find it much easier than Brazil to move into the higher value-added, tech-intensive segments of the manufacturing space. Finally, China found and will continue to find it easier to maintain a competitive exchange rate than Brazil whose exchange rate is much more volatile.
Brazil is unlikely to become a manufacturing powerhouse like China or an internationally competitive “service centre” like India(although it will have internationally competitive manufacturing and service companies). Building on its comparative advantage, Brazil will have to move to more high-value-added, adjacent parts of the “product space”. Brazil is well-placed to offer the whole range of commodities ranging from energy over metals to soft commodities. The key challenge will be to increase the “value-added” in these sectors. But Brazil is in a unique position to draw on its resource wealth, to further develop its technological edge in agriculture, alternative energies etc. and move downstream (e.g. distribution, marketing) in order to capture the more profitable stages of the value chain. Brazil is one of the few countries with a sufficiently large resource base and a relatively sophisticated research infrastructure in promising economic sectors (e.g. ethanol, agricultural research) placing it in a fairly unique position among resource-rich emerging markets.
It is a mistake to believe that the only path to sustained economic growth leads via export-oriented, manufacturing-based development. Granted, pursuing an export-oriented economic development has historically proven a relatively successful strategy. It provides economies with important benefits like stable demand and a clear technological upgrading trajectory. But in the end, Paul Krugman is right. What matters is productivity growth, not trade or international competitiveness. It may be that an internationally integrated manufacturing sector makes it easier to overcome domestic opposition to economic reform. But in the end it is increasing productivity that propels an economy forward, not trade or a large manufacturing sector. Focusing efforts exclusively on building a competitive export sector is a dubious strategy (as the 1970s demonstrated), especially if amongst other things the economy is relatively closed and services already represent 2/3 of the gross national product. The key to economic growth is domestic economic reform, nomatter whether the economy is closed or open, or whether its export industry is dominated by manufacturing or commodities. Again an internationally integrated manufacturing sector may spur productivity-enhancing reforms, but it is by no means the only way to achieve sustained economic growth. This is particularly true for continental-sized economies with large domestic markets like Brazil. China will therefore appear to some economic experts as a giant panda, to others as a fire-spitting dragon. But for Brazil as a whole the panda/ dragon question is a moot one. China’s meaning for Brazil will be whatever Brazil wants it to be and this in turn will depend on whether Brazil gets on with economic reforms.