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09.07.07
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Russia And Brazil: Facing The Future
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By Michael Akerib
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Editor's Note:
In 2003, economists at the Goldman Sachs Research Institute introduced the idea of the BRIC – an acronym that refers collectively to Brazil, Russia, India and China. The economists at Goldman Sachs believed that these emerging markets, if properly managed, could dominate the world economy. Over the summer, Russia Profile is running a series of articles comparing Russia with its BRIC counterparts, focusing particularly on issues of population growth, education and adherence to Western business practice and guidelines. The series will be published in a special edition of Russia Profile magazine this fall.
The challenges countries face to develop and grow economically are numerous, complex and differ greatly from one country to another. Understanding the drivers behind both the development and the economic growth of the BRIC economies in an era of globalization is of primordial importance considering that they are at the forefront of global economic expansion.
Brazil’s economy grew by 3.7 percent in 2006 with low inflation, a rather unusual feat for the country, but a small success compared to the other BRIC members, and its currency has shown unusual strength. This growth rate, however, is low compared with its neighbors, many of which scored substantially higher rates, averaging over 5 percent.
Although major advances have been made in certain areas, much remains to be accomplished through structural changes. Thus, for instance, foreign debt has been greatly reduced – the Central Bank has $100 billion in reserves – and is replaced by domestic debt. This now stands at 50 percent of GDP, and servicing it is a strain on the country’s budget.
In spite of several cuts, the Central Bank still maintains a base rate of 12.5 percent, thus attracting foreign funds and creating strong support for the Real. The currency has also gained strength due to a generally positive view of the future of the country’s economy.
Brazil’s income gap between the very rich and the poor is colossal and is considered one of the major causes of urban violence in the country. Unfortunately, the poor have not benefited from economic growth as the country’s distribution of wealth disproportionately favors the rich.
Corruption is another major problem in Brazil, and the government itself reckons that billions of dollars of public work contracts are siphoned off by corrupt officials. Those that had hoped that the government of President Luiz Ignacio Lula de Silva would be cleaner than its predecessors have been disappointed, since nearly 100 members of the last parliament have been accused of corruption.
Members of parliament are elected on party lists rather than individually and have little contact with their constituents so they do not feel accountable to them. Party hopping is quite common.
Government employees retire after 30 years of service for women and 35 for men. Their pensions take up 11 percent of GDP even though the country’s population of people over 65 is only 5 percent.
Advances in the field of education are an urgent necessity and should contribute to attracting foreign direct investment that looks for quality human capital rather than cheap labor.
Entrepreneurship needs to be encouraged and barriers such as long delays to register a company (152 days) and immense bureaucratic obstacles and high contributory levels on employees should be removed. Mechanisms to offer access to seed and venture capital as well as corporate credit need to be put in place. The development of secondary markets such as national or regional stock exchanges like AIM or NASDAQ would greatly contribute to make available increased liquidities to SMEs.
The result has been a very large informal economy, estimated at 40 percent of gross national income, which employs 50 percent of Brazil’s available labor force. Informal businesses not only avoid paying taxes, but also have lower productivity and little opportunity to invest and grow. The tax burden is thus transferred to the larger corporations that are heavily taxed.
Additionally, there are very large disparities between regions; Brazil’s wealthiest area, the southeast is more than twice as rich as the northeast. This results in major transfers of funds from one region to another through federal government programs.
Agriculture is a major component of the country’s economy, representing 40 percent of its exports, and has considerable potential for further growth. Brazil is the world’s first or second producer or exporter of a wide range of commodities including cocoa, coffee, corn, meat, orange juice, sugar, timber and tobacco, hence the country’s economic health is to an extent reliant on sustained prices of food commodities and on the conclusion of the Doha round of trade talks, which would open substantial new markets.
Sugar cane merits a more than passing attention. This industry grows by 25 percent annually, largely due to the production of alcohol. Brazilian production represents nearly 50 percent of world production with annual exports of 2.6 billion liters. Production is carried out mostly by large, government-supported conglomerates that do not hesitate to use violence, including murder, to displace the indigenous people and occupy their land. Laborers are exploited and some live basically as slaves.
Brazil is a major producer of ores and is the world’s major exporter of iron ore. Hence a sustained steel market is essential for this industry.
Brazil has a positive trade balance. In 2006, the country boasted a surplus of $ 46 billion. Its major partners, both for imports and exports, are the EU, the United States and Argentina.
While it has been a member of the WTO since 1995, Brazil is also a member of Mercosul, the Latin American Common Market that has recently expanded to include Venezuela, offering the country export growth opportunities. Mercosul is conducting bilateral and trilateral negotiations with other countries such as India, South Africa and the members of the EU.
Exporters are hindered by the large number of laws and regulations that govern procedures, subsidies and tariffs. Simplification could only help drive exports. The strong Real has also been an obstacle for exports of industrial products such as cars.
Historically, Brazil has been heavily dependent on oil imports, and energy imports have weighed heavily on the country’s trade balance. However, several discoveries have made the country nearly self-sufficient; total self-sufficiency is about to be reached and the country plans to become a net exporter. Most of the oil lies offshore, which has led the country to develop technology for deep offshore extraction, making Petrobras, the Brazilian state-owned oil company, a possible partner for the Russian companies as they increasingly produce offshore.
Brazil has also been at the forefront of green fuels and is the world’s leading producer of ethanol from cane sugar. The country invented the so-called flex-fuel car that runs on a combination of fuel and ethanol. Eighty-five percent of all cars in the country use the flex-fuel technology.
There are, however, limitations to the expansion of this fuel, particularly if forecasts of doubling the production by 2015 or earlier are correct. The investments required for production and transport logistics would amount to nearly $100 billion.
Brazil has a positive trade balance with a 2006 surplus of $ 46 billion. Its major partners, both for imports and exports, are the EU, the US and Argentina.
While it has been a member of WTO since 1995, Brazil is also a member of Mercosul, the Latin American Common Market which has recently expanded to include Venezuela, offering the country export growth opportunities. Mercosul is conducting bilateral and trilateral negotiations with other countries such as the EU, India and South Africa.
Exporters are hindered by the large number of laws and regulations that govern procedures, subsidies and tariffs. Simplification could only help drive exports.
The world is also now witnessing the rise of the Brazilian multinational, a good example being CVRD – Companhia Vale do Rio Doce – a producer of iron ore and minerals – which has become the world’s second largest mining company. In 2006, for the first time, Brazilian companies invested more abroad than foreign companies invested in Brazil.
Innovation, however, is still lagging behind and spending on research and development is minimal; the little that is done is led by universities rather than industry.
Tourism has also developed in the country. The industry has generated income of $11 billion last year, but still requires considerable investments to develop the required infrastructure.
These complex combinations of challenges will need to be faced head on before Brazil’s development and economic growth allows it to become the fabled land it has promised to be for the last 200 years.
Russia’s economy does present some similarities to Brazil’s, although it has grown more than twice as fast.
Both countries are heavily dependent on commodities and should therefore diversify into higher-value products. The Russian government has recently taken some steps in this direction particularly with the creation of major organizations centralizing efforts in the defense industry and nanotechnology. Although this is the right step towards a multi-polar economy, having the state head up these initiatives rather than industry may make them less efficient.
Reserves at the Russian Central Bank are bulging, inflation appears to be under control and the currency is strong. Consequently, Russian corporations will need to increase productivity to remain competitive in the face of increasing costs, in particular in non-resource-based industries. Russia needs to reform its institutions to encourage the rise of such industries. Failure to accomplish such a transformation will lead to the decline of the economy once mineral resources are exhausted.
Both Russia and Brazil require major investments to build or upgrade their infrastructure. Most of the equipment in the natural resource industry, for example, is over 20 years old. The energy industry is also in bad need of major investments.
The role of both countries in an increasingly globalized economy depends on their ability to attract foreign direct investment (FDI) – along with foreign technology and managerial skills. In this sphere, Russia faces greater challenges as it is considered more risky than Brazil, particularly with regards to investments in natural resources. This perception will need to change if internal investment is to be maintained or to grow. In particular foreign investors need to feel that their property rights and contracts are respected and that deals are more transparent and less politicized than they are at present.
Foreign investments are starting to trickle in and have gained some support from a government fund that matches private investments in start-ups. A major advantage of investments in Russia, compared to other Eastern European countries is the existence of a substantial domestic market. What is lacking, however, are major local venture capitalists to support the local entrepreneurs.
Regional disparities are also large in Russia, as Moscow and St. Petersburg attract the bulk of investment and remain the two major decision making centers. Like Brazil, Russia has substantial areas that are remote, devoid of commercially-exploitable resources and, consequently, extremely poor. They only survive through redistributing wealth from the more developed regions. This can be changed with the help of FDI.
The bureaucracy in both countries is overwhelmingly present and is immensely corrupt.
In Russia, too, conditions are favorable for a gray economy.
In both countries, although not for the same reasons, pensions will be a significant drain on the economy. Russia can, however, use its stabilization fund to boost revenues of pensioners with the corollary that this will slow GDP growth.
Yet the countries still face different challenges. Unlike Brazil, Russia is not yet a member of the World Trade Organization. And agriculture is not a major employer in Russia – only 15 percent of Russia’s population works in the sector. Nor does Russia favor geographical mobility of the labor force, particularly with the increasing restrictions on working in Moscow.
The list of required changes is long, but achievable and they should provide an interesting challenge for the new president and Duma.
Michael Akerib is a Senior Consultant with Rusconsult and a professor at Sacred Heart University in Luxembourg. This is the third in a series of three articles comparing Russia with Brazil in the context of the BRIC framework. |
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