Brazil and its Chinese challenges

Author: Mauricio Mesquita Moreira, IDB

In December 2004, during an official visit from President Hu Jintao, and amid great euphoria, Brazil signed a Memorandum of Understanding, granting China eagerly sought market economy status.

It was sold as a sign of great confidence in the benefits of the relationship and as part of a bargain whereby China would … well, that was never very clear (although there was talk of China accepting to talk about Brazil’s aspirations for a seat in the UN Security Council).

Almost seven years later, this euphoria has turned into unease. It became clear that the impact of China’s emergence is much more complex and nuanced than initially thought. Yes, the trade relationship has developed even faster than predicted. When the Memorandum was signed, China accounted for 5.6 per cent of Brazil’s exports and about 6 per cent of its imports. Now China is Brazil’s top trade partner, accounting for 15 per cent of its exports and 14 per cent of its imports. And challenges have come to the fore in at least two dimensions: market access and competition in manufacturing.

Brazil’s export opportunities in China have been limited to a few commodities, basically iron ore and soy, between them accounting for 67 per cent of total exports. This heavy concentration in exports is not a story of comparative advantages alone. Brazil’s exports in China face an average tariff of 15.3 per cent in agriculture and 9.1 per cent in manufacturing, compounded by tariff escalation and non tariff barriers (NTBs). Among these NTBs, one of the most prominent is the use of WTO-banned, trade-related investment measures against Embraer, Brazil’s flagship aircraft exporter, whose entry in the Chinese market was only possible through a joint-venture with a local state company.

Alongside market access, there is the challenge of Chinese competition, which has hurt Brazil’s manufacturers at home and abroad. This type of dislocation, although never painless, should normally be seen as part of the process of obtaining the overall gains from trade. Yet, the still ubiquitous presence of the Chinese state, as well as its very explicit industrial policy — with instruments that go from concessional credit to its under-valued exchange rate — have been lending a degree of legitimacy to even the most overtly protectionist claims.

These market access and unfair competition issues have changed the political economy of the relationship, forcing Brazil to take action. The shift began with anti-dumping measures, voluntary export restraints, non-automatic import licenses and custom valuation. More recently, the government has gone (prominently) as far as mentioning the ‘currency wars’ (although in a context that mixed apples — China’s exchange rate regime — with oranges — US monetary policy) and has signalled that, to fight unfair competition, it is ready to go beyond traditional trade defence and selectively raise most favoured nation (MFN) tariffs to their considerably higher WTO-bound rates.

This all suggests that Brazil’s approach to China is moving away from that almost Pollyannesque mode of the early 2000s. But there are risks that the pendulum might swing too far. Market access concerns are fully justified and should be pursued with more conviction, but the response to the manufacturing challenge does need more consideration. Endowments alone are likely to be the main source of the difficulties manufacturers are now facing. With less than 20 per cent of China’s population, and with an acute skill shortage, Brazil can hardly compete head-to-head in the labour- or skill-intensive industries. Brazil’s wealth of natural resources makes this possibility even more improbable given the well-known exchange rate effects. So, even in a world with China competing entirely by the WTO book, restructuring would be inevitable and would encourage going toward more resource intensive industries.

In this context, it seems particularly wasteful and counterproductive to pour billions of dollars of concessional loans and fiscal incentives, or to raise MFN tariffs — as it has been the case recently — to prop up industries whose chances of surviving are minimal. A heavy industrial policy stance also takes away the legitimacy of any claim against China’s trade practices. Brazilian policy makers should reconsider their long standing position to give developing countries more ‘policy space’ to implement industrial policies. You cannot have it both ways: either you fight for the market- and rules-based international trade, where a country such as Brazil can have a better chance of competing against powerful and wealthy states such as China; or you do not complain about ‘unfair’ trade practices at all.

Instead of going for an all-out, tit-for-tat interventionist strategy that would eventually bring back all the distortions that paralysed Brazil’s economy in the 1980s, the country would be better off allowing resources to flow to industries that have a better chance of thriving in this new Asian-centric world economy. This stance should be backed by more forceful and effective diplomatic action toward reigning in China’s excesses, preferably in cooperation with the (many) other countries that also have a large stake in seeing this happening.

Mauricio Mesquita Moreira is Principal Economist, Integration and Trade Sector, at the Inter-American Development Bank, Washington, DC.