Chapter 14: Catching Up

Aircraft manufacturing is part of the modern sector of Brazil's dual economy.

Development Policies

For most of the 19th and part of the 20th century, underdeveloped countries had little in the way of development policies other than policies to support the growth of primary commodity exports. Transportation policy was usually geared toward the infrastructure necessary to get the export crop to the harbor. Agricultural research institutes were established for sugar cane, cotton, coffee, etc., while there was little or no expenditure on the improvement of crops for domestic consumption such as corn, potatoes. beans or manioc. However, in the 20th century underdeveloped countries started actively looking for ways to induce an industrial revolution and reduce their dependency on agricultural exports.

One of the first approaches is called Import Substitution (IS). The basic idea is simple: establish protective tariffs and/or quotas which allow domestic firms to begin producing the manufactured goods that are normally imported. Start with the simplest products (textiles, shoes) and move up to more complex products (steel, appliances, autos, tractors). Successful import substitution usually requires massive expenditure on infrastructure. IS policies are often complemented by the establishment of state firms in industries that are too large or risky for the private sector (steel, aircraft) or are judged to be too important to trust to foreign firms (oil). IS was the major development policy of the larger Latin American economies (Brazil, Argentina, Mexico) from early in the 20th century until about 1980.

In 1917 the Russian Revolution brought a new development model: abandon most market connections, radically redistribute land and income, and develop according to priorities determined by the state and encompassed in a plan. While this has usually been called socialism, it certainly was not what Karl Marx had envisioned. Marx's socialism was to come about after an industrial revolution drastically increased productive power. The socialist development strategy was later used by China, Algeria, Vietnam, Cuba and numerous other countries.

South Korea and Taiwan pioneered a new development strategy in the 1960s. They offered foreign firms a combination of cheap labor, adequate infrastructure and minimal taxes and red tape as long as the foreign firms would produce goods for export. This policy, called Export-Oriented Industrialization (EOI) was reinforced with a network of trade agents who would help South Korean and Taiwanese firms get contracts to produce goods for retail networks in the rich countries.

Import substitution and export-oriented industrialization are both explored in depth below.

Import Substitution: The Case of Brazil

There are at least three reasons we should examine the economic development of Brazil. First, while the Brazilians didn't invent import substitution, Brazil has carried it further than other underdeveloped countries. Brazilian economists have analyzed its effects, and Brazilian policy-makers were consciously planning the country's industrial development while many other countries were stumbling into import substitution almost by accident. Second, it is a large and important country. Its population of 170 million make it the world's 5th largest country. It has the world's 8th largest GDP. Covering half of South America, it is the 5th largest country by land area. Third, Brazil's rich endowment in forest reserves, agricultural land, minerals, navigable rivers and hydroelectric capability plus the vibrant pastiche of Europeans, Africans, Amerindians and Asians that make up its population would seem to give Brazil a head start on the road to development. We have to ask: If Brazil cannot achieve development in some reasonable period of time, what hope is there for countries not so well endowed?

Most of the period from the 1950s through the 1970s confirmed the optimistic view. Brazil was touted as "the land of the future." From practically nothing in 1950 Brazil established the largest motor vehicle industry outside of the developed countries. By 1980 Brazilian aircraft were flying on United States commuter airlines. Brazilian shoes could be found everywhere. Brazilians opened up the world's richest iron mine, built a new capital city -- Brasilia -- in what had been a roadless jungle, and bulldozed a network of roads deep into the Amazon. When rising oil prices threatened to derail their development express, Brazilians simply borrowed more money to launch huge hydroelectric projects to run the growing industries of the "Golden Triangle" encompassing Rio de Janeiro, São Paulo and Belo Horizonte and required that most new automobiles be tuned to run on rum rather than gasoline.

By the 1980s, however, the pessimists agreed that Brazil was indeed the "country of the future," but added: "and always will be." The "miracle" growth stopped before Brazil was even close to ripening. Brazil's modern cities are surrounded by miserable shanty-towns with open sewers. Modern trucks and busses share roads with hand carts. Brazilian executives are some of the best paid in the world, but the wages of average workers barely provide for subsistence. Some describe the economy as "a Switzerland within an India." Others consider Brazil to be a case of economic growth without economic development. According to Brazilian economist Celso Furtado:

The Brazilian economy constitutes a very interesting example of how far a country can go in the process of industrialization without abandoning its main features of underdevelopment: great disparity in productivity between urban and rural areas, a large majority of the population living at a physiological subsistence level, increasing masses of unemployed people in the urban zones, etc.

Colonial Heritage

Brazilian historians often write the country's history as a series of product cycles -- high prices lead to rapid expansion of a particular crop; land is seized, labor is dragooned, an entire region becomes cultivated and populated. Then overproduction leads to falling prices, but the land stays in the same hands with the descendants of the original workers as the labor force.

Sugar cane was planted on the Northeastern coast of Brazil as early as 1540. By 1570 there were at least 60 sugar mills in Brazil. Portuguese landowners were borrowing Dutch capital to purchase African slaves to produce a product that was sold throughout Europe. Prices collapsed in the 1600s as the center of sugar production shifted to the Caribbean. But the sugar industry survived, just as it would later survive the shift to large centralized steam-powered sugar mills (1870s), the abolition of slavery (1888) and the competition from a more mechanized sugar industry in south-central Brazil (1940s). And the industry is still there today, with the descendants of the families that received huge land grants in the 1500s owning the richest land in northeastern Brazil, while many of the descendants of the more than 10 million Africans who were brought to Brazil in chains between 1550 and 1850 still plant, cut and haul the cane for a wage that barely buys enough cheap calories to keep working.

A similar process occurred with gold, coffee, cotton, cocoa and rubber. By 1900, Brazil was an agricultural powerhouse, with exports making up a quarter of its output. Coffee alone accounted for half the exports, rubber a quarter, and half a dozen other commodities, including cocoa, sugar and cotton, constituted the rest. But there was little manufacturing. Brazil had to import cotton cloth, matches, beer, canvas, iron hoes, soap and even bags for shipping coffee and sugar.

There had been little industrialization because the large landlords held most of the political cards. Tariffs high enough to launch import substitution would initially raise the cost of imports as well as bring Brazil into a trade conflict with Great Britain. But without protective tariffs, Brazil's few infant industries succumbed to a very high infant mortality rate. Northeastern Brazil in the 19th century would have appeared to be an ideal place for a textile industry. High quality cotton was abundant. There was a ready market for crude unprinted cloth for sugar bags and clothing for slaves. Yet even textile mills using slave labor could not compete with Britain's advanced industry.

There were other barriers to industrialization in 19th century Brazil. An economy based on slaves working on relatively self-sufficient estates lacked the demand for manufactured goods that would be necessary for industrialization based on import substitution. British trade policy and foreign policy presented an additional barrier. At the time of Brazil's independence, 1822, it was a larger export market for Britain than all the rest of Latin America combined; in fact, Britain's sales to Brazil were half as large as her sales to the United States. The weak new country desperately needed Britain's recognition of Brazilian independence and Britain was able to extract a very high price: a trade treaty with Britain which prohibited import substitution tariffs.

Import Substitution -- The First Steps

The march toward industrialization began in the 1890s. Slavery had just been abolished and the hereditary emperor had been overthrown. European and Japanese immigrants were pouring into the country, primarily to work the coffee plantations of São Paulo and Paraná. Tariffs on basic manufactured goods were raised to protective levels. Textiles are the ideal first industry. Demand is high and fairly stable, the technology is not particularly complex, machinery can be purchased from the industrial countries, and the industry can employ lots of unskilled workers. Brazil's nearly non-existent textile production (22 million meters per year in 1882) had matured into a 470 million meter per year industry by 1915. Food processing and other "easy" industries also expanded.

Advanced Import Substitution

Pro-industrialization policies and global events propelled Brazil into the subsequent stages of industrialization. World War I made some normally imported manufactured goods unavailable. By that time, Brazil had a number of people with industrial skills -- skills that had been developed by operating and repairing railway equipment, sugar mills, and coffee-hulling equipment. Some repair shops were able to turn themselves into small-scale manufacturing operations. But many of these new manufacturers were wiped out when trade returned to normal after the war.

The Great Depression also stimulated industrialization. When the prices of coffee and other agricultural commodities collapsed, export earnings fell by two-thirds and Brazil had to devalue its currency. This acted like a protective tariff, making imported equipment much more expensive and forcing buyers to substitute such equipment with Brazilian-made versions. The pro-industrialization government of Getulio Vargas tried to speed the process by creating a Brazilian steel industry. Efficient production of steel was a large-scale enterprise and not something that small firms could easily accomplish. The government first negotiated with major steelmakers abroad, notably Dupont and U.S. Steel. But these firms would only establish steel mills in Brazil if they could retain full ownership. Nationalists in the Brazilian government demanded that local firms be able to purchase partial ownership so no deal was possible. Vargas next sought help from foreign governments to finance a modern steel mill which would be government owned. When the U.S, refused to help, he turned to Germany, which offered technical assistance and financing. The U,S,, afraid that Brazil might tilt toward Hitler, then came up with $20 million in assistance.

This is a common import-substitution pattern that has been played out in numerous countries. A modern industry such as steel making or petroleum refining is either too large or too risky for the local capitalists. Foreign firms will only enter as full owners, not as partners. So the industry is established under government ownership. It is important to note that these government enterprises were not established as part of a commitment to a partially-socialist form of economic development. Rather they came about due to the inability or unwillingness of national capitalists to enter a critical industry and the unacceptability of foreign control of such an industry.

By the 1950s Brazil's industrial development through import substitution had become a planned process. A number of methods were used to protect new industries from foreign competition. Direct subsidies or full state ownership seemed most appropriate for basic industries such as steel, petroleum refining and electrical power. Brazil's Law of Similars put high tariffs on imported products -- sometimes as high as 300% -- whenever a firm located within Brazil began to manufacture something "similar." A national development bank would allocate credit under favorable terms to industries that were considered high priority. At one time, the government even established multiple exchange rates as a method of making imported capital equipment cheaper to new industries while making imported finished goods very expensive.

One of the industries targeted for growth in the 1950s was motor vehicles. The government initially tried to obtain foreign financing for the expansion of Brazilian firms that were already making motor parts, truck and bus bodies, etc. in the hopes that they could become full scale motor vehicle manufacturers. But the ownership of critical technology by a handful of United Stastes and European firms and the reluctance of the United States government to extend loans for such purposes necessitated a different approach. Volkswagen, Ford, General Motors, Mercedes and Fiat were threatened with the loss of their Brazilian markets if they did not produce vehicles within the country. But they were also lured in by soft-currency credits that could be used to purchase land, buildings and other things that did not need to be imported.

We are now so accustomed to manufacturing shifting to low income countries to reduce labor costs that we forget how relatively recent this trend is. The major reason for a firm to locate in Brazil in the 1950s and 60s was to retain access to markets. Certainly only a small portion of the population could purchase automobiles, but a small portion of a large country was still an important market. These firms were not locating in Brazil in hopes of cutting costs. The small scale on which they would initially operate would more than offset any labor cost advantages. But the high tariffs would assure them that their only competition would be other firms producing under the same small-scale conditions in Brazil.

The import-substitution process was facilitated by one characteristic of much modern manufacturing. The production of motor vehicles, appliances, TVs and many other modern goods is a complex process involving a mixture of operations requiring substantial knowledge and skill and operations requiring very little skill. Fortunately, final assembly is both the last stage of production and the stage of production requiring the least skill. So Brazil and other lesser developed countries launching modern industries could start with final assembly and gradually extend their industrial reach "backwards" to encompass the more difficult procedures. Volkswagen could start by importing complete engines, wheels, body parts, etc. and assembling them in their São Paulo plant. Tariffs allowed them to sell their 1960 30%-Brazilian Beetle for twice what a German would pay even though the quality was not as high. The tariff wall was gradually moved upstream to force VW to assemble the engines in São Paulo. Eventually even most of the parts would be Brazilian. Quality gradually improved and competition from Brazilian Fords, Fiats and Chevrolets would push the price down. By the 1970s the industry was efficient enough to export parts and subassemblies to the United States and Europe. By the 1980s entire vehicles were being exported.

A Partial Success

By the late 1970s, a middle-class Brazilian could watch Brazilian soap operas on a Brazilian color TV, drive a Brazilian car, take a short flight on a Brazilian commuter airliner, etc. There was nothing one needed to live a perfectly middle-class life that was not marked "Industria Brasileira." With the exception of some types of modern capital equipment, Brazil had successfully substituted most imports with nationally-made products. And, although most of the firms were U.S., European or Japanese, Brazilians were doing the skilled work, the engineering work, the administrative work and even devising the marketing plans. Yet it was painfully obvious that the country was still very far from developed.

The advanced import substitution that Brazil undertook from the 1930s on had created a fairly small number of good jobs. Professional and skilled-labor opportunities propelled a number of people into middle-class incomes. Even a $2.00 per hour assembly line job meant an escape from the shanty-town into a cement-block house with plumbing and electricity. But the steel, auto, appliance and other modern industries brought in modern equipment from the industrial countries and used the same high-productivity methods they used in the high wage countries. Additionally, some of the modern industries were not substituting imports but were producing goods that competed with existing low-productivity occupations. Mass-produced thongs displaced the village sandal-makers; plastic basins replaced crude pottery and, of course, the potters. Since there was never a shortage of unskilled workers there was never any pressure to increase wages. With low wages throughout most of the economy markets were quickly saturated.

Plenty of available labor meant that the industrialists did not have to wrest labor away from the agricultural sector. The large landowners were (and still are) able to resist any movement toward land reform and even use forms of debt peonage plus threats from their hired gunmen to keep agricultural workers in conditions of slavery. The Pastoral Land Commission, an organization under the sponsorship of the Catholic Church, documented over 16,000 cases of slavery in 1992 and believes this to be just the tip of the iceberg. The World Bank reported that 41% of Brazilians had to live on $2 per day or less during the 1980s. The 1991 census indicated income disparities were continuing to grow in the country which already had the most extreme maldistribution of income ever measured in any large country.

Once import substitution in the consumer durables sector was chosen as the primary development policy it became difficult to reverse the trends toward greater income disparities. This was not only due to the limited employment opportunities provided by this development strategy. The cars and appliances had to be sold if IS industrialization was to proceed. During the late 1960s and into the 1970s, Brazil's military government was extending subsidized credit to the middle class in order to keep the car and appliance factories humming at the same time that unions were being suppressed in order to contain inflation by keeping wages low. A North American political scientist noted the perverse logic of this strategy:

The pattern was thus selfreinforcing: increased consumer demand for durables, expansion of productive capacity for those products, then the need again to augment demand in the top 10 percent of the income scale. The industrial structure of the 1950s became an iron maiden for perpetuating a highly skewed income distribution.

The import substitution model, at least in its Latin American form, also led to extensive foreign ownership in all industrial sectors except those dominated by state enterprise. While "industrialization by invitation," as critics called it, is a quick way to gain access to technology, there are many drawbacks. The U.S., German, Japanese, French, Italian and British firms that dominate Brazilian industries are quick to call on their nations' state departments when their interests are threatened by proposed tax, labor or environmental legislation. The United States State Department in particular regards maintaining a favorable "business climate" as one of its key objectives. In Brazil this has occasionally meant undermining the government. In 1964 United States officials encouraged a group of Brazilian generals to overthrow the constitutional government.

It is no accident that the two countries best known for their IS development policies, Brazil and Mexico, also have the some of the largest foreign debts in the lesser-developed world. Infrastructure development is expensive and requires lots of hard currency imports. If the infrastructure will increase exports and hard currency earnings a country can borrow in dollars then earn the dollars needed to make the interest payments. But IS policies require borrowing in dollars for economic development which expands domestic production without necessarily expanding exports.

By the end of the 1970s, Brazil and other import substituting countries faced the most serious question: Where do we go from here? The next logical step was to export the products they had just learned to produce efficiently. And they did. By the mid-80s, Brazil was earning almost twice as much from shoes as from coffee exported to the United States; in fact, of the ten major Brazilian exports to the United States, six were manufactured projects. However, these expanding exports of manufactured goods made Brazil and other IS economies vulnerable to retaliatory tariffs. By the 1980s, underdeveloped countries could not simultaneously pursue their next layer of import substitution (computers, microchips, capital equipment) while enjoying open foreign markets for their manufactured consumer goods.

Chapter 14: Catching Up