Brazil’s Grievous Manufacturing Collapse

Brazil has become a posterchild for the Middle-Income Trap which hinders countries  no longer able to compete against low-wage countries but without the productivity growth to compete in the higher value added industries dominated by advanced economies. But little attention has been given to the related  economic phenomenon which strikes commodity producers – “Dutch Disease,” also known as the Natural Resource Curse. The combination of the two for Brazil  has caused crippling premature deindustrialization.

Brazil has suffered two severe bouts of “Dutch Disease.” The first during the commodity boom of the 1970s which was followed by the bust of the 1980s and a “lost decade” of economic stagnation. The second, during the 2001-2012 commodity super-cycle  driven by China’s “economic miracle, which was also followed by a long economic depression. These two commodity booms were marked by similar excesses — overvalued currencies, unsustainable consumer booms, excess fiscal spending and high levels of debt accumulation, a deterioration of governance and a rise in corruption. In their wakes, the booms left behind a debilitated manufacturing sector, high debt levels and lower growth prospects.

Brazil’s “Dutch Disease” has been worsened by the concurrent strong growth of the farming, mining and oil sectors — all productive and  capital intensive activities with a high degree of export competitiveness. The rapid growth of these sectors, and the discovery of the giant offshore pre-salt oil fields,  has strengthened the current account and caused a structural appreciation of the Brazilian real. The loss of competitiveness of Brazil’s manufacturing sector has been more than compensated by the increased production and dollar revenues of the growth sectors. Unfortunately, these successful sectors generate scarce jobs and lack the significant multiplier effects of the manufacturing sector.

The chart below shows manufacturing GDP as a percentage of GDP for both resource rich and resource poor countries in emerging markets. The declining trend for commodity exporters relative to commodity importers is notable, and Brazil stands out in particular.

In 1980, at the end of the 1970s commodity boom, Brazil was the dominant manufacturing power in emerging markets  (China surpassed Brazil’s production levels but was behind in terms of complexity and quality of manufacturing). The following chart from the World Bank shows manufacturing value added for the primary emerging markets (and France for comparative purposes) both for 1980 and 2021. The rise of China and the relative decline of Brazil are striking.

The same data is shown below with Brazil as the benchmark, to measure relative performance.  Over this period, China’s manufacturing value added went from two times Brazil’s to 31.3x, a relative increase of  15.7x. India went from 44% of Brazil’s level to 2.9x. Every single country in the chart has gained relative to Brazil. This includes commodity producers (highlighted in red) which also may have suffered Dutch Disease. Most striking are Indonesia and Malaysia which went from 15% of Brazil to 150%, and 8% to 56%, respectively, a testament to the Asian commitment to currency stability and manufacturing exports.

Finally, the following chart shows the decline in industrial employment in Brazil over the past decade. In 2019, according to World Bank data, only 20% of employment in Brazil was in industry, a decline from 23.4% in  1991. This places Brazil at a level similar to advanced rich countries with service-intensive economies. In Brazil these service jobs tend to be poorly paid and unproductive with very few opportunities for training and advancement.

Brazil’s manufacturing collapse has no easy solution. Brazil’s successful commodity exporters yield extensive political power, not the least with the oversized financial sector. Schemes like those adopted by Argentina, featuring  multi-tiered currencies and taxes on exporters are difficult to implement and have high costs. A return to high tariffs on imports would be highly unpopular. A mix of these policies is likely to be introduced by the new administration with elevated short-term costs and unclear long=term benefits.