AS/COA – Interview: BRICLab Co-Director Marcos Troyjo on the 2013 Outlook for the BRICs

December 13, 2012

 

After a decade of copying and adapting, [the BRICs] have to move on to a new decade of designing, formulating, and innovating.

Marcos TroyjoMarcos Troyjo serves as an adjunct professor of international affairs and as co-director of Columbia University’s BRICLab, a forum dedicated to the rise of the BRIC countries (Brazil, Russia, India, and China). AS/COA Online’s Rachel Glickhouse spoke to Troyjo about how the BRICs will fare next year in terms of technology and innovation, energy, and economic policies.

AS/COA Online: You’ve mentioned before that the BRICs need to change their DNA in terms of policies. What do you mean by that? 

Marcos Troyjo: One of the reasons the BRICs were considered rising countries back in 2001 is because they were capable of adapting creatively to the global economy. That is, their rise has more to do with adapting and copying practices and benchmarks from other economies instead of coming up with something of their own. So I think that the main way to explain the rise of BRICs from 2001 to 2011 was creative adaptation.

Creative adaption meant different things for Brazil, Russia, India, and China. For China, creative adaptation meant reorganizing their productive capacities to become an export-led country. So China received Most Favored Nation status in its trade with the United States. China devised a very intelligent program of public-private partnerships that allowed for the necessary capital to expand infrastructure. It capped wages and other factors of production, including the exchange rate, to provide for this competitive image.

Brazil’s creative adaption meant a policy of import substitution 2.0. Brazil was using the surpluses it acquired from commodities, particularly agriculture and mineral commodities trade with China. Brazil discovered rich deepwater offshore oil reserves, and was also able to devise one of the most advanced biofuels programs in the world. So these three characteristics created the necessary resources to allow for import substitution.

India adapted creatively in the past 25 years by providing cheaper alternatives in areas such as information technology, pharmaceuticals, and textiles. It also developed services such as call centers that could be outsourced from other countries.

Now, the traditional markets of the United States and Europe are stalled. Therefore, BRIC countries have to change their DNA in the sense that they have to grow not because of creative adaptation, but because of creative destruction. BRIC countries have to direct resources towards innovation. After a decade of copying and adapting, they have to move on to a new decade of designing, formulating, and innovating. If the BRICs are able to perform that DNA change, I think that they will continue to be some of the most dynamic growth markets in the world. If they’re not able to change their DNA, then they face a bumpy road ahead.

AS/COA Online: Local content policies require companies to purchase or produce a certain percentage of goods or services domestically in order to operate in a given country. In your opinion, how do local content policies impact the BRIC economies and trade strategies? Do you foresee any changes to these policies in the coming year?    

Troyjo: Local content is essential for the BRIC countries, although each of the BRIC countries approaches local content in different ways.

China, for example, is now implementing a number of countercyclical measures that have local content at the core. If you are an aircraft manufacturer and you want to sell your product to the most important client in China, which today is the Chinese government, you have to produce essentially 70 percent of those aircraft in China—therefore generating local taxes and local jobs. China has foreign exchange reserves at around $3.7 trillion as a countercyclical measure in order for companies to divert their production capacities to China and to have China as the final destination for their products. So China is operating a DNA change from export-led growth to growth that will also be fostered by domestic consumption.

Brazil’s local content policies are important in the sense that it has an industry to protect. Brazil has been deindustrializing very rapidly due to global competition, particularly Asia. One of the ways the Brazilian government came up with to reindustrialize is local content policies, especially by the so-called Brazilian champions: the large multinational corporations in which the Brazilian government owns the golden share. That is the case of Petrobras, Embraer, and Vale. Many of these companies play the role of the leading local content implementers.

Petrobras, for example, has to buy approximately 20 big oil tankers a year. If Petrobras were to buy these tankers in South Korea, China, or Singapore, the average price tag would be $65 million. Petrobras is prepared to pay $125 million for each of those ships if 65 percent of the ships are produced in Brazil. What’s the logic behind paying a $50 million premium on each ship? It’s that Brazil believes that there is a learning curve for the entire production chain in this particular sector—engineers, welders, technicians—that will allow for a 50 percent reduction in production costs over a period of 10 years. The remainder of the premium has to do with labor and fiscal regulation reforms to make the country’s companies more competitive.

Do I see any changes in how these countries will approach local content in the next few years? I don’t think so, because when it comes to international trade and investment, I think we’re about to see a much more de-globalized set of agreements and institutions in the next couple of years. That’s because countries are very much turned inward with insular policies.

AS/COA Online: You’ve discussed innovation and technology as key areas for the BRICs to invest in. How does Brazil compare to the other BRICs in terms of innovation and technology?

Troyjo: I think innovation is the result of the interplay of four factors: a stock of knowledge, a stock of capital, a stock of entrepreneurship, and the atmosphere that you have to create in order for these three to operate efficiently.

In this sense, Brazil did very well, as in the case of biofuels or aircraft. Look at Embraer, for example; it’s one of the top three air manufacturers in the world. In biofuels, when research was applied to industrial ends, Brazil fared very well. Today, eight out of 10 Brazilian automobiles run on flex fuel, which uses biofuel. Look at the case of agriculture. Brazil has a great research and development company called Embapra, which is responsible for raising the competitive advantages of seeds and of shortening the maturation process of some crops.

But when it comes to overall science and technology investments directed toward innovation, I am less optimistic. Brazil is only investing 1 percent of its GDP in research and development, whereas a country like South Korea—which many acknowledge as one of the top examples of growth through innovation—is investing in excess of 3 percent of its GDP in R&D. Ten years ago, China directed only 0.6 percent of its GDP to R&D. Now, it invests 1.5 percent, and by the time China overtakes the United States as the world’s largest economy between 2022 and 2025, China will be investing 2.5 percent of its GDP in research and development.

In India, we have a very uneven situation. When it comes to IT, biotechnology, and pharmaceuticals, it is very advanced, with a great deal of investment from the private sector. Multinational corporations do their research in India because of the relatively low cost of production and high level of intellectual human capital there. But throughout society, you will not find the same enthusiasm for R&D investment, and this is one of the reasons why you find such disparities. Today in India, there are more cell phones than toilets. There are more billionaires than in the UK and France put together. But it’s also a country where there are more poor people than on the entire African continent. I think that’s all a result of the many disparities that you have in research, development, and innovation investments.

Russia is one of the classic examples of the distance between pure research and research applied to markets. In the late 1970s, four out of 10 scientists in the world were working in the Soviet Union. This country was able to perform things that were really remarkable, like sending a man to outer space, but it couldn’t produce an alarm clock that would ring on time. So Russia’s problem is transforming its great level of science that it has into a market. Many of the market mechanisms that are so common in the United States—start-up capital, projects financed by companies, individual entrepreneurship—are not present in Russia. These are the bottlenecks that keep Russia from playing an even more important role in terms of innovation. Some of the more democracy-oriented characteristics of society that are so important for technological entrepreneurship are still missing in Russia.

AS/COA Online: President Dilma Rousseff is making efforts to reduce the so-called “Brazil cost,” a combination of insufficient infrastructure, high taxes, and bureaucracy that hinder businesses in Brazil. What legislation or reforms under consideration could have an impact on the Brazil cost next year? 

Troyjo: To be very honest, I see tactical movements by the Brazilian authorities, but I do not see anything that is either essential or structural. But I think that’s understandable.

Let me give the example of fiscal reform. In Brazil, the overall tax burden on society is about 37 percent of GDP, whereas in South Korea, for example, it’s only 26 percent. Why is Brazil’s tax burden so high? The Brazilian government is too big and this is a choice by society. Brazil keeps saying that it has achieved near full employment with one of the lowest unemployment rates in the Western Hemisphere. But if you analyze the organic composition of employment, you realize too many people are employed either by the city, state, or federal branches of government or in state companies and activities.

Not only is the government too big, but it’s too inefficient and too expensive. One structural reform to be enacted would be to reorganize Brazilian administration to allow for a decrease in the fiscal burden. It could happen, but it takes a lot of political will. The Brazilian government would have to sacrifice in the short term for the benefit of the long run. Because we have an electoral cycle every four years in a democracy, that’s a difficult bet to make. That’s true especially in Dilma’s case, where in terms of economic growth, the first two years of her administration have been nearly lost. Brazil only grew 2.7 percent last year and this year it’s only going to grow around 1 percent.

Labor reform would also be important. Labor costs are enormous in Brazil right now. The minimum wage is three times the minimum wage base in countries like Indonesia or Vietnam. If you’re a company establishing yourself in Brazil, you’re probably going to hire someone and pay one salary to the employee and the equivalent of another salary to government due to the absurd medieval requirements when it comes to labor protection and pensions. Once again, the government could enact reform in that area. It would have to pick a fight with the labor unions. Does it want to do so in the long term? I don’t think so.

But I do not see these two reforms on the radar in any way, shape or form in the next couple of years.  Whatever the government comes up with in terms of reforms is only tactical and short-term.

AS/COA Online: One of the Brazilian industries to watch in coming year is in oil and gas, as the first round of concessions in five years is due to take place in 2013. What are some of the opportunities and challenges in Brazil’s energy sector that will be important next year?

Troyjo: Well, I think there are three dimensions. One is the challenge related to the deepwater, pre-salt oil, so immense in scope that Petrobras will probably leave some of the onshore exploration opportunities to foreign companies or companies that could partner with other Brazilian players. So I see a lot of things coming from onshore, which is really not the tradition in Brazil and is really not where most of the attention is. But because Petrobras’ challenges in pre-salt oil are so huge, something is going to be left behind as far as onshore oil.

When it comes to pre-salt oil, it’s obvious that the technological challenge is huge. Think about the kind of remote robotics you have to have, the chemicals used in taking oil and gas out of a depth of about 7,000 meters (22,965 feet). Technological partnerships are key. The companies that are able to understand the workings of Petrobras, the requirements of local content, and mapping the area of technological demands can be very successful.

The third area of opportunity is biofuels. More and more countries are interested in the Brazilian model of flex fuel engines. Countries in Scandinavia are very interested; Sweden, for example, is already the top destination for Brazilian ethanol in Europe. The companies that want to partner in Brazil with biofuels will be able to join the Brazilian locomotive that may be destined to make ethanol a global commodity. If that happens, all of those companies that partnered with Brazilian companies in extending the global outreach of biofuels—particularly sugar cane-based biofuels—will have a lot to profit from.

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