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Investment Policyin Brazil

� An Agenda for Action

CUTS – C-CIER NEIT-IE

Investment Policy in Brazil� An Agenda for Action

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CUTS Centre for Competition, Investment & Economic RegulationD-217, Bhaskar Marg, Bani Park, Jaipur 302 016, IndiaPh: +91-141-220 7482, Fax: +91-141-220 7486Email: [email protected], Website: www.cuts.org

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Nucleo de Economia Industrial e da Technologia-NEITInstituto de EconomiaCP 6135 Unicamp, 13083-970 Campinas, São Paulo, BrazilPh: +55-19-3788 5766/3788 5714, Fax: +55-19-3289 1512Email: [email protected], Website: www.eco.unicamp.br

AcknowledgementThis report* is being published as a part of the Investment for Development Project,with the aim to create awareness and build capacity on investment regimes andinternational investment issues in seven developing and transition economies:Bangladesh, Brazil, Hungary, India, South Africa, Tanzania and Zambia. It issupported by:

CopyrightCUTS, 2003, The material in this publication may be reproduced in whole or in partand in any form for education or non-profit uses, without special permission from thecopyright holders, provided acknowledgment of the source is made. The publisherswould appreciate receiving a copy of any publication, which uses this publication asa source. No use of this publication may be made for resale or other commercialpurposes without prior written permission of CUTS.

Citation

CUTS, 2003, Investment Policy in Brazil – An Agenda for Action

Printed by: Jaipur Printers P. Ltd., Jaipur 302 001

ISBN 81-8257-002-6

*Other country reports are also available with CUTS

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DFIDDepartment forInternationalDevelopment, UK UNCTAD

NEIT-IE

CONTENTS

Preface ...................................................................................................... 5

Introduction ............................................................................................... 6

Investment Policy, Performance and Perceptions in Brazil..................... 7

Stakeholders’ Views on FDI................................................................... 10

Agenda for Action – Government............................................................ 15

Agenda for Action – Civil Society........................................................... 17

Agenda for Action – Inter-Governmental Organisations....................... 18

Conclusion .............................................................................................. 20

Annexure ................................................................................................. 21

4 u Investment Policy in Brazil � An Agenda for Action

LIST OF ABBREVIATIONS

ANPEI National Association of Research, Development andEngineering of Innovating Companies

BEA Bureau of Economic AnalysisCUTS Consumer Unity & Trust SocietyDFID Department for International DevelopmentFDI Foreign Direct InvestmentFTAA Free Trade Area of the AmericasGATS General Agreement on Trade in ServicesGDP Gross Domestic ProductGNP Gross National ProductICMS Merchandise Circulation Tax (Imposto Sobre Circulacao de

Mercadovias e Servicos de Qualquer Natureza)IFD Investment for DevelopmentIPI Industrial Products Tax (Imposto Sobre Produtos

Industrializados)MERCOSUR Common Market of the South (Mercado Commun del Sur)MIA Multilateral Investment AgreementNAFTA North American Free Trade AgreementNEIT Nucleo de Economy Industrial e da TecnologiaNRG National Reference GroupTNC Trans-national CorporationTRIMs Trade Related Investment MeasuresUNCTAD United Nations Conference on Trade and DevelopmentWTO World Trade Organisation

Investment Policy in Brazil � An Agenda for Action u 5

PREFACESince the mid-nineties, Centre for Industry and Technology Economics (NEIT,in Portuguese) has been doing extensive theoretical and applied research onFDI in Brazil and its contribution to Brazilian development. During the last twoyears, the Investment for Development Project (IFD) provided a uniqueopportunity to cooperate and learn from the experiences of research teamsfrom other developing countries.

Cooperation with researchers from other developing countries, under the aegisof Consumer Unity & Trust Society (CUTS), India, has been extremely usefulin many ways. For us at NEIT, one of the most important contributions of IFDwas generating awareness on the importance of involving civil society at theonset and during the research process. We learned to discuss with civil societyrepresentatives the research hypothesis and the preliminary research resultsand, more importantly, we asked for inputs from civil society for this policyadvocacy document.”

The present report is based on the results of the discussions held with themembers of the Brazilian National Reference Group (NRG) and on the results ofthe Civil Society survey conducted during the Project. We also benefited fromthe discussions held with the project stakeholders at the Project Review Meetingin Geneva, in May, 2003.

On behalf of NEIT, I would like to acknowledge the contributions of NRGmembers and the suggestions made by CUTS reviewers on the first draft ofthis Report. The responsibility for the policy recommendations, of course,belongs to NEIT.

November, 2003 Mariano Francisco LaplaneProject Coordinator in Brazil

Institute of Economics State University of Campinas

São Paulo, Brazil


The Investment for Development ProjectThe Investment for Development Project (IFD Project) is being conducted byConsumer Unity & Trust Society (CUTS), India, in collaboration with UnitedNations Conference on Trade and Development (UNCTAD) and is supportedby the Department for International Development (DFID), UK. It is aimed atidentifying key issues regarding Foreign Direct Investment (FDI) policy inselect developing/transition economies, namely Bangladesh, Brazil, Hungary,India, South Africa, Tanzania and Zambia. NEIT-UNICAMP is working withCUTS as the partner organisation in Brazil for this project. During the course ofthe project, experiences and policy issues common to developing countrieshave been identified and discussed at regional seminars as well as in projectmeetings.

National Reference Group (NRG) MeetingsA National Reference Group (NRG) was created in each country at the onset ofthe research. The purpose of NRG was to get inputs from civil society aboutFDIand key policy issues. Research reports were submitted to NRG membersand discussed at meetings held along the project. In the case of Brazil, NRGmembership included people from business associations and unions, as wellas from consumer associations, public servants and researchers.1

The purpose of this report is to summarise policy recommendations thatemerged from the research and from NRG meetings in the Brazilian case.

Organisation of the ReportThis report consists of seven sections and an annexure. Introduction to thepaper is the first section. Section two of this paper discusses briefly Brazil’sinvestment policy, its performance and perceptions. Section three deals with thestakeholders’ views on FDI. Section four, five and six discuss policyrecommendations for the government, civil society and inter-governmentalorganisations respectively. The seventh section is the conclusion of this report.

Annexure contains the summary of the reports of the first, second and thirdNRG meetings.

CHAPTER-1

Introduction

1 See the summary of the discussions at the NRG meetings in the Annexure of this Report.


As in many other developing countries, Brazilian FDI policy until the ninetieswas very selective regarding the type of investments that were to be allowedinto the country. Strong restrictions applied to the mining as well as servicessectors, viewed at that time as “strategic” activities and reserved for State orlocally owned firms. Manufacturing activities were almost completely open toforeign investors, though some limits to equity ownership existed in specificcases, like in petrochemicals and telecommunications equipment.

Operational restrictions concerned mostly remittances of profits and dividendsas well as payments of technology services. Remittances were controlled andrestrictions took the form of higher income taxation. There also existed strongrestrictions to patent recognition.

As described in the Country Report, Investment Policy in Brazil – Performanceand Perceptions, FDI policy changed profoundly from the mid-nineties onwards.Entry barriers were almost completely removed, even in services. Few equityownership limits remained in place (like in media services). Operational barrierswere also eliminated. Payments to head companies for technology serviceswere made possible. Intellectual property rights were granted following WorldTrade Organisation (WTO) standards, though long bureaucratic delays inpatent recognition remain even today.

Performance requirements (local sourcing, export targets, employment creation,etc.) were not established, at least not specifically for foreign investors.Although applying for financing from public banks could eventually involvebargaining over performance requirements, this would apply to all potentialinvestors, whether domestic or foreign. Thus, national treatment was ensured.

Fiscal incentives were granted (mostly at sub-national level) for large FDIprojects, mainly in the car, telecommunications equipment and electronicsindustry. In the cases of the telecommunications equipment and electronicsindustries, incentives took the form of income tax reductions in exchange ofresearch and development (R&D) activities (which were also granted to domesticfirms) and tax (import duties and manufactured products tax) reductions foradding value in local assembly operations.

CHAPTER-2

Investment Policy, Performanceand Perceptions in Brazil


The car industry earned a more complex set of incentives, from 1995 to 2000,related to tax discounts for the imports of equipment, components and evenvehicles for firms that committed to invest in Brazil. A very expensive “biddingwar” developed between the Brazilian state and local governments to attractinvestments from the car industry, resulting in additional (and most probablyredundant) grants and fiscal incentives for those firms. Long state and local taxholidays were granted to investors, as described in ‘Investment Policy in Brazil-Performance and Perceptions’ (Country Report).

At the time when policy reform was being implemented, FDI flows to Brazilincreased rapidly, reaching very high levels even compared to the previousFDI boom in the sixties and seventies. During the nineties, Brazil had a highranking among the developing countries, who have been most successful inattracting FDI. Even though the huge increase in inflows can be interpreted, tosome extent, as a proof of the success of the new liberal FDI policy orientation,it seems reasonable to consider the new policy regime as a necessary, but notsufficient condition for increasing inflows. Massive FDI was motivated by theprocess of privatisation of large State companies during the second half of thenineties, by the improvement of macro-economic conditions and by the prospectof sustainable growth in Brazil during that period. Indeed, FDI inflowsexperienced significant reduction after the privatisation process was concludedand after expectations about growth failed to materialise.

The Country Report summarised the result of a survey on the civil societyperceptions of FDI in Brazil. The overall perception is that FDI plays a key rolein development of the Brazilian economy. Respondents correctly identified thebranches of the economy that had attracted most FDI in the nineties and wherethe benefits from foreign investments concentrated (telecommunicationsservices, banking and finance and automobile production). Some respondentsexpressed concerns about FDI in Brazil being focused mostly in the domesticmarket, in not creating sufficient opportunities for local business and in lack ofinterest in local civil society.

Civil society perceptions on current macro-economic conditions are completelyin line with the reality. From a macro-economic perspective, the main challengecurrently facing Brazil is to build economic conditions capable of sustaininggrowth. Experience in the nineties has shown that it would take more to achievemacroeconomic stability. The overall level of efficiency in economic activitymust increase for sustainable growth to become possible.


This, in turn, would require a significant effort in innovation in products andprocesses throughout the economy. Foreign companies, both those alreadypresent in Brazil, as well as the potential investors, should contribute with theirtechnological, trading and financial capabilities to foster innovation in theBrazilian economy. The FDI policy regime in Brazil should aim at maximising thedevelopmental contribution of the existing stock of foreign capital and tocontinue attracting high quality FDI in order to help build better conditions forgrowth in the near future.


Discussions at the NRG meetings focused on FDI policy (First Meeting), FDIperformance (Second Meeting) and Policy Advocacy Issues (Third Meeting).The contributions made by NRG members2, summarised in this chapter, pointto the need to take advantage of the Brazilian experience with FDI, so as toredefine policy priorities in order to increase the developmental contribution offoreign investment in the coming years.

Brazil has been one of the most successful developing countries in attractingFDI under the previous “import substitution style” FDI policy as well as thenew more “market oriented” FDI regime of the nineties. In spite of stronginstability, Brazil’s large domestic market and growth potential recurrently actedas strong attractors of FDI. It more than compensated the operationalrestrictions established by regulations and the usual risks of investing in adeveloping country.

To a large extent, the reform of FDI policy in the nineties eliminated entryrestrictions to activities, which were until then, beyond the reach of foreigninvestors and allowed market size and growth potential to attract investors.Certainly, the business environment had changed significantly compared tothe previous wave of FDI in the import-substitution age, as a consequence ofextensive policy reforms implemented in the nineties not only regarding FDIbut also in other policy areas (exchange rate regime, monetary and fiscal policy,regulation, trade, etc.) as well. Nevertheless, most FDI projects in the ninetieswere “market seeking”, more so in the service sector. In other words, the hugeBrazilian domestic market was still the main FDI attractor as it used to be in theimport substitution era.

Location advantages played an important role in attracting FDI to Brazil. Thesize of the domestic market, transportation costs to and from, as well as withinBrazil, preferential access to neighbouring countries in MERCOSUR (MercadoCommun del Sur) and in South America were important factors. The existenceof sophisticated manufacturing and services systems inherited from theindustrialisation process also contributed to the creation of local advantages.

CHAPTER-3

Stakeholders’ Views on FDI

2 Contributions sent by NRG members who were not present at the meetings were alsoincorporated in this Report.


Last, but not the least, the fact that Brazil had a sizable stock of FDI alsoresulted in strong attraction influence. This was true both for trans-nationalcorporations (TNCs) that had already invested in Brazil (those firms had animportant sunk cost in the country), and for the “new comers” that sought tocompete with the “old hands” under more balanced conditions of proximity tothe market and to local suppliers.

During the nineties, traditional location advantages were complemented bythe availability of large former State firms on sale within the framework of theprivatisation programme. Such firms constituted valuable assets that could bebought by TNCs that had an interest in gaining access to activities that wereformerly monopolised by the State. Buying such assets was a strategic moveby foreign companies looking for opportunities to enlarge their business in theregion, and in this sense such investments could be classified as “strategicasset seeking”.

Overall economic conditions also improved significantly during the nineties.Price stability and gross domestic product (GDP) growth from 1995 to 1997fuelled the interest of foreign investors in buying their way into the Brazilianeconomy. By the time economic conditions worsened, after 1998, mostinvestment decisions had already been made and investment projects werewell under way.

An overall positive civil society perceptions about foreign companies andtheir potential contribution to growth and development should also bementioned. The fact that civil society in Brazil had an experience in interactingwith TNCs during the industrialisation process from the fifties to the lateseventies, contributed to a positive assessment of the input of foreign firms intransferring technology, in creating employment and in improving workingconditions. In turn, foreign companies already active in Brazil conveyed totheir headquarters and to potential newcomers that Brazil was open to TNCsand that the prevailing business climate was favourable to foreign investors.

The fact is that Brazil has a long history of playing host to foreign investorsand that no single factor can be held solely responsible for the upsurge offoreign investment in the nineties. Policy reforms made an importantcontribution, but the other factors listed above were also important. In otherwords, policy reforms might have been a necessary condition, but it was not asufficient condition for Brazil to attract large flows of FDI as it did in thenineties. Other domestic factors were also important, not to mention the globalconditioning factors.


Assessing the real contribution of the domestic market growth potential, onthe basis of location advantages, the positive attitude of civil society towardsforeign firms and the existing stock of foreign assets in the country, is importantfor the purpose of improving FDI policy in the near future. In this regard, somekey issues should be taken into consideration:

l International conditions have changed significantly, reducing FDI flows todeveloping countries, including Brazil.

l The privatisation process has almost been concluded. The State has alreadysold most of the assets it can afford to, at least in the current politicalconditions.

l Most barriers to FDI have now been eliminated. Few restrictions remain,mostly in service activities, like education.

It seems, therefore, that the FDI attraction potential of the public assets, whichare up for sale and further liberalisation is severely restricted and that thesupply of FDI to Brazil is shrinking compared to what it used to be in thenineties. At the same time, macro-economic conditions have worsened in thelast few years, diminishing the potential contribution of the domestic marketgrowth to attract new investors.

Considering these factors, the primary goal of Brazilian FDI policy in the nearfuture should no longer be, to attract new investments, but to successfullyobtain more contributions to development from foreign investment already inthe country. In other words, FDI policy in Brazil should target maximisingpositive spillovers from the activities of TNCs, which have already invested inBrazil, either in the nineties or before, rather than concentrating its efforts onattracting new investors.

In fact, if spillovers from FDI gradually help in improving macro-economicconditions, in reducing the Brazilian deficit in technology and finance, and inrestoring growth, attracting new investors would become easier. This does notimply, that the current policy regime should be abandoned or that it will notmake any difference. It simply means that the degree of success of FDI policiesin the next decade should be measured by their capacity to increase spillovers,rather than to restore FDI levels of the nineties.

Brazilian economic authorities in the nineties seemed to believe that the presenceof TNCs in Brazil would bring automatic spillovers. Therefore, FDI policieswere mostly concerned with enlarging the presence of foreign companies inservice activities and in manufacturing.


The case studies reviewed in the Country Report showed that the results didnot match expectations. New FDI in the car industry updated car models andproduction facilities. However, most local suppliers of parts and componentscould not take part in the modernisation process and in the end, lost theirmarket to imports. One of the main reasons was the lack of financial support forsmall and medium firms in the auto parts industry to invest in new equipmentand in technological upgrading. There were, however, plenty of financialresources being made available for large car assemblers. A more balancedallocation of resources between foreign assemblers and local suppliers couldhave increased spillovers from the former to domestic firms.

In the case of the pharmaceuticals industry, large foreign laboratories that hadinvestments in Brazil hindered local production of critical inputs and shiftedsupply sources abroad to their head companies. The government expectedthat imports would help reduce costs and make medicines cheaper and moreaffordable to consumers. Instead, what actually happened was that high transferprices for imported inputs resulted in huge consumer price increases formedicines, well above the average of consumer price index increases duringthe nineties.

In the case of telecommunications equipment manufacturing, the arrival ofmassive FDI had a greater positive impact, since it resulted in an increase notonly in local manufacturing, but also in local research and development (R&D)and access to foreign markets. As described in the Country Report, this positivespillover balance resulted not from the FDI policy itself, but from regulationsthat applied to telecommunications services and equipment manufacturingspecifically. Thus, the case of telecommunications equipment strengthens theargument in favour of shifting the focus of FDI policy design from attractinginvestment through a more business-friendly environment, to policies thatencourage foreign investors to increase spillovers from their activities in thecountry.

The discussions at the NRG meetings during the project revealed a widespreadview that the Brazilian economy was not benefiting as much as expected fromFDI. Two issues in particular were repeatedly raised: the huge amount of publicfunds granted to subsidise foreign companies (contrasting the limited amountavailable for local, small and medium enterprises) and the poor trade performanceof foreign firms, seen as contributing to trade balance problems. On the positiveside, there was a consensus on the contribution of FDI to improvingtelecommunications infrastructure, especially in the enlargement of the mobilephone network.


At the last NRG meeting of the project an attempt was made to address theconcerns on how to increase the contribution of FDI to development byselecting three issues for discussion: the use of public funds to attract FDI(bidding wars), trade performance of foreign companies and the prospects forthe creation of the Free Trade Area of the Americas (FTAA) and R&D activitiesof foreign companies in Brazil. The discussion of the three issues led to aconsensus that Brazilian FDI policy in the future should be more closely linkedto other policies like trade, technological development, employment andcompetition, in order to obtain more spillovers. This recommendation seemedto be very similar to a conclusion voiced at the Latin American Regional Seminarheld in Sao Paulo a few months earlier.


The main point for designing a new approach to FDI policy is to acknowledgethe fact that the phase of attracting foreign investors to infrastructure andservice activities is almost over, since foreign companies are currently presentin mostly all activities of the Brazilian economy. Furthermore, international anddomestic conditions are no longer favourable to large-scale attraction of FDI.Thus, efforts to attract investors should be more selective, and should notconstitute the main policy axis.

The regulatory regime for FDI built in the nineties already establishes fairlyfree access for foreign companies in the Brazilian economy. Entry restrictionswere almost completely eliminated, except in some service activities. Non-discriminatory treatment has already been granted. Remaining “obstacles” toFDI are non-discriminatory (bureaucracy, legal system, etc.) in the sense thatforeign and domestic investors are affected equally. Liberalisation cannot,therefore, be the main axis of FDI policy in the years to come.

Within the new policy orientation the following initiatives should be taken:1. Attracting selectively high quality FDI

Goal: attracting FDI to activities that need technologies available onlyfrom TNCs.Action: making information on investment opportunities in Brazil availableto potential investors through public agencies and offering support indealing with government agencies at the national and sub-national levels.

2. Avoiding “bidding wars” at sub-national level, within Brazil, and at theregional level, within MERCOSURGoal: eliminating fiscal cost and other distortions that result from any raceto the bottom.Action: getting approval for tax legislation within the context of the taxreform currently being discussed in Brazil to prevent sub-nationalgovernments from granting fiscal incentives.

3. Promoting linkages between foreign firms and local innovation activitiesGoal: increasing technological spillovers from FDI.

CHAPTER-4

Agenda for Action - Government


Action: government agencies assessing projects of foreign companies thatseek investment incentives (financing from the national development bank,for instance), should give preferential treatment to those projects thatinvolve long-run commitments to establish linkages with the national systemof innovation (research institutions public and private).

4. Promoting linkages between foreign firms and local firmsGoal: increasing spillovers from FDIAction: giving preferential treatment by government agencies to projectsinvolving long-run commitments to local suppliers both for supply contractsand for technological assistance.

5. Promoting employment creation and trainingGoal: increasing spillovers from FDIAction: granting preferential treatment to investment projects involvingthe generation of employment and the qualification of workers.

6. Promoting Small and Medium Enterprises' (SMEs) interaction with TNC’sand their global networksGoal: increasing spillovers from FDIAction: coordinating activities of government agencies and foreigninvestors to improve capabilities of locally owned SME aiming at increasingtheir ability to participate in global supply networks.

7. Reducing crowding out of local investorsGoal: increasing spillovers from FDIAction: strengthening competition policy and regulatory agencies,restraining business practices that discriminate against local producersand restraining transfer pricing.

8. Supporting FDI by Brazilian firms abroadGoal: increasing the competitiveness of local firms, strengthening its abilityto benefit from spillovers.Action: supporting asset- or market-seeking investment by Brazilian firmsabroad.

9. Enlarging the scope of the Census of Foreign CapitalGoal: increasing transparency in information regarding contribution offoreign firms to Brazilian development.Action: updating Census data on the following, employment, training, longterm commitments with local firms, innovation activities and data that couldallow to assess the position of the local subsidiary within the globalcorporation.


Civil society should demand more transparent information, both fromgovernment agencies and TNC’s to assess the behaviour of large firms, eitherforeign or locally owned. This is crucial in the case of Brazil, where, since thecapital market is rather small, most large firms do not access local capital andthus are not obliged to disclose financial information to shareholders. Mostforeign subsidiaries are totally owned by their head companies and have nolocal partners who could demand disclosure of information on local activities.Given these conditions, civil society should implement the following initiatives:

1. Cooperation between local and foreign employees unionsGoal: increasing transparency and workers’ cooperation.Action: local unions should establish agreements with workers of headcompanies and subsidiaries in other countries to exchange informationabout investment projects and working conditions.

2. Cooperation between consumers’ associationsGoal: increasing transparency and cooperation.Action: local consumer associations should establish cooperationagreements with consumer associations in home countries and in otherhost countries of TNCs.

3. Cooperation between competition policy agenciesGoal: increasing transparency and cooperation.Action: strengthening cooperation agreements with agencies from homecountries and other host countries, by competition policy agencies.

CHAPTER-5

Agenda for Action - Civil Society


For Brazil, as for any developing country, it is essential that investmentagreements – bilateral, regional or multilateral – be drawn keeping in mind adevelopment perspective. Ideally, such agreements should result from apartnership for promoting development and should involve trans-nationalcorporations, home countries and host countries as equal partners.

From this perspective, investment agreements should preserve (and evenincrease, if possible) the ability of host countries to implement measures seekingto maximise the developmental contribution of FDI in their economies. Thisinvolves the ability to implement some form of selecting and screening beforeFDI establishment and the ability to regulate FDI activities (post-establishment).

Broadly speaking, Brazil and other developing countries should preserve theability to design FDI policies suited to their stage of development and to theirpriorities regarding the role of FDI in their economies. In other words, investmentagreements should not reduce more “policy space” than what is strictly neededby developing countries to promote FDI spillovers, and business practices byforeign companies that could have negative effects on development of localbusiness should be restricted.

In this regard, from a Brazilian perspective, it also seems that the WTO TradeRelated Investment Measures (TRIMs) restrictions on performancerequirements should be made more flexible and narrower. Also, the legitimateinterests and the needs of developing countries should be considered. Giventhe instability of financial flows to developing countries, it seems reasonablethat host developing countries should be allowed in future also to establishtrade balance requirements, at least in critical balance of payment conditions.Safeguards should be introduced against instability and external shocks.

For the same reason, within the framework of any international investmentagreement (IIA), developing countries should be allowed to be selectiveregarding sectors open to foreign investors following the “positive list”procedure used in General Agreement on Trade in Services (GATS). Suchmechanism offers developing countries the chance to gradually increase thenumber of sectors involved in the agreement.

CHAPTER-6

Agenda for Action – Inter-GovernmentalOrganisations (IGOs)


Given the diversity of priorities and the huge differences among developedand developing countries and within developing countries themselves, it seemsthat the scope of an IIA should be fairly general, leaving more detailednegotiations for bilateral or regional agreements, which could be flexible andtailored for specific cases.


The review of the Brazilian experience with FDI, focusing on foreign investmentflows and performance and policy reform in the nineties, helped us to putforward a few recommendations for government, civil society and IGOs thataim at increasing the developmental contribution of TNCs.

The main targets of the recommendations that emerged from the NRG meetingsare TNCs that invested heavily in Brazil during the last decades. This group offoreign companies can influence in Brazilian growth and development. Spilloversfrom these companies can contribute to faster development and in the long runimprove profits. In order to explore the potential contribution of FDI todevelopment, linkages between TNCs, local firms and local institutions mustbe strengthened.

International Investment Agreements (IIAs), should preserve the ability ofdeveloping countries to design and implement FDI policies, best suited to theirneeds. Such agreements should only establish general principles regardingthe rights and obligations of TNCs, home and host countries, and leave roomfor each developing country to regulate FDI according to its developmentneeds and priorities.

Civil society should aim at increasing transparency of data related to TNCsperformance in Brazil. Cooperation with unions, consumer associations andcompetition policy agencies from other countries can contribute to this goal.The results of the IFD project itself provide evidence that internationalcooperation can be fruitful.

CHAPTER-7

Conclusion


First NRG MeetingApril 26, 2002, Campinas

The first NRG meeting was held on April 26, 2002. The agenda included adiscussion on the Country Report: Investment Policy in Brazil – Performanceand Perceptions. Copies of the documents discussed were e-mailed to NRGmembers and made available through internet to the public at large.

Discussions focused on assessing the extent of changes in regulatory aspectsexplained by observing trends. While it seems clear that financial liberalisationreduced the cost of entry/exit for potential investors and offered additionalsecurity over local assets, it was not sufficient enough a condition to triggerthe upsurge of FDI that occurred in the nineties. Determining factors seem tohave been more of the sector-specific kind, like privatisation intelecommunications, restructuring of the banking sector, incentives for theautomobile industry, and the like. The common explanatory factor in FDIattraction seems to have been the size and/or the growth potential of thedomestic market.

Nevertheless, it was also noticed that most activities that successfully attractedlarge amounts of FDI also benefited from some form of incentive. Privatisedservices contracts signed with the Federal or State governments ensured stableinstitutional conditions, privileged access to the market, pricing rules, etc. Inthe case of the automobile industry, fiscal incentives for investment and localproduction (besides significant tariff protection) were important factors forattracting large investments. Fiscal incentives were important for the dataprocessing and telecommunication equipment cases, but played no role inother sectors that also attracted FDI (food and beverages or steel industry, forinstance).

ANNEXURE

Summary of NRG DiscussionsOne of the most important activities of the IFD project was the formation of aNational Reference Group (NRG) in each project country to provide a soundingboard and quality check on the research outputs. The main purpose of theNRG meetings was to attract attention to the project at a national level.


Telecommunications was one of the service activities that attracted more FDIin Brazil in the nineties. Companies in this sector (mostly foreign companies)invested heavily in expanding and upgrading telecommunication services allover the country. Equipment manufacturers, thus, enjoyed a rapidly expandingmarket for their products and invested heavily themselves as well.

The telecommunications equipment boom lasted five years, but the bubblefinally burst as investment plans of telecommunications services companieswere concluded and demand growth for services slowed down. Foreigncompanies that had invested both in services and in equipment manufacturingin Brazil are experiencing excess capacity and low profitability. Financialconditions of their head companies abroad are not good either, so theprobabilities of Brazilian subsidiaries obtaining financial support from thatsource are not exactly bright.

The improvement in telecommunications resulted in significant welfare andefficiency gains for the economy and society as a whole. Some participantsargued that proper co-ordination between service companies and equipmentmanufacturers could have avoided excessive concentration of investmentsover a relatively short period of time and thus avoided or at least minimisedcurrent excess capacity. The agency that regulates telecommunications servicesin Brazil (ANATEL) could have acted as a channel to facilitate co-ordination.Other participants mentioned that the agency should have been more active inensuring a prominent role for locally owned engineering firms in system design(both in hardware and software), taking advantage of capabilities developed inthe last twenty years. It was suggested that increasing exports could helpsolve part of the excess capacity problem in the telecommunications equipmentsector.

Discussions on banking compared the process of internationalisation of thebanking system in Brazil, with the process of the European Community. Thecomparison is relevant because European banks were the most important newinvestors in the Brazilian banking system in the nineties. FDI in the bankingsector in Brazil can be explained as a part of the process of regional integrationand internationalisation of the European banking system. Banks from Spain(Santander and BBV, for instance) and the Netherlands (AMRO) and inMERCOSUR in general, found a frontier in Brazil to internationally expand theirbusiness and improve their stance in international competition by increasingtheir size.

Debates focused on the future of large locally-owned banks and their ability tocompete with foreign banks in the domestic markets. Participants argued that


Brazilian banks would also have to expand internationaly to increase theirchances of survival. Others mentioned that the internationalisation of thebanking system hadn’t gone further because the large size of the leadingdomestic banks (Bradesco and Itau) made them too expensive to be bought bymedium sized banks, which invested in Brazil. Only large European or USbanks could have faced the challenge.

Debates focused on the factors that explain the great diversity of the modes ofintegration into the world market of foreign subsidiaries in Brazil. It seems thatdifferent waves of foreign investment brought foreign subsidiaries with differentinterests and strategies regarding Brazil. Sector- and firm-specific factors seemto be very important when attempting to predict the impact of FDI on trade.

It depends, as the participants noticed, on sector and firm-specific determinants.Macro-economic policy is also an important factor, since significant changesoccurred after the Brazilian currency was devaluated in 1999. The extent towhich regional trade agreements, like the one MERCOSUR is negotiating withthe European Union or like the Free Trade Area in the Americas, influencetrade patterns of foreign subsidiaries remained uncertain. It was scheduled fordiscussion in the second NRG meeting scheduled for June.

Second NRG MeetingJuly 5, 2002, Campinas

The second NRG meeting was held on July 5, 2002. The agenda included adiscussion of the Country Report Investment Policy in Brazil - Performanceand Perceptions.

The ongoing work on the Report was presented at the opening of the meeting.The report covers field research on the perception of civil society on theimpact of FDI, as well as three case studies on activities that succeeded inattracting FDI in the last few years. While case studies progressed accordingto schedule, the response to the questionnaires mailed to firms andorganisations proved to be low and took much longer than expected. A largenumber of respondents only answered some of the questions. Participantssuggested that fieldwork be stopped by mid-July even if the numbers of returnedquestionnaires were low, to avoid further delay in the report.

The panel discussed the prospects for market access for MERCOSUR’s exportsto the European market after the end of current negotiations on the bilateraltrade agreement. A paper entitled ‘Access of MERCOSUR's exports to theEuropean Market’ presented by Marta Castilho, researcher from the Institute


of Applied Economic Research (IPEA), Rio de Janerio, Brazil, gives an overviewof current barriers to Brazilian exports in the European market and useseconometric resources to model potential impact of preferential access afternegotiations.

The debate focused on the role of multinational firms in gaining market accessto developed markets for products from developing countries through intra-firm trade. One of the three cases included in the Country Report, the automobileindustry, was referred to by the participants to point out some of thecontradictory aspects of trans-national corporation (TNC) behaviour. Europeancar constructors that are leaders in the Brazilian markets, channel most of theirexports to neighbouring countries in South America or even to the US, not tothe European market.

Subsidiaries located in Central and Eastern Europe are more frequently used asexport platforms to the European Union than MERCOSUR’s subsidiaries.Paradoxically, the subsidiaries of US car constructors tend to export more tothe US market than their European counterparts. As in the first meeting,participants pointed out that sector-specific and firm-specific factors areextremely important in determining trade behaviour of foreign subsidiaries andtrade effects of FDI.

Third NRG MeetingApril 14, 2003, Campinas

The third NRG meeting was held on April 14, 2003. The main agenda of themeeting was to discuss the draft of the report Investment Policy in Brazil – AnAgenda for Action as well as to gather comments on the policy and perceptionsreport.

Bidding WarsThe bidding war among the Brazilian states has long been used as a tool toattract new investments from both national and foreign private companies.The growth of the bidding war was motivated by the absence of a morearticulated and integrated industrial and regional development policy. Incentivesfrom different spheres of government (federal, state and municipal) were oftenimposed, with no criteria of efficiency or strategic guidelines. The main incentiveused has been the deferral of state taxes on new investments. This incentivehas been offered with a fairly long-term view in mind.

Although there is no official evaluation of the total number of incentivesgranted, it is believed that their cost was very high. For example, between 1997-1999, for approximately US$6.6bn in investments of car and auto parts


manufacturing and other automotive activities, the public funding bank BNDESfinanced US$3bn at far lower rates than those offered on the domestic financialmarket. Another important federal incentive was the reduction or the exemptionof import tax and of IPI associated with imports. In the 1997-2001 period, importsof the transport material sector (which include the aeronautical sector) benefitedfrom exemptions to the value of US$4.1bn. In the vehicle sector, in the two-yearperiod 2000-2001 alone, there was tax reduction to the value of US$560mn.

Recommendationsa) Extensive tax reforms should be carried out for elimination or reduction of the

bidding war. It should be noted that despite its initial proposal by the Cardosogovernment (1994-2002), it was never carried out and now it is once againbeing considered crucial by the Lula da Silva government (2003-2006).

b) Incentives should be articulated at the national level, to avoid the expenditureof public funds to attract FDI , which would have come to the country inany case.

c) Incentives should be used at the state levels in a perspective of regionaldevelopment.

d) There should be improvements at the national and regional (MERCOSUR)markets to attract new investments.

FDI, Trade and FTAAThe accelerated growth of FDI in Brazil in the nineties rekindled the debate onthe influence of the TNCs on the country’s trade performance and, more recently,on the importance of these companies in the negotiations to set up agreementsfor free trade areas, whether in the FTAA ambit or in the free trade agreement ofMERCOSUR /European Union.

Several factors led to the boom in FDI in 1990s. However, for FDI inmanufacturing, this attraction was conditioned to stable currency and tradeliberalisation. These two processes allowed both the TNC already installedand the new entrants to adopt domestic/regional market seeking as their mainoperating strategy, thus strongly favouring production that is dependent onimported inputs. This partly explains why TNC participation in exports grewmuch less than its participation in imports, even after the 1999 devaluation.

New rounds of trade liberalisation, such as that proposed by FTAA, couldincrease these processes. Tariff reductions for industrialised products, wheremost of the imported inputs are to be found, could increase intermediary foreignbuying even further since they originate mainly from North American FreeTrade Agreement (NAFTA) countries.


Even with low tariffs in the USA and in Canada, with a devalued exchange rate,it can be seen that the increase in the exports of the TNCs installed in Brazil toNAFTA (47.7 percent between 1997 and 2000) differ minimally from the growthrate of the total Brazilian exports to this region (44.6 percent). It is unlikely thata greater increase of exports to this region be brought about merely because oftariff reduction. In other words, most of the export potential to NAFTA and topart of Latin America would depend less on the success of reduced tariffs andmore on the operating strategy of the TNCs in Brazil.

The trade results from the implementation of the FTAA depend considerablyon TNC strategies. On one hand, the reduction of barriers may possibly reaffirmthe process, led by the TNCs, to import inputs and high technology goodswith negative repercussions in the Brazilian trade balance. On the other hand,if the Brazilian subsidiaries of these companies became more important in thecorporate network, generating a trade surplus, an increase in production, localjobs and technological spillovers, then the effectiveness of the FTAA wouldbe commercially more profitable for Brazil.

RecommendationsBrazil needs to reassess its policy towards FDI. During the nineties, liberalisationsought to attract FDI by reducing barriers and improving regulation. A newpolicy agenda is now needed, to increase the benefits from the presence offoreign affiliates in the Brazilian economy. Regarding manufacturing, incentivesshould be targeted towards increasing spillovers as well as towards takingadvantage of intra-firm trade flows coordinated by head-companies. Linkagesbetween foreign affiliates and local suppliers and the national innovation systemmust be strengthened to increase value added in manufacturing, particularly inexports. Regarding multilateral negotiations related to FDI, it was recommendedthat Brazil should argue in favour of developing countries being allowed toestablish performance requirements to maximise spillovers from MNCs. ForBrazil, this would be particularly important in view of FTAA negotiations.

Role of TNCsGiven the rise in the importance of TNCs in the productive structure of theBrazilian economy, the issue of how these companies have carried out theirR&D activities in the country and contributed to the evolution of the nationalsystem of innovation becomes fundamental. This is especially important whenone takes into account that the R&D expenditure in relation to the gross nationalproduct (GNP) in the Brazilian economy has stagnated at relatively modestlevels (0.87 percent in 1999) and largely financed by public resources (42.6percent of the total as opposed to 37.6 percent financed by the private sector).Despite the absence of consolidated data on the technological activities of the


affiliates, like those existing for sales and exports, there exists evidence that theTNCs operating in Brazil have a considerably lower share in the total R&Dexpenditure made by the Brazilian private sector than in sales or in foreigntrade, even though they have a greater intensity in the R&D expenditure thanthe average of the national companies.

According to the ANPEI (National Association of Research, Development andEngineering of Innovating Companies) data bank, that stores information fromaround 400 companies; it is possible to verify that in 1998 the foreign companiesspent 1.4 percent of their gross sales in R&D, as opposed to 1.2 percent spentby national companies. However, in terms of percentage, the volume of R&Dexpenditure spent by the foreign companies in 1998 corresponded to 33 percentof the total. It is worth noting, however, that the companies that are included inthe ANPEI data bank answer questionnaires voluntarily and do not, therefore,constitute a representative probabilistic sample of Brazilian industry as a whole.Another indicator that can be used refers to the share of the R&D activities ofthe Brazilian affiliates in the total R&D carried out by all TNC’s affiliates. In thiscase, the only available information is the data of the Bureau of EconomicAnalysis (BEA) for the United States TNCs.

Most of the R&D activities performed outside the USA take place in developedcountries. The expenditure of the affiliates in the countries of the EuropeanUnion, Japan and Canada represented 79.2 percent of the total sum of the R&Dexpenditures of the North American TNCs in 2000. This proportion isconsiderably higher than the share of sales in these countries. Among thedeveloping countries analysed, it can be observed that in general, the share inthe total sales is greater than that in the R&D expenditures. However, in somecases, such as China, Korea and Malaysia, the participation in the R&Dexpenditure is higher than their share in sales. It is worthwhile highlighting theChinese case, which represents only one percent of the total sales but accountsfor 2.5 percent of the total R&D expenditures.

In the Brazilian case, while the share in the total sales reaches 2.5 percent, theR&D expenditure accounts for only 1.3 percent of the total. Even so, the Brazilianposition is the best among Latin American countries, since in Mexico theparticipation in sales is around twice that of R&D expenditures. In Argentinaand Chile this ratio is even greater. Also with regard to the R&D/sales ratio,Brazil occupies an intermediary position among developing countries, with a0.4 percent ratio, considerably lower than that of Asian countries, but higherthan the other Latin American countries.


The affiliates operating in Brazil could have a much more relevant role intechnological development and in generating spillovers with a capacity toincrease the competitiveness of industry as a whole. However, this is not atrivial task since, as shown in UNCTAD (1999), the globalisation of R&Dactivities, albeit growing, is doing so at a slower pace compared to that of othercorporative functions. Besides this, it takes place in a more selective manner,demanding advantages of localisation related to scientific and technologicalinfrastructure and a qualified work force. It also demands the capacity of thepublic sector to coordinate actions to attract investments or stimulate TNCs,which are already installed to perform activities with greater interaction withthe national system of innovation and with a greater capacity to generatespillovers.

In this context, it is importanta) To highlight the launching of the Sectoral Funds to Technological and

Scientific Development by the Brazilian Science and Technology Ministry.It is not a programme directed specifically toward the TNCs, but it has toguarantee the increase and the stability of the resources for science andtechnology, as well as magnify the participation of the private sector and itsinteraction with universities and research institutions. The programme,started with the oil sector in 1999, had been implemented in 2001 in thesectors of electric energy, hydro resources, transportation, spatial, mineral,telecommunications, computer equipment, infrastructure, and the “green-yellow” one, and aimed to stimulate university and enterprise interaction.

The sectoral funds have many sources that include parts of revenue of thebeneficiary companies like tax incentives, royalties, donations, loans andlicenses. The total resources estimated to compose the funds in 2001represented about 10 percent of all R&D expenditures carried by the publicand private sector in 2000. The management of the funds is considered to beinnovative, with the organisation of managing committees integrated by theScience and Technology Ministry, enterprises, universities and regulatingagencies.

b) A similar scheme could be implemented in the future at a regional level. Thecreation of such mechanisms, for instance, could be established to stimulatestronger interaction between TNCs and national innovation systems indeveloping countries within FTAA. Those funds could be created out ofcontributions linked to exploitation by TNCs of new business opportunitiesresulting from trade creation.


Recommendationsa) Ways to Improve the Contribution of the Existing FDI:

l Increase the weight of local branches in the corporate network.l Intensify R&D activities of local branches and stimulate the connection

between TNCs and the local innovative system to maximise technologicalspillovers.

l Stimulate the increase of exports to the USA and European Union.l Expand the production of the local branches to attend foreign markets.l Stimulate the purchase of local intermediate goods by TNCs.

b) Ways to Attract New FDI:l Encourage TNCs of capital-intensive sectors.l Encourage TNCs with high export coefficients.

c) General Issues:l Tax reform.l Reduce the capital cost through the reduction of the interest rates.l Improve national infrastructure: transport, ports, exports facilities.

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