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Law and Business Review of the Americas

VOLUME 18 FALL 2012 NUMBER 4

SYMPOSIUM: ECONOMIC AND POLITICAL LEADERSHIP: THE BRICS

TABLE OF CONTENTS

SYMPOSIUM INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 437

Introduction

Kathleen B. Cooper . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 439

SYMPOSIUM ARTICLES

The Rise of the Emerging Markets Anne O. Krueger . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 445

The Brazilian Miracle and Its Limits

Peter Kingstone . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 455

Development Progress in Russia Richard E. Ericson . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 471

The Politics of Human Development in India and China: It

Pays to Invest in Women and Children Devin K. Joshi . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 487

World Trade and Investment: Where do the BRICs Stand?

Thomas Osang . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515

Observations on Innovation and Technology Use in the BRICS Keith E. Maskus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 537

Explaining the Energy Consumption Portfolio in a Cross-

section of Countries: Are the BRICs Different? David M. Arseneau . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 553

The Energy of Brazil: Tudo acaba em samba

Carlos Rufın . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 585

UPDATES

FCPA Risks for U.S. Companies in Latin America, Renewable Energy Thrives in Brazil, and Mexico and the New PRI: Enrique Pen a Nieto Fernando Avelar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 605

Canada Update: A Review of Canada’s Recent Holding

Regarding the Proposed Securities Act, Canada’s Anti- Spam Law that May Soon Take Effect, and the Disciplinary Hearing of Joe Groia David Paulson . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 615

NAFTA Updates and American Trade News Highlights for

Summer 2012 Sarah Bridges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 627

DOCUMENT

Report of the OAS Electoral Observation Mission in

Ecuador . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 637

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OFFICIAL CITATION LAW & BUS. REV. AM. FALL 2012

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Southern Methodist University Dedman School of Law’s Law Institute of the Americas

(formerly SMU Centre for NAFTA and Latin American Legal Studies)*

Established in 1952, the LAW INSTITUTE OF THE AMERICAS at Southern

Methodist University Dedman School of Law was originally designed to promote good will and to improve relations among the people of the Americas through the study of comparative laws, institutions and governments respecting the American Republics, and to train lawyers in handling legal matters pertaining to the nations of the Western Hemisphere. Today, in reviving the institution, the Law Institute of the Americas comprises meaningful academic research, teaching and programs pertaining to the “NAFTA/FTAA processes” and other Western Hemispheric integration efforts; to Latin and Central American law and judicial reform, particularly focusing on Argentina, Brazil, Chile, Guatemala, Mexico, Peru and Venezuela; and to a more limited extent, to Canadian legal issues, particularly as they interrelate to the NAFTA/FTAA. The Law Institute of the Americas also is concerned with increasing (regional and hemispheric) legal and economic interconnections between the “NAFTA/FTAA processes” and European and Asia-Pacific integration activities.

The officers of the Institute are as follows: the HONORABLE ROBERTO

MACLEAN, President; PROFESSOR JOSEPH J. NORTON, Executive Director; and PROFESSOR GEORGE MARTINEZ, Associate Executive Director. The Institute is also supported by distinguished group of Professorial Fellows, Senior Research Scholars, Professional Fellows, and Student Research Fellows.

As the Institute focuses primarily on issues pertaining to the North American

Free Trade Agreement and the pending Free Trade Area of the Americas, and the broader economic, political, legal, and social integration processes underway in the Western Hemisphere, Law and Business Review of the Americas is one of the International Law Review Association of SMU. Other parties of the journal are the Cox School of Business, the SMU Departments of Economics and Political Science, the London Forum, and the American Bar Association Section of International Law and Practice.

* From 1952 through the early 1970s, the name was the Law Institute of the Americas: in 1993, it was reactivated as the Centre for NAFTA and Latin Amer- ican Legal Studies; and in 1998, it returned to its original name. For further detailed historical information on the Law Institute of the Americas, please refer to the Law Institute of the Americas’ website at http://www.law.smu.edu/lia.

Introduction

I

INTRODUCTION

Kathleen B. Cooper*

NCLUDED in this volume are papers from a conference entitled Economic and Political Leadership from the Emerging World: A Focus on the BRICs. The conference was held on March 28-29,

2012, at the Meadows Museum, Southern Methodist University in Dallas. The conference was sponsored by the John Goodwin Tower Center for Political Studies, the Law Institute of the Americas, and the Department of Economics at Southern Methodist University and was funded primarily by the Jno. E. Owens Foundation.

The conference brought together scholars and policy experts to discuss the current state of thinking on whether emerging markets would be able to continue carrying world growth to higher levels and whether emerging markets’ new leadership roles might lead them to open their regulatory and other market structures as they develop toward advanced economy status. The conference highlighted the BRIC countries of Brazil, Russia, India, and China due to their importance in the world economy. Ques- tions and issues addressed included (1) reviews of economic and political developments over the past five years and whether those and other important changes would persist over the coming five years; (2) the potential for continued rapid further convergence toward advanced economy income levels; and (3) the concern that advanced economies depend too much on the continued growth and opening of these emerging economies.

Anne Krueger’s overview paper provides a very useful recounting of the rise of emerging markets over the postwar period, including some of the bumps along the road and the “might-have-beens.” She argues that the rise of these particular countries – Brazil, Russia, India, and China – was not predictable and that other countries will certainly come along to seize growth-leading roles in future years. She compares them with the rise of the four East Asian Tigers from the 1960s to the 1990s, highlight- ing their open economy strategy that encouraged others to try the same policy mix. Krueger also discusses the implications for these and other rapidly growing economies for the global economy and its institutions.

The second set of papers addresses the specific development progress in Brazil and Russia and a comparative look at development progress in China and India. Peter Kingstone raises the specter of Brazil’s uneven past performance and whether the country might replay some of its past.

* Senior Fellow and Professor of the Practice of Economic Policy, Southern Method-

ist University.

439

440 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 18

He focuses on the importance of its political institutions and, over the last decade, the importance of its market-oriented policy decisions and the boost from strong commodity prices. He makes the crucial points, however, that Brazil’s recent performance has been especially good relative to its more distant past but that it is not a high-growth country compared with China and that it needs significant investment to be able to maintain its place among its competitors.

Richard Ericson discusses the many differences between Russia and the other BRICs. High oil prices have played a critical role in Russia’s development over the past decade, pushing it to the sixth largest economy in the world on a PPP (purchasing power parity) basis. Unlike the other BRICs, it has undergone a recentralization of power under a strong president after initially opening some of its institutions. Russia was very hard-hit by the financial crisis. Given its recentralization, will Russia be able to generate the kind of growth it experienced in its early more open phase? Ericson raises important questions about whether Russia will be able to return to the higher growth needed to meet its ambitions, given the closed economic system built by Putin since 2005.

The final paper in this section was provided by Devin Joshi and focuses on comparing human development issues between China and India. Joshi proposes that major differences in ideology and state capacity are important in explaining why India has fallen behind China. The analysis suggests that these relatively hidden political factors play a major role in transforming and advancing human development. For example, India has not yet succeeded in replacing the pervasive ideology of caste and social stratification, whereas China has neither a caste system nor the degree of gender discrimination present in India. This difference has resulted in a Chinese labor force that is more skilled, literate, and mobile than in In- dia. His findings also support the notion that public investment in the capabilities of women and children have significant social and economic payoffs in both the short and long run.

The papers in the third section deal with trade and investment issues in the BRICs. Thomas Osang’s paper examines the absolute and relative contributions by Brazil, Russia, India, and China to world trade and foreign direct investment over the past three decades. In addition, it briefly discusses major achievements as well as remaining shortcomings of the international trade and foreign investment policy reforms that were implemented by the BRICs over the same period. Empirical estimates of the long-run equilibrium relationship in exports between the BRICs and the G3 (US, Japan, and Germany) as well as the role of the BRICs’ economic performance within a larger cross-section time-series data framework are also presented. That relationship over the past decade lends credibility to the view that the BRICs will be the world economy growth engine for years to come.

The focus of Keith Maskus’s paper is the BRICs’ use of innovation and technology in their development. He reminds us that over long-term ho-

2012] INTRODUCTION 441

rizons the driving forces behind growth are demographic trends, educational attainment, trade liberalization, deregulation, and the ability to innovate and adapt technologies. The BRICs have registered different performance records on these basic factors. Some have succeeded in moving unemployed labor and capital to more efficient uses (China, In- dia). Others have taken advantage of increasing commodity prices (Bra- zil and Russia). Some have invested heavily in education and infrastructure (China), while others lag behind (Russia, Brazil, India). The BRICs all share some features and successes in their technological catch-up processes, but their experiences have been quite varied in terms of industry mix, capital markets, R&D, and public policy. Maskus argues that potential roadblocks remain but can be overcome in the long term with appropriate policies and vision.

The fourth group of papers focuses on energy use and policy in the BRICs. David Arseneau first analyzes data from a broad cross section of countries to assess differences in energy consumption profiles. His work confirms that, as an economy develops, it transits away from a heavier reliance on traditional fuel sources (such as wood, waste, and peat) towards higher use of modern commercial energy sources. He also confirms that, as countries transform from an agricultural base to industrial and then service, energy use patterns change and more efficient use develops. Interestingly, however, the patterns of energy consumption and generation in the BRIC economies are importantly different from those of other economies and from one another, implying that understanding global energy market developments requires a more intense focus on developments at the country-and industry-specific level.

Carlos Rufın focuses on Brazil’s energy industry, where he notes the three transformations that have shaped its development in Brazil. The shift towards the use of modern energy supply in Brazil began with the effort to harness the country’s huge waterways as sources of electricity, an effort that continues until today, although with increasing acrimony and difficulty. The second great transformation was Brazil’s success in turning its vast land mass into the world’s most advanced biofuel supply complex. The third and newest transformation is due to the discovery and ongoing development of major oil deposits in very deep waters off the coast of Brazil.

I would especially like to thank Thomas Osang and James Hollifield for their significant contributions to the conference’s success by identifying and attracting key participants. Other faculty members of the Political Science Department assisted as well. In particular, Hiroshi Takeuchi provided helpful suggestions and outreach to attract important speakers. Thanks are due as well to Tower Center staff—especially Noelle McAl- pine (before her return to France), Carole Wilson, Jieun Pyun, and Ray Rafidi—who helped make this conference a success from an organizational standpoint.

Articles

T

THE RISE OF THE EMERGING MARKETS

Anne O. Krueger*

Keynote Address Given at Southern Methodist University Conference on Economic and Political Leadership from the

Emerging World: A Focus on the BRICs March 28, 2012

HE rapid and successful economic growth of the emerging markets, and especially of the BRICs (Brazil, Russia, India, and China), has caught the attention of the world over the past decade,

and certainly warrants a conference such as this. I congratulate the conference organizers for their choice of topics. It is both timely and important.

The BRICs are large countries whose integration into the international economy has been, perhaps, the single most important shift in the world in the past decade or so. But the importance of the shift stems, in part, from its being a symptom of a larger trend: the reduction in the earlier dominance, indeed the virtual monopoly, of the industrial economies since the Second World War.

As such, its importance lies, in part, because of the rise of the BRICs themselves, but also, in part, because of the successful emergence of other countries that were previously part of the developing world—not only the East Asians, but also Chile, Mexico, Turkey, and more.

Moreover, as I shall emphasize later, it was certainly not predictable— or at least any prediction of the rise of the BRICs was not noticed in the mainstream, even as an outside possibility. And there is a lesson in that: there are likely, indeed almost certainly, other countries that may emerge and grow rapidly in the next several decades. Predicting which countries they will be is impossible, but certainly Indonesia, Nigeria, Pakistan, and the Philippines are possible candidates. As I shall note later, it was not the earlier, most successful of developing countries that succeeded in changing in ways that permitted rapid growth.

* Anne Krueger is the Research Professor of International Economics at the School

for Advanced International Studies at Johns Hopkins University, the Senior Fel- low at the Stanford Center for International Development at Stanford University, Professor Emeritus of Economics at Stanford University, and the Senior Research Fellow at the National Bureau of Economic Research. Professor Krueger was previously the First Deputy Managing Director at the IMF from 2001-2006 and the Chief Economist of the World Bank from 1982-1986.

445


Because of this, and because most of the BRICs learned from earlier successful emerging markets, I will start with a bit of economic history regarding the world economy after the Second World War. I’ll then take a few moments to outline the current status of the four BRICs, and provide a brief contrast between them.

That background provides a basis for an evaluation of the current status of the BRICs and their prospects, to which I then turn. Finally, I shall focus on the key policy issues for the United States and the industrial countries that arise because of the emergence of the BRICs and other previously poor economies.

I. A BRIEF ECONOMIC HISTORY

At the end of the Second World War, the United States emerged as the predominant global economic power. While the United States accounted for only 40 or so percent of world GDP, much of the remaining 60 percent went for basic subsistence in the war-devastated countries and the third world.

To its great credit, the United States used its power to support reconstruction efforts in Western Europe and Japan, and to foster international economic institutions which, it was hoped, would enable an open international economic system to support growth throughout the world. The United States assumed a leadership role in postwar planning, especially with regard to the political and economic institutions designed to prevent a recurrence of the Great Depression, and of conflict between nations. Both through the International Monetary Fund, the World Bank, and the GATT (which became the World Trade Organization), and through its bilateral efforts, Americans supported postwar reconstruction—especially through the Marshall Plan—and foreign aid to assist in fostering rising living standards and economic growth in third world countries.

For Western Europe and Japan, the results of economic reconstruction efforts and the liberalization of trade were almost immediate and remarkable. By the late l950s, these economies had not only exceeded their prewar levels of output, but they were growing rapidly. Tariff levels on manufactures were already significantly reduced and the European Com- mon Market formed. It is now forgotten that the German wirtschaft- swunder, or “economic miracle,” surprised the world, and that living standards rose rapidly throughout Western Europe, and even more so in Japan, even after prewar levels had been overtaken. For a quarter century, the world economy, led by the industrial countries, grew at a rate unprecedented in human history.

During that time, all became accustomed to thinking of the world economy in three parts: the industrial countries (of which the United States was still preeminent), the developing (earlier called underdeveloped) countries, and the centrally planned economies that had effectively de- linked from the rest of the world.

2012] EMERGING MARKETS 447

Most of the developing countries were growing in fits and starts, having put in place policies that they hoped would protect them from competition from the industrial countries, as a means of inducing economic development. Although the intent was to accelerate economic growth and raise living standards, the outcome led to stop-start growth under regimes, which resulted in shortages of foreign exchange at an overvalued exchange rate and slowing growth over the course of successive stop-start cycles. At the end of the golden quarter century, it seemed unrealistic to anticipate that developing countries’ economic performance would improve. Although their growth rates were above those they had experienced prior to the Second World War, they were generally no faster than those of the industrial countries. Moreover, population growth rates were high—2 or 3 percent, or even more—and per capita income growth was consequently slow.

All of the industrial countries were growing at sustained rates higher than ever in world economic history, with Japan growing at the fastest rate. In the l950s, economic development textbooks classified countries as developed or underdeveloped (as the term then was), and often noted that Japan was halfway in between. The country experienced growth rates of around 8 to 9 percent from l959 to the l970s, by which time there was no doubt as to Japan’s status.

But largely unnoticed by industrial countries’ businessmen and policy makers, a few relatively small developing countries shifted policies. The first group to do so, and one that attracted great attention subsequently, was the East Asian Tigers (as they were then called)—Hong Kong, Singa- pore, South Korea, and Taiwan. These four economies became outer- oriented, shedding most of their protection for domestic industries, and shifting to reliance upon what came to be called, export-led growth.

Starting from an incredibly low base, all four economies experienced unheard-of rates of economic growth and poverty reduction. At first, most observers believed these high growth rates to be a short-run, unsustainable phenomenon, but as time passed, and growth persisted, or even accelerated, it came to be recognized that these four were achieving long- lasting results.

It is worth pointing out that South Korea, probably the most successful of the four (although the Taiwanese would argue with that), was one of the poorest countries in Asia, and the world, in the l950s. The country had followed the same inner-oriented policies as other developing countries and, despite the devastation of the Korean War (and the aftermath of hyperinflation in the late l940s); annual growth rates did not even average 5 percent, with population growth of over 2 percent. South Korea’s per capita income in l960 was estimated to be about the same as that of Ghana, and below that of a number of Sub-Saharan countries.1 The

1. It is worth noting that South Korea’s per capita income is estimated to have been

$25,010 in 2011, contrasted with Ghana’s $1,600 estimated per capita income for 2011.


country had the highest rate of inflation in the world, multiple exchange rates, a huge fiscal deficit, and much more. Most observers viewed the prospects for growth of the South Korean economy as dismal—with the U.S. Congress even passing a resolution stating that there was no hope for growth and that there should be foreign aid to support consumption levels only.

Taiwan had also opened up the economy in the mid-l950s, and the two both began growing rapidly after their policy shifts. The move toward an outer-oriented trade strategy in both cases was accompanied and supported by a number of other key policy reforms, including fiscal consoli- dation with sharply reduced inflation; infrastructure and educational investments; and greatly reduced protection for import-competing producers.

For South Korea and Taiwan, as well as Singapore and Hong Kong, the subsequent period until the second half of the l990s witnessed an economic transformation that had previously been regarded as unthinkable. Economists in the l960s thought that 6 to 7 percent was the highest possible sustainable rate of economic growth for a poor developing country, yet all four economies exceeded that range with double-digit growth rates in the first part of the period. To give an idea of the orders of magnitude, South Korea is estimated to have realized an annual 8 percent growth rate of real wages from l964 to 1995; exports grew at an average annual rate of over 40 percent for several decades (during which world prices were fairly stable), so that they rose from about 3 percent of South Ko- rean GDP in l960 to around 40 percent by the late l980s (and was last year the 8th largest exporting nation globally). Domestic savings rose from approximately 0 percent in l960 to about 37 percent by the late l980s. And there was much else, including rising educational attainments and a sharp drop in the rate of growth of population. The achievements were similar in the other three Asian Tigers.

As the success of the East Asian Tigers became increasingly evident, policy-makers in other countries began altering their development strategies. Some adopted the sorts of policies undertaken in the Asian Tigers wholeheartedly, while many others at least reduced their trade barriers and moderated other economic policies that were deleterious to growth.

The four East Asian Tigers are now regarded as industrial economies. But for purposes of understanding the BRICs and the shift in the global economy, two other points are crucial. First, that the four East Asian Tigers would be the first to shift toward an open economy, for a successful development strategy was not predicted. Many observers credited In- dia with the greatest chances of success, and regarded Brazil’s and the Philippines’ prospects as relatively bright. Indeed, the four were each seen to have significant problems: the size of the two city-states, Taiwan’s diplomatic isolation, and South Korea’s poverty. Hence, my initial statement that one cannot predict which countries will get it right and adopt


policies successfully leading to rapid increases in income and reductions in poverty.

The second point is that it was the success of the four East Asian Tigers that induced others to try the same policy mix. Although I shall focus on the growth of the BRICs, it should be noted that a number of other countries, such as Chile, Mexico, and Turkey, have also been successful in accelerating their growth and increasing their participation in the international economy.

The BRICs are the largest of them. China abandoned her policies of economic isolation in the early 1980s; India began her economic reforms in 1991 in response to a crisis. Of course, the fate of the Soviet Union stemmed largely from the failure of central planning, giving yet further impetus to the policy shifts in other countries. Russia’s growth has again hinged on policy reforms, although the oil and natural gas sector has been very important. Brazil’s emergence was somewhat different, in that there was a period of rapid growth in the l950s, another one in the late l960s and early l970s, with more sustained growth since 2002.

Despite the fact that Chinese exports began rising rapidly after that country’s policy reforms, which started in the early 1980s, China’s participation in the international economy had been so small that high growth from that small base did not constitute a major shift in the global economic structure until around the turn of the century. India’s policy reforms came almost a decade later, so that India, like China, still had a relatively small share of world trade until very recent years. Indeed, Bra- zil, China, and India together accounted for only 3.29 percent of world exports in l990, and 5.45 percent in 2000—contrasted with 4.52 percent in l960 (they had lost share in between). By 2010, the same three accounted for 13.3 percent of world exports (I leave Russia out because there are no data available from the IMF for 1990 and before, and Russia’s share was only 2.6 percent in 2010, mostly oil and gas).

Thus, until the last decade, the success of the emerging markets that had adopted more realistic growth strategies was an important phenomenon from the viewpoint of their people’s welfare. But this did not constitute a very significant shift in the structure of the global economy.

But the past decade marked a watershed. Not only had the BRICs become important, but other emerging markets—the East Asian Tigers, Mexico, Turkey, Chile, and others—had also altered policies and become more important participants in the international economy. As late as 1970, all developing countries accounted for only 25 percent of world exports; by 2010, their exports were 39 percent of the world total, up from 25.4 percent only ten years earlier—a huge shift!


II. WHERE THE BRICS ARE NOW2

At the present time, four of the emerging markets with the largest populations and real GDPs have become important players in the international economy. Per capita incomes of Brazil, Russia, India, and China on latest estimates were respectively $12,850 ($12,500 at PPP), $13,650 ($l7,750 at PPP), $1,940 ($4,170 at PPP), and $6,120 ($9,280 at PPP). These compare with an estimate for the U.S. per capita income of $49,340 (and the same at PPP).

These numbers alone testify to the great variation in the situations and relative weight of the BRICs. Total GDPs in 2010 are estimated to have been: Brazil, $2.1 trillion; Russia, $1.5 trillion; India, $1.7 trillion; and China, $5.9 trillion (compared to the U.S. GDP of $14.6 trillion, and $5.5 trillion for Japan). Even including China, the real GDP of the four does not equal that of the United States. Except for China, their GDPs are below those of the larger countries in the European Union (France’s GDP is $2.6 trillion).3

While it can be argued that at PPP the relative weight of the BRICs is somewhat larger, one can question whether PPP is a relevant measure when estimating economic size relative to the rest of the world. But either way, the notable aspects of the BRIC economies are that

- all of them have grown rapidly; - their share of world trade has grown very rapidly; - all started as relatively poor countries, but especially India and

China; and - none has per capita incomes even close to those of the industrial

countries.

While the industrial countries have experienced a reduced relative importance, the BRICs still have a long way to go to reach industrial country status. And each has a number of challenges to meet along the away, although they differ among themselves.

Brazil had a much higher per capita income than the other BRICs thirty or forty years ago, and has the second highest per capita income of the four behind Russia. It has also had the slowest growth of the four in recent years, and its relatively more rapid growth only started in about 2005. It would appear to be challenged even to maintain a 4 to 5 percent growth rate in coming years (growth in 2012 is estimated to have been 3.5 percent, and even that resulted in, or was accompanied by, some overheating). In addition, the government has, in recent months, been undertaking policies that would appear detrimental to growth prospects over the long-run. At least as a partial offset, the discovery of oil offshore may lead to a significant windfall in income and significant policy challenges to manage it successfully.

2. Economist Intelligence Unit, The World in Figures Countries, ECONOMIST, 2011. 3. Gross Domestic Product 2010, World Bank, http://siteresources.worldbank.org/

DATASTATISTICS/Resources/GDP.pdf (last visited Jan. 19, 2013).


Russia has the highest per capita income of the group, and experienced fairly high growth until the recent recession. In Russia’s case, however, the heavy dependence on natural resources, and especially on gas and oil, leaves the economy challenged to provide economically efficient incentives for the development of non-natural resource activities. Russia’s human capital is very good, and with appropriate policies growth could accelerate, but in the short to medium-term, the prices of Russia’s major commodity exports will be a significant determinant of economic growth. Russia is also confronted with a demographic challenge: population has fallen in recent years, and it is not clear whether, and how, that can be reversed.

So the two of the BRICs with the highest per capita incomes also face the biggest challenges in maintaining or accelerating economic growth. India, with the lowest per capita income of the group, has grown more rapidly than almost any other sizeable country, except China, in the past decade. Most economists agree that attaining better fiscal balance, developing infrastructure, increasing flexibility in the labor market, and further removing the heavy hand of bureaucracy from economic activity, will be needed to maintain the rate of acceleration of economic growth. In the short-run, prospects for these needed reforms do not appear promising, especially as the government is mired in political challenges that will probably stalemate reform.

India may potentially have a demographic dividend over the next several decades, as her labor force will grow significantly more rapidly than the total population. But to benefit from that, major labor market reforms will be needed. India still has a very large population of very poor people. Despite success to date, the need for rapid growth of a kind that enables improvement in the living standards of the poor is urgent.

China, the largest of the four BRICs by far, had the highest growth rate of the group throughout the last decade. Its track record over the past three decades is impressive because the authorities have been able to find appropriate policy responses to all of the challenges that they have been confronted with, given such rapid change. The leadership appears to accept that growth must slow down somewhat, with a stated target for 2012 of 8.5 percent. If that were achieved, China would continue to be the most rapidly growing BRIC nation. But questions arise as to inflationary pressure, the sustainability of the export drive, environmental sustainability, and more.

Moreover, China has relied on export-led growth for the past three decades. Domestic consumption is around 35 percent of GDP, and there is considerable evidence that there is wasteful government investment as efforts have been made to maintain the growth rate. The Chinese authorities clearly recognize that they must undertake policies that will result in an increase in domestic demand and raise its contribution to growth. Do- ing so is clearly a priority for them, but also presents a number of challenges. Going forward, China also faces a demographic challenge similar


to that in the industrial countries. The legacy of the one-child policy is that new entrants to the labor force are already falling, and there is not a demographic dividend, which India can potentially use to good effect.

Although the BRICs have been very successful to date, each faces a number of challenges going forward. For Russia, the key challenge lies in removing the legacy of the Soviet era, and finding ways to improve the business climate for nontraditional activities. For Brazil, financial liberalization and reducing government intervention will be a key. For India, finding the political will to carry out major reforms in the bureaucracy and the rule of law to accelerate infrastructure development and reform labor market regulations (to enable more rapid employment growth), constitutes a significant challenge. The Chinese are confronted with the need to prevent further overheating of the economy while simultaneously shifting reliance for growth from exporting to domestic demand.

III. IMPLICATIONS FOR THE INTERNATIONAL ECONOMY

The rise of the BRICs and other emerging markets has raised a number of issues for the world economy. Many of them are issues that would have arisen regardless of which country, or group of countries, was growing rapidly and increasing its share of world GDP and trade.

There is nothing that guarantees that the BRICs will continue their rapid growth, and that needs to be kept in mind. All face challenges, and all are still relatively poor when contrasted with middle income countries. Several countries have grown to middle income status, only to experience a slowdown in growth and become stuck in that status. All four BRICs need to alter some of their economic policies if growth is to continue successfully.

For several reasons the industrial countries need to be supportive of growth efforts. On one hand, those reformers seeking to sustain growth rates need support, and sustaining growth rates is certainly in the industrial countries’ interests. On the other hand, the BRICs remain poor cousins, and those concerned with poverty alleviation need to recognize that success to date has lifted many out of extreme poverty in India and China, but that there is still a long way to go.

Moreover, the self-perceptions of the BRICs remain that they are weak relative to industrial countries. Ironically, the BRICs have not even recognized the extent to which their influence in international fora has increased. On the other hand, the industrial countries tend to overestimate the extent to which the BRICs have succeeded.

A more realistic assessment by BRICs and industrial countries alike, as to the magnitude of the changes that have taken place, would probably improve understanding on both sides.

From their changed status—and potential future changes—two sets of challenges arise for policy makers in the rest of the world. The first concerns the international organizations and their role and governance. The second focuses on economic policy.


Turning first to international organizations, the intent from the l940s was that voting shares should be approximately equal to economic weight.4 But with the rapid growth of the emerging markets, and especially of the BRICs countries, the shifting of voting shares has fallen behind the economic realities despite slow moves in the appropriate direction. Finding means to enable the governance structure of the institutions to more closely reflect that economic reality is a challenge, both because the countries most overrepresented (mostly European) are reluctant to accept reduction in their shares (and seats on the Executive Board), and because finding a formula that will satisfy most parties is exceptionally difficult. It must also be said that the BRICs, and other emerging markets, need to recognize their interest in the system as a whole to a greater extent than they have heretofore—when they regarded themselves as lacking influence and essentially were free riders on global economic growth.

But in addition to governance, the international economic organizations are assuming increased importance in the international economy as the relative weight of the industrial countries (and in particular the G-7) diminishes. It is all too easy for the industrial countries to assume that they can continue to dominate decisions, as they did in earlier times. But in those times, the industrial countries represented a very high share of what mattered in the international economy, as I showed earlier. As more countries develop, reaching consensus among a small group, such as the G-7, will be increasingly unsatisfactory and prove ineffective as a means of addressing global economic problems. When a group such as the G-7 cannot lead, more will have to be done through the IFIs.

A second major implication concerns international trade. As I mentioned earlier, the increased openness of the international trading system was a key factor in the growth of the international economy, but also was crucial in permitting poor countries to alter their economic policies to achieve rapid growth.

Over the past decade, support for the World Trade Organization (WTO) appears to have diminished, and the Doha Round of multilateral trade negotiations has languished. That has happened despite the fact that faster and cheaper modes of transport and communications have opened, increasing possibilities for gains from trade, especially in services. But failure to complete the Doha Round has led to a paralysis of multilateral decision-making on trade issues.

As the BRICs and/or others increase in importance, the need for an effective multilateral decision-making body, such as the WTO, will increase. Yet policy in most industrial countries seems to have turned away from the WTO, whether because of protectionist pressures or because of frustration at the failure to conclude the round. The rise of the BRICs

4. It seems to be forgotten that in the l940s, at the IMF and the World Bank, the

United States and the United Kingdom held more than half the voting power between them. Today the U.S. share is down to 17 percent.


and other emerging markets makes the WTO, like the IMF and World Bank, more important, not less so.

The industrial countries must also recognize the increased importance of the emerging markets. A key and sensitive issue here is the confrontation, or near-confrontation, between the United States and China over the Chinese exchange rate. Both sides agree that there are imbalances that should be corrected. The Chinese solution, not surprisingly, is to say that the United States should save more and spend less. The U.S. solution is, of course, that China should permit its currency to float and encourage increased domestic consumption.

Obviously the solution (unless fortuitously things happen to go right) is for Chinese measures to increase domestic demand, and American measures to increase domestic savings. Indeed, one could even argue that it behooves the industrial country, in this case the United States, to increase its savings rate in its own self-interest, regardless of what happens in the rest of the world. Finger pointing at China is both counterproductive and ineffective; raising U.S. savings would, in any event, be in the U.S. self- interest. Solving that particular problem would go a fair distance to eas- ing the tensions that naturally arise when a rapidly growing economy is increasing its share in the international economy.

With these key issues, and many subsidiary ones, there still remain questions. A first is whether growth will be sustained in the BRICs and other rapidly growing emerging economies. After all, Argentina is thought to have been the richest country in the world, or close to it, in l900. Its economy faltered after that. Myanmar is estimated to have had the third highest living standards in Asia in the early postwar period, and is now one of the poorest countries.

Even for very successful economies, there is no guarantee that growth will be sustained. Growth always presents challenges that must be, more or less, satisfactorily addressed if growth is to be continued at satisfactory rates. That is true for industrial countries, as well as for emerging markets, and of countries that still have not begun to make rapid progress.

But the BRICs and other emerging markets have done very well so far. And they have overcome challenges that would have resulted in growth- reducing policies in many other countries. It is hoped that they will persist. They are important because of their size; their living standards are important because we, as a people, abhor poverty; and their growth can prove an important boost to the entire international economy.

B

THE BRAZILIAN MIRACLE

AND ITS LIMITS

Peter Kingstone*

King’s College London March 29, 2012

Paper prepared for presentation at the Conference on BRICs, Tower Center, SMU

I. INTRODUCTION

RAZIL has enjoyed a high status among developing countries through much of the twentieth century. Its large size and population, coupled with abundant natural resources, made it a “sleeping

giant” that had dwarfed even its colonizer, Portugal, well before independence arrived in the early nineteenth century. But for most of its history, the “sleeping giant” did not awaken—as Brazilians jokingly observed, “Brazil is the country of the future, and always will be.” Even its miracle years of 1967-1974 proved short-lived, culminating in a much longer period of debt, inflation, and declining wealth and welfare.

As of 2012, Brazil appears once again to be enjoying its status as a leading developing economy, this time as a member of the “BRIC” group of emerging markets poised to challenge the position and influence of the developed economies. Yet, the country’s long history of failing to live up to its promises raises the question of whether this period is any different than other episodes of rapid growth in the past. This paper explores the issue over three sections. In the first section, the paper makes the case that this current period does indeed offer evidence of performance wor- thy of celebration. In the second section, the paper reviews some of the areas of strong performance and establishes that there are grounds to believe that something durable and sustainable might be happening in Brazilian politics and the economy. In particular, the argument centers on the consensual support for a “pragmatic neoliberal” orientation to economic policy that combines elements of both market and state-led models of development. In the third section, the paper considers some of the

* Peter Kingstone is Professor of International Development and Co-Director of the

Institute of International Development at King’s College London. He has published various articles and book chapters on the subject of democratization and the politics of neoliberal economic reforms. His publications include Crafting Coali- tions for Reform (1999) and The Political Economy of Latin America: Reflections on Neoliberalism and Development (2010).

455


deep challenges that continue to face Brazil and limit the possibility of meaningful and sustainable development progress. The conclusion reviews the evidence and warns that Brazil has made important strides on the backs of good policy and sound economic management. Neverthe- less, there are real risks of falling into a commodity trap and losing out in the longer term to other emerging markets, particularly China.

II. A BRAZILIAN MIRACLE?

Brazil’s development progress, particularly over the 2000s, has granted it a starring role among emerging markets, one of the so-called “BRIC” countries. As of 2012, Brazil’s economic performance led it to surpass the United Kingdom as the sixth largest economy in the world, and its greatly improved international stature manifested itself in a variety of ways, including successful bids to host both the 2014 World Cup and the 2016 Summer Olympics. This newfound stature comes as something of a surprise for long standing observers of the Brazilian political economy. From the 1980s into the early 2000s, a wide array of analysts focused on what were believed to be critical impediments to overcoming deeply rooted economic, political, and social problems. Brazil’s political institutions, in particular, made the country “ungovernable,” suffering from what Barry Ames called a “deadlock” and Bolıvar Lamounier referred to as “hyperactive paralysis.”1

These institutional dysfunctions suggested that policymakers would not be able to get policy solutions to long-standing problems through the cha- otic legislative environment. Those problems included enormous challenges like bringing down high levels of poverty and inequality; reforming financially unsustainable social policies that did little for the mass of Brazilians; promoting adjustments among uncompetitive producers, dependent on decades-old protection and incapable of integrating into a globalizing economy; improving inadequate infrastructure, suffering from years of neglect; cleaning up severely disordered public finances; and perhaps most notably, taming the high persistent inflation that had been the scourge of the country since the 1940s. In short, the set of challenges facing Brazilian policymakers was formidable and appeared to over- whelm the political mechanisms for advancing and implementing solutions.2

1. Barry Ames, The Deadlock of Democracy in Brazil. Berkeley, CA: University of

California Press, 2001; Bolıvar Lamounier, “Brazil: The Hyperactive Paralysis Syn- drome” in Constructing Democratic Governance: Latin America and the Carib- bean in the 1990’s, edited by Jorge J. Dominguez and Abraham F. Lowenthal. Baltimore: The Johns Hopkins University Press, 1996.

2. The issue of Brazil’s political institutions has provoked one of the richest and most productive debates in the politics of the developing world. Early works critiquing the country’s institutions, many published by U.S.-based scholars, led to a response, largely by Brazilian scholars, arguing that the system was largely func- tional. This latter wave of scholarship has made considerable advances in identifying and elaborating a far more detailed and in-depth portrait of the functioning of Brazil’s institutions. For a review of the rise of this alternative view,

2012] BRAZILIAN MIRACLE 457

Through most of the period since 1985, the year democracy returned to Brazil after twenty-one years of military rule, the country’s performance matched the low expectations. Economic growth was erratic at best. In- flation remained at crippling levels and provoked repeated and often extreme measures to contain it. Poverty, inequality, and unemployment all remained high. Debt, both external and internal, and persistent government deficits complicated struggles to bring order to the macro-economy. Politically, the period from 1985 to 1994 witnessed a new constitution, derided and declared a failure almost immediately; at least two completely ineffective presidents, and a third impeached after nearly three years; marked by continuous fighting with the legislature; and a massive scandal that led to a rash of congressional resignations. As of the early 1990s, The Economist’s labeling of Brazil as “drunk” or Scott Mainwar- ing’s accusation of “feckless democracy” seemed perfectly apt.3

Eighteen years later, the picture has changed dramatically. Space considerations do not permit a full examination of how Brazil has altered its path. But the extent of the change does invite some effort to substantiate the enthusiasm with which much of the world sees Brazil today—a new “Brazilian miracle.”4 There are least three different indicators that can be used to demonstrate the degree of Brazil’s success: international stature, economic data, and the quality of policy.

International Stature: One of the clearest, albeit subjective, indicators of Brazil’s progress is the country’s new status in the world. Winning the bids for the 2014 World Cup and the 2016 Summer Olympics, both to be held in Rio de Janeiro, point to the perception that Brazil is a leader in the global South. But Brazil’s status also finds expression in its leadership position in the effort to expand the G-8 to the G-20, as well as its role in several new organizations challenging the architecture of the global political economy. As a “BRIC” country, Brazil has met with its counterparts to develop common positions on key issues of international political economy. It has also moved on a new organizational initiative with India and South Africa, IBSA, as well as a new South American organization, UNASUR. Moreover, Brazil’s strengthened performance

often referred to as “coalitional presidentialism,” see Timothy Power, “Optimism, Pessimism, and Coalitional Presidentialism: Debating the Institutional Design of Brazilian Democracy.” Bulletin of Latin American Research, Vol. 29, No. 1, 2010: pp. 18-33.

3. The Economist, “Drunk Not Sick: Brazil, the Blessed and the Cursed (Survey of Brazil),” December 7 (1991), p. S1; Scott Mainwaring, “Brazil: Weak Parties, Feck- less Democracy,” in Scott Mainwaring and Timothy J. Scully, eds., Building Demo- cratic Institutions: Party Systems in Latin America. Stanford, CA: Stanford University Press, 1995.

4. The ‘Brazilian Miracle’ typically refers to the period 1967-1974 when rapid growth and industrial deepening made Brazil one of the best performing economies in the world. Unfortunately, the real progress was overstated, the real obstacles under- stated, and ultimately the havoc that began with the 1973 oil shock led to the dis- appointments of the “lost decade” of the 1980s. For what turned out to be a prescient skepticism about the ‘miracle’ see Albert Fishlow, “Some Reflections on Post-1964 Brazilian Economic Policy” in Alfred Stepan, ed., Authoritarian Brazil: Origins, Policies and Future. New Haven, CT: Yale University Press, 1973.


has turned the country into the leading model of a democratic political economy, supplanting both Chile and Venezuela (too radical and destabi- lizing) among Latin American nations. Thus, recent leftist victories in both El Salvador and Peru featured presidents who explicitly evoked “Lulism”5 and the Brazilian model in their plans for governing. Finally, Brazil has assumed a greater visibility in the global political economy in a variety of ways, including the prospect of developing into a leading producer of oil and through its multilatinas’ (Latin American multinational corporations) operations around the world.

Economic Performance: If Brazil’s international stature is somewhat subjective, its economic performance paints a striking picture of change. From 1985 to 2000, Brazil suffered from volatile growth, chronic debt and deficits, high poverty, inequality and unemployment, and high inflation through 1994. Yet, by 2003, growth stabilized at modest, but positive levels; debt and deficits were replaced by surpluses; poverty, inequality, and unemployment all declined dramatically; and inflation disappeared as a serious threat. The data presented below tells a stark story. Brazil is not among the fastest growing economies in the world, but the contrast between the pre- and post-2003 period is so striking that it is impossible to deny that something significant happened.

For example, GDP growth between 1988 (the year the young democracy’s constitution was promulgated) and 2003 averaged only 1.8 percent per year. Real wage growth was better, averaging 4.2 percent per year, although both GDP and real wage performance were very volatile. The Real Plan of 1994 played a crucial role in reducing inflation from an average of over 1300 percent per year to an average of only 9.3 percent through 2003. By contrast, average GDP growth since the early 2000s has roughly doubled to 3.6 percent with average GDP/capita growth close to 3 percent. Inflation, even with pressure from rising capital inflows and currency appreciation, has remained below 6 percent per year. The GINI coefficient fell from highs around .60 in the 1990s to roughly .54 by the late 2000s.

The Quality of Policy: The country’s performance since 2002 has improved, but there is no question that growth in the global economy, particularly driven by Chinese expansion and commodity consumption, has played a critical role. One could argue, then, that Brazil’s success is to have had the good fortune to be a major exporter of commodities like soy. High commodity prices and unusually positive terms of trade for commodities are an important factor in Brazil’s success, but the country also stands out for the quality of policies passed, especially since 1994. That quality has shown in a number of different areas, such as health

5. “Lulism” is a term coined by The Economist. See, for example, “Stepping into Outsize Shoes.” The Economist, November 4, 2010.


care,6 privatization of telecommunications,7 and financial regulation. But probably no area has captured as much attention globally as the conditional cash transfer program, Bolsa Famılia (Family Stipend).

Bolsa Famılia is a monthly stipend targeted to the poorest Brazilians (about eleven million families). It has several important features that ele- vate it beyond a simple aid program and reveal the quality of both the design and the implementation.8 The program’s goals are to alleviate poverty and hunger while developing human capital. In addition, the design empowers female heads of households and dramatically reduces the possibilities for clientelist or partisan manipulation. Each month, poor households identified locally and verified by census data, receive cash transfers with sliding values depending on income and the number of children. The money is transferred electronically and drawn through a debit card to prevent middlemen and/or local officials from withholding or manipulating payments. Mothers receive the debit cards, because fathers are frequently absent in poor households; and if they are present, they are much less likely to spend money on the household. Finally, households need to meet a series of requirements in order to receive payments, including regular medical check-ups for children and at least an 80 percent attendance rate in school.9

The program is not without flaws or critics,10 but there is little argument about several tangible benefits. First, it has contributed to an ongo-

6. See James McGuire, Wealth, Health and Democracy in East Asia and Latin

America, New York: Cambridge University Press, 2010 for a discussion of the enormous advances in health care achieved in Brazil over the 1990s and 2000s.

7. Brazil’s regulatory institutions are still a work in progress, but the privatization of Telebra s and the subsequent regulation of the sector remains one of the more successful cases in the region. See Peter Kingstone, “Privatizing Telebra s: Brazilian Political Institutions and Policy Performance.” Comparative Politics. Vol. 36, No. 1, 2003: 21-40; and Aline Diniz Amaral, Peter Kingstone and Jonathan Kriekhaus “The Limits of Economic Reform in Brazil,” in Peter Kingstone and Timothy Power, eds. Democratic Brazil Revisited. Pittsburgh: University of Pittsburgh Press, 2008.

8. See Mo nica Haddad, “A Spatial Analysis of Bolsa Famılia: Is Allocation Target- ting the Needy?,” in Brazil under Lula: Economy, Politics and Society under the Worker-President, Joseph L. Love and Werner Baer, eds. New York: Palgrave MacMillan, 2009.

9. Details of the policy can be found in Natasha Borges Sugiyama, “Theories of Dif- fusion: Social Sector Reform in Brazil,” Comparative Political Studies 41, no. 2, 2008. The process of political diffusion and ultimately expansion into a national policy is discussed in Natasha Borges Sugiyama, “Diffusion of Good Government: Social Sector Reforms in Brazil.” Notre Dame, IN: University of Notre Dame Press, Forthcoming, as well as Marcus Andre Melo, “Unexpected Successes, Unan- ticipated Failures: Social Policy from Cardoso to Lula” in Peter Kingstone and Timothy Power, eds. Democratic Brazil Revisited. Pittsburgh, University of Pitts- burgh Press, 2008.

10. Among the more interesting critiques is Anthony Hall, “Brazil’s Bolsa Famılia: A Doubled Edged Sword?” Development and Change, 2008, vol. 35, no.5, 2008: 799- 822, as well as Edmund Amman and Werner Baer, “The Macroeconomic Record of the Lula Administration, the Roots of Brazil’s Inequality, and Attempts to Overcome Them,” in Brazil under Lula: Economy, Politics and Society under the Worker-President, Joseph L. Love and Werner Baer, eds. New York: Palgrave MacMillan, 2009.


ing decline in the level of poverty and inequality in the roughly ten years since its inception. While Bolsa Famılia arguably accounts for at most only a small part of this change—much of it is driven by economic growth;11 reports suggest that it has helped alter household consumption patterns toward food and clothing for children. Furthermore, school enrollment rates have risen to roughly 100 percent through the eighth grade. Finally, the program appears to have succeeded at delivering a popular and effective social good without falling prey to either clientelis- tic or partisan manipulation. In sum, the example of Bolsa Famılia demonstrates that Brazil’s international standing and solid economic performance rest on more than good fortune.

III. UNDERSTANDING BRAZILIAN SUCCESS

The Brazilian success story stands on the emergence of broad political acceptance of a “pragmatic neoliberal” orientation to the economic policy. Brazil’s pragmatic neoliberal model rests on three pillars: a commitment to macroeconomic stability; a stronger commitment to market- oriented policies, but with a continued, pragmatic role for the state; and social policies to address the legacy of poverty and inequality in the country, of which the Bolsa Famılia, discussed above, is the most widely discussed example. This path began to take form under President Collor (1990-1992) and has deepened and broadened in its support since then to the point that, as of 2012, there is no real alternative in the electoral arena. The discussion below elaborates on the first two elements of this model.12

A. MACROECONOMIC STABILITY

Macroeconomic stability presents perhaps the greatest surprise from the country’s performance in the 1980s and into the 1990s. Brazilian inflation appeared unsolvable, rooted both in inertial expectations and structural sources of financial imbalance. Brazil wrestled with high external debt, large budget deficits, and a weak financial system. High external debts were a legacy of the “lost decade.” Over the 1980s, Brazilian export performance improved, but debt-servicing costs remained high while low growth limited the country’s capacity to find domestic savings. The 1988 Constitution contributed to the weakness of public finances

11. Nancy Birdsall, Nora Lustig, and Darryl MacLeod, “Declining Inequality in Latin

America: Some Economics, Some Politics” in Peter Kingstone and Deborah Yashar, eds. The Handbook of Latin American Politics. New York: Routledge Press, 2012.

12. For an in-depth discussion of Brazil’s “pragmatic neoliberal” model and its origins, see Peter Kingstone and Aldo Ponce, “From Cardoso to Lula: the Triumph of Pragmatism in Brazil,” in Wendy Hunter, Raul Madrid, & Kurt Weyland, eds. Leftist Governments in Latin America. Cambridge University Press, New York, 2010. The label “pragmatic neoliberalism” comes from Eduardo Silva in reference to the Pinochet regime in Chile in the 1980s. See Eduardo Silva, State and Capital in Chile Business Elites, Technocrats, and Market Economics Boulder: Westview Press, 1996.


through mandated transfers to the state and local level without accompa- nying spending obligations. As a result, this perverse fiscal federalism consistently undermined federal efforts to reduce budget deficits while facilitating patronage and clientelist spending behavior at the state and local level. Legislators in the national level Congress tended to work together to protect transfers to their own states specifically as well as resist efforts to restore revenues at the federal level.13

Persistent budget deficits and their related consequences for national debt (external and internal) also made it difficult to solve inflation. Infla- tion had been the scourge of Brazil’s economy almost continuously since the 1940s. The military dictatorship had developed and implemented a system for managing inflation through indexation of virtually all contracts and prices (“monetary correction”), but the inflationary spiral that took off under restored democratic rule after 1985 overwhelmed it. High inflation contributed to weak control over public finances as well as the private banking system. In large measure, that was because high inflation made it difficult to precisely measure assets and liabilities. Thus, high debt, persistent budget deficits, chronic high inflation, and disordered finances in both public and private institutions imposed seemingly impassa- ble barriers to development.

Yet, by the late 1990s, Brazil was well on its way to cleaning up the mess inherent in this cluster of interrelated problems. The starting point was Fernando Henrique Cardoso’s (PSDB) Real Plan negotiated over 1993 and gradually implemented over 1994. The plan’s combination of transparency, negotiation, and gradualism were vital ingredients in the effort to convert Brazil’s currency into a new one, the real. The real was loosely linked to the dollar and premised on a negotiated fiscal adjustment that temporarily shifted sufficient revenues back to the federal government to lend credibility to the administration’s anti-inflation commitments. The effects appeared rapidly. The full conversion to the real took place in July of 1994, with inflation running at roughly 25 percent per month. By October of 1994, inflation had fallen to 2 percent per month. Inflation has remained at manageable levels, averaging below 10 percent since then and below 8 percent almost continuously through the 2000s.

The negotiation resulting in the temporary drawback of revenues—the “Emergency Social Fund”—turned out to be the opening salvo in an ongoing round of efforts to restore federal control over revenues. As Kurt Weyland has argued, President Cardoso effectively traded short- term patronage benefits for administrative reforms that restored the federal government’s fiscal balance.14 In addition, passage of a new tax on

13. Fernando Luiz Abrucio, “Os baro es do poder: O poder dos governadores no Bra-

sil, pos-autorita rio.” Master’s Thesis, Department of Sociology, Universidade de Sa o Paulo, 1994.

14. Kurt Weyland, “The Brazilian State in the New Democracy.” Journal of Interna- tional Studies and World Affairs 39:4, 63-94, 1997.


financial transactions led to a surge in federal tax revenues. From 1994 to 2011, tax revenues rose from roughly 25 percent of GDP to over 35 percent of GDP, sharply improving the government’s fiscal position and enhancing the credible commitment to keep inflation low.

Ultimately, the Real Plan collapsed as a run on the currency in January 1999 forced the government to give up on the dollar as a loose anchor. But a much stronger fiscal position allowed the Cardoso administration and its successors to rely on inflation targeting as a mechanism for keeping inflation low, even without the exchange rate anchor. Both President Cardoso (PSDB) and his Workers’ Party (PT) successors, Lula da Silva and Dilma Rousseff, have consistently announced annual primary surplus targets as high as 4 percent of GDP in their bid to maintain low inflation. The challenge has grown since the 2008 global crisis as Brazil’s economic performance has lured in vast amounts of foreign currency, driving up the real and generating inflationary pressure. Yet, inflation has remained below 6 percent per year due to the government’s diligence in meeting their targets.

Reduced inflation also contributed to Brazil’s new economic strength by allowing the Cardoso administration to begin cleaning up the banking system. Weak banks, private and public, had survived by profiting from the inflation tax as well as by the confusion over the exact state of their assets and liabilities. Reducing inflation forced banks to operate more efficiently and competitively and exposed fragile institutions—particularly state level banks that had relied on access to the federal government to continue to function. The Cardoso administration initiated a series of programs to strengthen the financial sector, including privatization of some state-owned institutions, as well as closing down or supporting the sale of weak institutions. The reform process did increase federal debt considerably, but the end result was a much stronger financial system supported by much better prudential regulation.15

The results of the country’s improved finances probably showed most clearly in the response to the 2008 global crisis. The initial effects of the crisis were transmitted to Brazil as a trade shock, with export volumes and prices falling sharply in early 2009. But while falling exports pushed the country into recession, the typical historic pattern of financial crisis did not emerge. Instead, the Lula administration responded with a series of stimulus measures, including an expansion of consumer credit and reduction of taxes on a range of consumer durables as well as a large-scale infrastructure investment program (the Program for the Acceleration of Growth—PAC). By late 2009, growth had resumed and capital was flowing into Brazil again with rising bond issuances and falling yields.16

15. The details of public sector and financial system reforms are detailed in Albert

Fishlow’s Starting Over: Brazil since 1985. Washington, DC: Brookings Institute, 2011.

16. See Jose Antonio Ocampo, “Latin American Development after the Global Crisis” in New Ideas on Development after the Financial Crisis, Nancy Birdsall and Francis Fukuyama, eds. Baltimore: The Johns Hopkins University Press, 2011 for a discus-


The country’s macroeconomic position was greatly improved, as Brazil paid off its dollar denominated external debt by the late 2000s and in fact, as of 2012, is an international creditor nation. Indeed, the IMF has turned to Brazil among other leading emerging markets for contributions to the European Financial Stability Facility (EFSF)—something that Bra- zil has indicated willingness to do, but in exchange for reforms of the IMF power structure.17 The sharp decline in external debt, in turn, reflects the country’s tremendous increase in export revenues over the 2000s. Export revenues have roughly quintupled since 2000 and while imports have increased as well, the current account generated large surpluses through much of the 2000s. Current account surpluses, capital inflows, and an appreciating currency all drove external debt down while high tax revenues helped drive down even domestic debt from a recent high of roughly 80 percent of GDP in 2003 to roughly 65 percent in 2011, despite the Lula administration’s turn to fiscal stimulus in the wake of the 2008 crisis.18

B. STATE SUPPORT AND MARKET REFORM

Brazil’s financial stability has been in turn both a cause of improved economic competitiveness as well as benefiting from improved micro- level performance. The improved performance has rested on two elements: greatly increased competitiveness in the agricultural sector and the emergence of a segment of leading firms in industry and services—the so-called multilatinas (the set of Latin American multinational enterprises among which Brazilian firms figure prominently). Agriculture, agribusiness, and agroenergy form the basis of Brazil’s position as an “agricultural superpower.”19 In fact, by 2005, Brazil was either the leading or second largest exporter in the world of a range of agricultural and agroenergy products, including soy, sugar/ethanol, coffee, orange juice, and meat. By 2011, Brazilian exports reached record volumes and values on the back of a nearly fourfold increase in commodity exports since 2005. The rise of agriculture actually dates back to the 1980s and ironically stems in no small measure from the withdrawal of government support and protection and the resulting need for the sector to improve its competitiveness.20 In the 1990s and into the 2000s, the government’s role

sion of the effects of the crisis and the response both in terms of stimulus spending and reactions in financial markets.

17. Annie Lowry, “I.M.F. Adds $430 Billion in Emergency Lending Ability,” New York Times, April 20, 2012. Accessed online June 30, 2012 at http://www.nytimes. com/2012/04/21/business/global/imf-adds-430-billion-in-emergency-lending-ability. html.

18. Data from Instituto Brasileiro da Geografia e Estatıstica (IBGE), accessed online June 30, 2012 at http://www.ibge.gov.br.

19. Andre Meloni Nassar, “Brazil as Agriculture and Agroenergy Superpower,” in Brazil as an Economic Superpower? Understanding Brazil’s Changing Role in the Global Economy, Lael Brainard and Leonardo Martinez-Diaz, eds. Washington, D.C.: Brookings Institute, 2009.

20. Steven Helfand and Gerva sio Castro de Rezende, “The Impact of Sector-Specific and Economy-Wide Policy Reforms on the Agricultural Sector in Brazil: 1980- 1998.” Contemporary Economic Policy, 22:2, pp. 194-212.


has been essentially complementary to private sector improvements, mainly through infrastructure investment, support for research, and negotiating commercial relations.21

The government’s role outside of agriculture has also worked to com- plement the market, particularly through support from the National Bank for Social and Economic Development (BNDES) for Brazil’s emergent sectors and firms. This represents a significant change from the “develop- mentalist” period of the 1950s through the 1970s, when Brazilian government intervention largely operated against markets—either through displacement of private firms, or by subsidizing private production and sheltering it from competitive pressures. By contrast, contemporary policy is aimed at strengthening private firms’ and sectors’ participation in global markets. The BNDES has actively supported key multilatinas such as Odebrecht (construction), Andrade Gutierrez (telecoms), Embraer (aviation), and CVRD (mining). BNDES financing has supported increasing sales, exports, and research and development (R&D) domestically and even expanding operations and acquisition of assets in new markets.22

Finally, the Brazilian government has promoted public-private partner- ships in infrastructure investment, primarily through the Plano de Aca o de Crescimento (PAC). The PAC, introduced in the wake of the global crisis of 2008-2009, injected roughly half a billion dollars to support private infrastructure investment. The PAC has not been as successful as hoped, and subsequent plans, such as the PAC2 or “Bigger Brazil,” have not been fully implemented. Furthermore, investments in infrastructure for the 2014 World Cup and the 2016 Summer Olympics, both in Rio de Janeiro, have fallen short of what is needed. Nevertheless, the new emphasis on supporting the private sector represents a shift in orientation. While there are still important elements of nationalism and protection- ism, the attitude towards the private sector and the international economy leans toward competitive integration and participation.

IV. THE LIMITS TO SUCCESS

While Brazil’s performance has generated enthusiasm both inside and outside the country, it is important not to overstate the case. Brazilian growth rates have looked good in the 2000s, but mostly in comparison to the country’s recent past or to the woeful performance of the developed economies. GDP growth has averaged only around 3.6 percent since 2000 and GDP per capita has averaged only 2.4 percent. Brazil weath-

21. Geraldo Barros, “Brazil: The Challenges in Becoming an Agricultural Super-

power,” in Brazil as an Economic Superpower? Understanding Brazil’s Changing Role in the Global Economy, Lael Brainard and Leonardo Martinez-Diaz, eds. Washington, D.C.: Brookings Institute, 2009.

22. Edmund Amman, “Technology, Public Policy and the Emergence of Brazilian Multinationals,” in Brazil as an Economic Superpower? Understanding Brazil’s Changing Role in the Global Economy, Lael Brainard and Leonardo Martinez- Diaz, eds. Washington, D.C.: Brookings Institute, 2009.


ered the 2008-2009 crisis well as GDP growth fell in the first half of 2009 before rebounding dramatically into 2010. But the rate of growth fell to 2.7 percent in 2011, led by very anemic results for industry, and projec- tions going forward are for continued modest performance, particularly if Chinese growth rates continue to slow along with declining consumption of commodity imports.23

This last issue points to one of the central concerns about Brazil’s performance over the last decade. Arguably, the main engine of the “miracle” is the dramatic increase in commodity exports, especially to China. Brazil exported roughly 6 percent of GDP in the 1990s in the wake of the trade liberalization process. As Brazil liberalized trade in the 1990s, exports rose considerably with manufactured goods leading the way. By 2000, exports of manufactured goods were over 50 percent of the value of total exports, exceeding the value of semi-manufactured and primary products combined. Exports to China were not vital and were almost entirely composed of commodities. But by 2011, the picture had changed considerably. Total exports had more than doubled in value to a total of 256 billion U.S. dollars, but more than 50 percent of that came from primary products, especially soy, iron ore, sugar, meat, and orange juice. Commodity exports increased by roughly four times between 2005 and 2010 alone. In addition, the dramatic increase in commodity exports was matched by the dramatic increase in dependence on China as a market. Soy and iron, two of Brazil’s most important exports, were heavily concentrated on sales to China, with over 40 percent of exports of soy and roughly one-third of iron going to China specifically.24

At the same time, currency appreciation has hurt manufacturing. The real has been appreciating (over 40 percent since 2010 alone and over 70 percent between 2003 and 2010)25 both because of Brazil’s export success and because it looks to be a safer haven than the debt-ridden developed economies. But the result is a weakening of Brazilian industry, with a sharp fall in the percentage of manufactured goods in total exports, especially since 2009, and a doubling of the coefficient of import penetration to 20 percent between 2003 and 2010. While roughly 75 percent of Bra- zil’s exports to China are commodities, China exports primarily manufactured goods to Brazil.

Perhaps the biggest indicator, however, of Brazil’s manufacturing challenge appears in estimates of export competition with other rising economic players, especially China. China’s export performance in both manufactured goods generally and in high-tech sectors specifically has

23. Data from the Instituto Brasileiro da Geografia e Estatıstica (IBGE), accessed on-

line June 30, 2012 at http://seriesestatisticas.ibge.gov.br. 24. Kevin Gallagher and Roberto Porzecanski, The Dragon in the Room: China and

the Future of Latin American Industrialization. Stanford, CA: Stanford University Press, 2010.

25. Annabelle Mourougane, “Examining the Appreciation of the Brazilian real.” OECD Economics Department, Working Paper No. 901. October 21, 2011. Ac- cessed online June 30, 2012 at http://www.oecd.org/eco/workingpapers.


grown dramatically over the past decade, more than doubling its share of global exports between 2000 and 2006. This has put Brazil and China in direct competition in a large number of export markets, with China pos- ing increasing threats to Brazilian goods. Kevin Gallagher and Roberto Porzecanski have charted this rising threat, differentiating between markets where Chinese exports are rising while Brazilian exports are falling (direct threat) and markets where both are rising, but China’s exports have been rising faster (partial threat).26 All told, they found that by 2006, 91 percent of all Brazilian manufactured exports and almost 94 percent of Brazilian high-tech exports were under threat from Chinese competition.

Brazil’s performance in the production and export of high-tech goods points to an additional source of concern about the country’s developmental progress. Sustainable and equitable development needs high quality jobs that in turn rest on the ability of the country to educate its citizens, produce high-skill labor, and develop and diffuse technology. These various elements of the “knowledge economy” are all areas where Brazil has made very limited progress even as other emerging market competitors have made considerable progress, again China in particular. The World Bank’s Knowledge Economy Index is an effort to capture the ability of a country to develop and diffuse technology and put it to productive use. Brazil ranks ahead of some of its competitors among middle income rising markets, including China, India, Mexico, and Turkey, but below others such as Russia, Chile, South Korea, and most of Eastern Europe. But perhaps more importantly, there has been only modest improvement between 1995 and 2012, with most of the improvement occurring between 1995 and 2000. In effect, commodity export profits have concealed the lack of success in promoting progress on deeper development goals.27

The lack of progress is not surprising when reviewing key policy areas related to developing a knowledge economy. For example, R&D spending, both public and private, fell over the 2000s, with significant decreases in state and federal spending offsetting at best modest increases in private expenditures.28 Brazil spends roughly 1 percent of GDP on R&D, well behind key competitors like China or South Korea.29 While China’s global share of high-tech exports has grown to over 13 percent by 2005 from .7 percent in 1990, Brazil’s has moved up and down from a low of .2 percent in 1995 to a high of .5 percent in 2000 and then falling to .4 percent by 2005. In short, the limited change in high-tech export perform-

26. Gallagher and Porzecanski, The Dragon in the Room. 27. Data from World Bank Knowledge Economy Index, accessed online June 30, 2012

at http://www.worldbank.org. 28. Ben Ross Schneider, “Big Business in Brazil: Leveraging Natural Endowments

and State Support for International Expansion,” in Brazil as an Economic Super- power? Understanding Brazil’s Changing Role in the Global Economy, Lael Brai- nard and Leonardo Martinez-Diaz, eds. Washington, D.C.: Brookings Institute, 2009.

29. Ibid.


ance is consistent with the limited changes in the Knowledge Economy Index.

Another key element limiting Brazil’s development is the weakness of its educational system.30 Bolsa Famılia, the highly touted and very successful conditional cash transfer program introduced by Fernando Henrique Cardoso and then expanded by Lula, greatly increased secondary school enrollments.31 But the success of Bolsa Famılia has not been matched by a sustained commitment to improving schooling. That is un- fortunate as Brazil’s public schools suffer from a cluster of deep structural problems stemming from both inadequate funding (such as lack of facilities, poor physical infrastructure, and low teacher pay) as well as institutional weaknesses (including poor teacher training and supervision and patronage hiring of unqualified principals and teachers).32 Moreover, public funding of education at all levels has actually declined over the 2000s even as enrollments have increased. One measure of the lack of progress in education is Brazil’s poor performance and lack of improvement on Programme for International Student Assessment (PISA) scores over the 2000s. Brazil’s results, especially in science and math, rank well below China, Russia, and Latin American leaders such as Chile, Costa Rica, and Uruguay. Similarly, Brazil ranks among the weakest countries on the percentage of students at or below the lowest level of proficiency in science and among the highest student to teacher ratios.33

The economy reflects this in a number of ways that limit Brazil’s performance in manufacturing generally and high-tech production particularly. Perhaps the most important way is in the scarcity of skilled labor and the low productivity of labor. Both factors have contributed to rising unit labor costs (although currency appreciation has played a significant role) over the past ten years. Unit labor costs have risen over 120 percent since 2003, hurting the competitiveness of Brazilian manufacturing.34

The scarcity of skilled labor has meant that firms rely heavily on unskilled labor even among more capital-intensive sectors of the economy.35

30. For an excellent review of the challenges facing Brazil’s education system, see Mary Arends-Kuenning, “A Report Card for Lula: Progress in Education,” in Bra- zil under Lula: Economy, Politics and Society under the Worker-President, Joseph L. Love and Werner Baer, eds. New York: Palgrave MacMillan, 2009.

31. In fact, the improvements in secondary school enrollments account for much of Brazil’s improvement in the Knowledge Economy Index from 1995 to the present.

32. See Bernd Reiter for a detailed discussion of the inequities and deficiencies of public education, particularly in poorer communities. Bernd Reiter, Negotiating Democracy in Brazil: The Politics of Exclusion. Boulder, CO: Lynne Rienner Press, 2009.

33. Programme for International Student Assessments data accessed online June 30, 2012, available at http://www.oecd.org.

34. The Brazilian Economy, March 2012, pp. 25-26. 35. Ben Ross Schneider, “Big Business in Brazil: Leveraging Natural Endowments

and State Support for International Expansion,” in Brazil as an Economic Super- power? Understanding Brazil’s Changing Role in the Global Economy, Lael Brai- nard and Leonardo Martinez-Diaz, eds. Washington, D.C.: Brookings Institute, 2009.


Investment in education is not the only challenge facing the country as it moves forward. The last problem for the development of the economy is that Brazil’s infrastructure is a crucial impediment to improving competitiveness. Unfortunately, investment in infrastructure—everything from energy to transportation—lags well behind the country’s needs. Even with increased government efforts in anticipation of the Rio-based Olympics and World Cup, infrastructure investment levels are far short of what is needed and well below investment rates of competitors like India, China, Chile, or Colombia. Between 2001 and 2010, both public and private infrastructure investment averaged less than 2.5 percent of GDP, while estimates are that at least 3 percent of GDP is necessary just to prevent deterioration.36 The lack of investment, in turn, is rooted in a series of factors. Among the most important are the low levels of savings—less than 20 percent of GDP—and the burden of social spending, most critically Brazil’s regressive pension system that accounts alone for 18 percent of GDP.37 Furthermore, the commodity boom discussed above helped generate record exports, but the associated currency appreciation also helped fuel comparable increases in imported goods, particularly of manufactured goods, minimizing available revenues for investment. In short, ongoing structural obstacles coupled with the limitations of the commodity boom stand in the way of the kind of productive investments necessary to secure prosperity in the medium to long term.

In sum, Brazil’s economic successes of the 2000s rest heavily on the commodity boom driven by Chinese consumption. But the boom has both weakened the manufacturing sector and concealed the urgency of the need to solve the deeper problems hindering development. Most critically, Brazil’s workforce is largely unskilled and, combined with a poor education system, prevents the economy from moving up the knowledge economy ladder. Unfortunately, some of Brazil’s most important competitors in the global economy, particularly China, have made much greater strides on this front. Equitable development sustained over the long term will depend on more than commodity exports. Brazilian policy makers understand that, but the measures necessary for addressing the challenges have not advanced in any notable way.

V. CONCLUSION

For those who have watched Brazil through the 1980s and 1990s, it is

hard not to feel optimistic about the country’s prospects. The voyage from chaos to “BRIC” has been impressive and credit is due to a sizable group of politicians, policy makers, and businesses. The economy stabilized and grew on the back of momentous improvements in macroeconomic management. The political environment has grown more orderly and provides a greater degree of certainty than ever before in the

36. The Brazilian Economy, August 2011, pp. 38-40. 37. The Brazilian Economy, February 2012, p. 10.


history of the New Republic. Brazilian firms have emerged as global leaders, while certain sectors, especially in agriculture and agroenergy, have emerged as genuine success stories. Nevertheless, the limits to growth and sustainable development remain significant. There is no guarantee that Brazilian policy makers will solve this in time to keep up with global competitors. Education, innovation, and infrastructure are critical pieces of the knowledge economy. Without investment today, there are no guarantees about the future.

R

DEVELOPMENT PROGRESS IN RUSSIA

Richard E. Ericson*

USSIA has been a prime mover in the organization of the BRIC group of nations. The BRICs, originally a Goldman-Sachs con- ception, comprise the leading developing economies in their re-

spective regions, with Russia central among the Eurasian emerging economies. In response to the question, “Can the BRICs be the drivers of world economic growth?,” we briefly explore Russian economic performance and structure, and the prospects for Russia to become a driver of the world economy in the coming decade.

I. THE RESURRECTION OF RUSSIA

Russia emerged from the collapse of the Soviet Union a disorganized and greatly shrunken economy, struggling through a “transformational depression” from 1991 through 1998, when Russia defaulted and its emerging financial markets collapsed. To the surprise of many, the economy “bottomed out” in the 1998 financial crisis and a strong recovery began; a recovery that coincided with the first Putin presidency, beginning with appointment by the resigning Boris Yeltsin on December 31, 1999, and then his first round election victory on March 26, 2000. Driven by a four-fold devaluation of the ruble and subsequent import substitution opportunities, tight fiscal and monetary policies, and renewed structural reform, the macro economy grew rapidly during Putin’s first presidential term, overcoming the transitional depression by 2004 (Eric- son, 2009).

Putin’s second term as president, 2005-2008, witnessed new economic growth and a significant and sustained, if unequally distributed, rise in the Russian standard of living. This growth of GDP, at a rate of over 7 percent per year in 2003-2008, made Russia the fastest growing as well as the largest economy in its region, and evidently a driver in regional, and indeed world, economic development. The performance indicators, presented in Table 1, gave credence to the Goldman-Sachs (2003) concep-

* Richard Ericson is a Professor and Chair in the Department of Economics at

Thomas Harriot College of Arts and Sciences, East Carolina University. He is actively involved with the Economics Education and Research Consortium (EERC), an organization formed in 1995 to strengthen economics education in former Soviet Union states. Dr. Ericson has also served as Professor of Economics and Director of The Harriman Institute at Columbia University and is a specialist in the study of economies in transition. His research has appeared in such publications as The Journal of Economic Theory, Research in Transportation Economics, and Econometrica.

471


tualization of the BRIC economies as presenting significant investment opportunities in emerging markets, with Russia as the Eurasian regional anchor.

Indicator 2000 2004 2005 2006 2007 2008 GDP2000 = 100 100.0 126.6 134.7 145.7 158.1 166.3 GDP % A 10.0 7.2 6.4 8.2 8.5 5.2 Industry % A 11.9 8.0 5.1 6.3 6.8 0.6 Investment % A 17.4 13.7 10.9 16.7 22.7 9.9 Unemployment % 10.2 8.3 7.6 6.9 6.1 7.8 Consumption % A 5.9 9.2 11.0 11.0 13.0 8.0 Current Account, $billion 46.8 59.5 84.6 94.7 77.8 103.5 FDI, $billion 4.43 9.4 9.0 29.9 47.1 76.0 Budget Balance % GDP 1.2 4.4 7.5 7.4 4.1 7.0 FOREX +Stab Funds, $billion 32.1 143.4 211.4 392.1 633.2 652.2 Inflation % 20.2 11.7 10.9 9.0 13.3 14.7 Fig. 1: Russian Macroeconomic Performance pre-Crisis (Source: Compiled from BOFIT Russia Statistics Reports).

Putin and the Russian leadership seized on this concept as a way to

return Russia to a significant position in world affairs. The humiliation of the 1990s—the loss of economic and military power, the loss of empire, and the encroachment of NATO in the post-Soviet spaces of Eurasia— had to be erased in the revival of Russia, and her renewed leading role in a new world order.1 Russia looked to international organizations and al- liances of convenience with other major and rising powers to restrain the United States and create a multi-polar world with Russia as a pole. Thus, Russia actively used the United Nations, OSCE, and other organizations in which it had a veto or decisive vote to block initiatives it opposed, and actively pursued the development of international organizations it could control such as the SCO, the Eurasian Economic Union, and a Gas OPEC.2 And with its substantial rate of growth, Russia had the eighth

1. This can be seen in numerous speeches by Putin throughout his time in office,

especially in the address to the Munich Conference on Security Policy, 10 February 2007, and in his recent election platform statements. See Vladimir Socor, Putin’s Eurasian Manifesto Charts Russia’s Return to Great Power Status, EURASIA DAILY

MONITOR (Oct. 7, 2011, 5:49 PM), http://www.jamestown.org/single/?no_cache=1& tx_ttnews%5Btt_news%5D=38501&tx_ttnews%5BbackPid%5D=512.

2. On the Eurasian Economic Community, see Eurasian Economic Community, EurAsEC Today, EURASEC (2011), http://www.evrazes.com/i/other/EurAsEC-to- day_eng.pdf. On the SCO, see SHANGHAI COOPERATION ORG., http://www.sect- sco.org/EN/ (last visited Sept. 15, 2012); Representatives from Russia, Qatar, and Iran, the top three holders of proven NG reserves with 60 percent of the total, met October 21, 2008, in Tehran to discuss forming a gas exporting cartel. Nothing, however, has come of this initiative. See Bruce Pannier, Russia, Iran, and Qatar Consider Gas Troika – Or Gas Cartel, RADIO FREE EUR. RADIO LIBERTY (Oct. 22, 2008), http://www.rferl.org/content/Russia_Iran_and_Qatar_Consider_Gas_

2012] PROGRESS IN RUSSIA 473

largest economy in the world in PPP terms by 2010, and has become the sixth largest in 2012 with expectation of moving into fifth place in the next three years.3

Thus, in 2008, Russia had great expectations for a new world order, one in which it would play a pivotal role. Russia had not only recovered economically, but had substantially internationalized her economy, with international trade being a major factor in both Russian economic growth and standards of living. The leading producing sectors of the economy were substantially integrated into and dependent on world markets, and consumption, particularly of electronics and automobiles, was heavily dependent on imports. Outside of dying rural regions, the economy was monetized and marketized, with financial and “real” markets substantially intertwined. And state finances were on a firm basis, with minimal state foreign debt and substantial state reserves and FOREX holdings.4

While Russian entities owed international creditors some $420 billion, over 93 percent of that was the private debt of large Russian companies; a reflection of the “globalization” taking place in the Russian economy. And both GDP and consumption, the standard of living of the Russian population, were apparently inexorably growing, and the poverty level inexorably shrinking, as Putin had promised in 2004 at the beginning of his second term (Ericson, 2009). This evident success was understood by the Russian leadership as the consequence of wise monetary and fiscal policy and the “firm hand of the state” directing economic development and reallocating its fruits. But as one commentator quipped, the Russian government confused high oil prices with the genius of their economic management.

Thus, high growth, high export prices, and substantial reserves spurred increasingly assertive state policy both domestically and abroad. In 2007- 2008, among the policies pursued was growing state intervention in the domestic economy, including price controls and openly questioning the property rights of companies failing to hold down prices and maintain employment.5 Major business leaders were required to regularly report to the government (i.e., Putin) on progress toward goals the government

Troika Or_Gas_Cartel/1332004.html; Iran, Qatar, Russia Form Gas Alliance, WALL ST. J., Oct. 22, 2008, at A13.

3. For Medvedev’s final State of the Nation address see Vladimir Rodionov, Outgo- ing Medvedev Proposes Sweeping Political Reforms, RIA NOVOSTI (Dec. 22, 2011, 3:37 PM), http://en.rian.ru/russia/20111222/170427189.html. For Putin’s final Re- port to the Duma as a Prime Minister see Konstantin von Eggert, Due West: A Few Surprises in Putin’s Final Duma Report, RIA NOVOSTI (Apr. 12, 2012, 2:15 PM), http://en.rian.ru/columnists/20120412/172771791.html.

4. Energy export revenues, largely from oil and natural gas, comprised some 25 percent of Russian GDP and over 40 percent of budget revenues in 2008. WORLD

BANK IN RUSS., RUSSIAN ECONOMIC REPORT NO. 18 (2009); WORLD BANK IN

RUSS., RUSSIAN ECONOMIC REPORT NO. 19 (2009). 5. Numerous food price controls were introduced beginning in 2007. In July 2008 a

federal investigation of Evraz Holding and Raspadsty Ugol mining companies for price fixing was launched, and Mechel steel was publically attacked by Putin for its price policies. See Stock Markets React to Prime Minister’s Statements, BOFIT WEEKLY (Bank of Fin., Helsinki, Finland), Aug. 1, 2008, at 75.


had proclaimed, and Putin has reminded business leaders that they needed to pay back society for their wealth.6 Major companies, including Gazprom, Lukoil, Rusal, etc., were encouraged to expand abroad as national champions, acquiring equity in companies in the same or related (upstream or downstream) industries. This was accompanied by an increasingly aggressive foreign policy, particularly in Russia’s near abroad, actively intervening in the Ukrainian elections, dictating the terms of “peacekeeping” in Moldova and The Caucasus, blocking any independent OSCE initiatives, and rejecting the right of any outsiders to monitor Rus- sian elections.7 The assertion of Russian preeminence in the region included “cyber warfare” in Estonia and Georgia, winter energy cutoffs (both oil and natural gas to Belarus and natural gas to Ukraine), ostensi- bly over pricing, and culminated in the long prepared invasion and dis- memberment of Georgia in August 2008.8 Economic confidence was evident in increasingly frequent calls for a new world economic order and replacing the dollar as the international currency, medium of exchange, and unit of account. Indeed, both Putin and Medvedev, elected president in May 2008, asserted that the ruble should become an international currency, equal to the dollar, with Moscow as an international financial center, and that Russia was ready to become a leader in the new world order (Ericson, 2009, p. 221). And as a step in that direction, Russia took the initiative in organizing and convening a BRIC group, beginning with ministerial discussions after G20 meetings in 2006 and 2008 and culminating in a BRIC Foreign Ministers Meeting in Yekaterinburg in May 2008, to provide a common front and supporting actions in the development of the new world order.9

6. Most recently, see Putin’s speech to the Union of Industrialists and Entrepreneurs on 9 February 2012, as reported in Ira Ioeabashvili & Jacob Gronholt-Pedersen, Putin Seeks Payments From Those Who Made Fortunes in ‘90s, WALL ST. J., Feb. 10, 2012, at A11.

7. One can see a complete record of this behavior in the Jamestown Foundation’s Eurasia Daily Monitor from 2003 through 2012. Archives, JAMESTOWN FOUND., http://www.jamestown.org/archives/monitor/m2002/ (last visited Jan. 6, 2013).

8. Putin recently admitted that the invasion was preplanned and provoked by Russia. Pavel Felgenhauer, Putin Confirms the Invasion of Georgia Was Preplanned, EUR-

ASIA DAILY MONITOR (Aug. 9, 2012, 1:18 PM), http://www.jamestown.org/programs/edm/single/?tx_ttnews%5Btt_news%5D=39746&cHash=177fd31d57370a96 ac7da644dc280014/. On Russian use of cyberwarfare, see Alexander Melikishvili, The Cyber Dimension of Russia’s Attack on Georgia, EURASIA DAILY MONITOR

(Sept. 12, 2008, 12:00 AM), http://www.jamestown.org/single/?no_cache=1&tx_tt news%5Btt_news%5D=33936.

9. Russia has continued as a prime mover in organizing BRIC summits, first in Yekaterinburg in 2009, then in Brazil in 2010, China in 2011, and New Delhi in March 2012. South Africa joined at the 2011 Summit, making the BRIC organization ‘BRICS.’ The fifth summit will be hosted by South Africa. See BRICS Offi- cial Documents: Summits, BRICS INFO. CENTRE, http://www.brics.utoronto.ca/ docs/index.html (last visited Jan. 6, 2013).


II. GROWTH FOUNDATIONS

This growth, and the confidence it engendered, was however built on a rather unstable foundation. While Putin’s first term had finished the transition process from Soviet-type to a market economy, completing many of the structural reforms started in the 1990s and reestablishing central authority and state functioning, much institutional and structural reform remained to be done (Ericson, 2006). Further, much, if not most, of the economic recovery and new growth was based on favorable world market conditions and on high and growing prices for that which nature and Soviet development had bequeathed Russia—energy carriers and raw materials. Thus, the foundation of this strong performance was resource extraction and the export of energy, metals, and grain, generating a huge financial surplus which the newly effective state was increasingly able to capture.10 The export earnings of these leading, largely extractive industries multiplied through the economy as they purchased inputs from domestic manufacturing and service industries, generated new incomes, and stimulated a rapid rise in consumption and the standard of living. This demand fueled a rapid rise in imports, as well as domestic consumption. The subsequent expansion of domestic economic activity spurred borrowing on international markets, particularly as domestic financial markets remained seriously underdeveloped. While newly created wealth remained highly concentrated, the Russian state redistributed much of these rents, primarily to maintain political power and the support of the elite (Gaddy & Ickes, 2011). Hence, rents were used in support of existing industrial, and other economic structures, in order to maintain employment and their continuing operation: a primary component of social and political stability.

In this fortuitous international economic environment, in part as a re- action to the economic and political chaos of the prior decade, it was easy for the Russian state to reassume a leading role in the economy. Indeed, some 50 percent of Russian economic activity remained under state control at the federal, regional, or local level.11 Putin’s Russia opted for state-directed development in the pursuit of national power and the au-

10. See the World Bank’s Russian Economic Report, especially number 1 through number 6, 2001 through 2003, for the statistical record and budgetary impact. E.g., WORLD BANK IN RUSS., RUSSIAN ECONOMIC REPORT NO. 1 (2001). The origin and use of resource rents in the Russian economy are analyzed in Clifford G. Gaddy & Barry W. Ickes, Resource Rents and the Russian Economy, 46 EURASIAN

GEOGRAPHY ECON. 559 (2005). 11. This was asserted by both Finance Minister Alexei Kudrin and Deputy Minister of

Economic Development Andrei Klepach during interviews. Interview with Alexei Kudrin, Finance Minister, Russia (Oct. 5, 2009); Andrei Klepach, Deputy Minister of Economic Development, Russia (July 2, 2009). A detailed study by the Siberian Academy of Innovation concluded that “the share of the state sector in the economy (is) . . . no less than 50%.” A. Neschadin et al., The Public Sector of the Economy: the Current Russian Case, SIBACADEMINNOVATION (Oct. 27, 2007), http://old.sibai.ru/content/view/1185/1330/ (translated by author).


tonomy of action of a world power.12 Thus, the extractive industries were natural leaders in the recovery and development processes, but they had to be kept under tight state supervision, if not direct control, for the state to properly benefit from their success. The oligarchs were reigned in, and they and their firms were subject to close political supervision, as were other major economic operations/firms. All major development projects/ investments required prior (at least tacit) ‘authorization’ by the leader, and business leaders undertook regular accountability reporting to him.13

Major corporations with foreign operations became “National Champi- ons,” and priority development areas were led by state directed Federal Corporations and National Projects. Among the National Champions at the time were Gazprom, Rosneft, Lukoil, Rusal, Polyus Gold, Alrosa, and Severstal. And the major Federal Corporations/National Projects (major funding channels) were Rosatom, VEB, Rostekhnologii, Rusna- notech, Olimpstroi, and the Housing and Municipal Infrastructure Devel- opment Fund. In addition, “leading sectors” and elites, however, directly and deeply integrated into the world economy, often served as (indirect) agents for the Russian state (e.g., Alfa-group in Central Asian energy development, and in Turkish telecoms) (Ericson, 2009). This “development structure” was controlled by Putin, both directly and through his plenipo- tentiaries, and through state control and use of the financial commanding heights, and key state banks: VTB, VEB, Gazprombank, Sberbank, and Rossel khozbank.14 It was a system of control, far looser than that of the Soviet command economy that appeared effective in an environment of effortlessly rising resource incomes and extremely easy international financial credit.

This system, however, allowed only limited room for institutional innovation. Maintaining control in such a system requires limiting experimen- tation with alternate structures or activities. This institutional conservatism was reinforced by the fear of political and social instability of the chaos associated with the democracy of the 1990s. Hence, there was no room for Schumpeterian creative destruction of firms and economic activity; only the politically inconvenient could be removed, and only the familiar and authorized could be initiated. Stability was maintained and cooperation was reinforced by the redistribution of resource rents; directing subsidies, benefits, and privileges toward social and politi-

12. Putin was quite explicit about this strategy of using natural resources for state

power in his doctoral dissertation at the St. Petersburg Mining Institute. See Har- ley Balzer, The Putin Thesis and Russian Energy Policy, 21 POST-SOVIET AFF. 210 (2005).

13. This can be seen in the regular meetings reported on the website of the President of the Russian Federation, particularly during Putin’s presidency. See PRESIDENT

OF RUSSIA, http://eng.kremlin.ru/ (last visited Jan. 6, 2013). 14. State officials were placed on Boards of Directors, usually as Chairman, or in exec-

utive positions, of major business operations. For example Medvedev at Gazprom prior to running for President, Igor Sechin in Rosneft, Vladislav Surkov in Trans- nefteprodukt, Sergei Prikhodko in TVEL (nuclear fuel), and Viktor Ivanov in Aeroflot and Almaz-Antei (air defense).


cal groups, and traditional economic activities/industries, supporting the existing structures of economic growth and political power (Gaddy & Ickes, 2011). Finally, a substantial portion of those rents were seques- tered in stabilization (Welfare and Development) Funds and State FOREX Reserves as a buffer against outside shocks, against market and price volatility.

III. CRISIS AND RECOVERY

Vladimir V. Putin handed over the (formal) presidency to Dmitry A. Medvedev on May 7, 2008, as the Russian economy began showing signs of overheating. Inflation was accelerating (to 15 percent year on year in June), provoking the controls noted above, and both output (10.3 percent to 3.2 percent) and investment growth (25 percent to 9.9 percent) began slowing. Financial markets were sharply hit (stocks down over 50 percent; ruble down almost 18 percent) by September, from both war-induced (invasion of Georgia) capital flight and the severe contraction in world financial markets, both of which led investors to pull out of Russia. Major Russian firms, heavily indebted to foreign banks, faced loan re- calls, just as commodity prices collapsed, destroying their ability to repay.15 After initially denying that Russia could be seriously affected, the Russian government (Putin, as Prime Minister) reacted strongly and deci- sively, providing both direct and indirect funding to Russian banks and firms, using control of the financial “commanding heights,” to the tune of one-seventh of Russian (dollar) GDP—an intervention unmatched in size, relative to that of the economy in the world.16 The primary focus of this support was on preventing equity transfer to foreigners, shutdown of manufacturing operations, and an increase in unemployment. Thus, subsidies and zero interest loans were provided to pay off foreign debts and to maintain manufacturing activity, compensating for the collapse in non- state demand and sales revenues.17

Despite this strong policy response, the world financial crisis of 2008/ 2009 hit Russia harder than the other BRIC countries, although it only reached Russia late in 2008.18 Indeed, in the first half of 2008, GDP grew

15. The inability to repay loans led creditors to demand the loan collateral, often eq-

uity in Russian firms, which the Russian state did not want transferred. Hence the state massively intervened, providing easy credits/grants to pay off loans, forcing sales of foreign subsidiaries, or blocking equity transfer through Russian court decisions. See Richard E. Ericson, The Russian Economy in 2008: Testing the “Mar- ket Economy”, 25 POST-SOVIET AFF. 223 (2009).

16. For comparison, the immediate U.S. response package of $752 billion, was about 5 percent of U.S. GDP in 2008, and less than half of it was expended by the end of 2008. President Obama’s near $800 billion stimulus package raised the total intended U.S. effort to about 10 percent of U.S. GDP.

17. Putin attacked a prominent oligarch, Oleg Deripaska, for failing to maintain operations in unneeded factories in Pikalevo, and subsidized the automobile maker, Avtovaz, to maintain employment despite a 90 percent drop in sales. See Ericson, supra note 16, at 224-25.

18. China, India, and South Africa continued to grow at robust, if slower, rates. Only Russian and Brazilian GDP fell in 2009, and Brazil’s drop was only 0.6 percent.


by almost 8 percent, investment and consumption by over 13 percent, and unemployment fell to a new post-Soviet low (5.3 percent). This maintained the appearance of continuing economic strength through 2008, with the full extent of the collapse in growth and economic activity only evident in the figures for 2009.

Indicator 2000 2008 2009 2010 2011 GDP2000 = 100 100.0 166.3 153.3 159.9 166.8 GDP % © 10.0 5.2 -7.8 4.3 4.3 Industry % © 11.9 0.6 -9.3 8.2 4.7 Investment % © 17.4 9.9 -15.6 6.0 8.3 Unemployment % 10.2 7.8 8.2 7.2 6.1 Consumption % © 5.9 8.0 -5.0 2.1 6.5 Current Account, $billion 46.8 103.5 48.6 71.1 101.1 FDI, $billion 4.43 76 27.7 13.8 18.4 Budget Balance %GDP 1.2 4.1 -5.9 -4.1 0.8 FOREX +Stab Funds, $billion 32.1 652.2 591.1 593.3 610.6 Inflation % 20.2 13.3 8.8 8.8 6.1 Fig. 2: Russian Macroeconomic Performance post-Crisis (Source: Compiled from BOFIT Russia Statistics Reports).

Indeed, in the first half of 2009, Russia suffered a much deeper drop

than the table reflects, as second half performance was supported by the massive subsidies of business that Putin implemented, including the use of over $250 billion from the stabilization funds. Growth from 2009 was also supported by a rapid recovery in energy prices,19 cushioning the drop in stabilization funds and renewing the substantial flow of funds into government coffers. Energy export revenues came to the rescue, supporting the subsidization policies of the government’s crisis rescue operation. Massive state intervention had pulled the economy out of serious contraction by 2011, albeit at a lower growth rate, but with higher incomes and employment, and lower inflation. But the result remained unsatisfactory; Russia was no longer a world leader in economic growth.

Russian economic policy in the face of the crisis had been sufficient to block a depression, and restore some growth, but nowhere near the prior rates that had made Russia a regional development driver. The economic situation, post crisis, reflected the stability and resilience of the system, but also showed its apparent inability to generate qualitatively new

Dominic Wilson et al., The BRICs Remain in the Fast Lane, GOLDMAN SACHS 3 (June 24, 2011), http://www.goldmansachs.com/our-thinking/topics/brics/brics-reports-pdfs/brics-remain-in-the-fast-lane.pdf.

19. From about $40/bbl., Brent oil rose over $80 within a year and was near $120/bbl in less than two years. See Crude Oil, Brent Price Chart, MONGABAY, http://www. mongabay.com/images/commodities/charts/chart-crudebrent.html (last updated June 9, 2012).


growth. President Dimitry Medvedev, who assumed his position as the country was overwhelmed by the crisis, began calling for a new growth model, moving from a resource to technology driven basis, in order to restore the dynamism of the Russian economy and its position as a potential engine of world economic development.20

IV. SEEKING A NEW GROWTH MODEL

In 2009, as the recovery from the crisis was underway, President Medvedev declared it inadequate. In a series of speeches, he pointed to the stultifying impact of the current economic system on economic growth and dynamism. In a major White Paper, presented to the legislature, “Forward, Russia!,” he called for a new innovative, liberal economic “model,” one built around the initiative of the creative classes that would create qualitatively new growth driven by technological innovation.21 His administration also commissioned, in 2008, the development of a new growth strategy, consistent with this vision, to be prepared by the Na- tional Research University—Higher School of Economics (NRU-HSE).22

The Russian Presidency (Medvedev) also proposed to the Russian Gov- ernment (Putin) and the legislature (Duma and Federation Council) a series of administrative reforms and anti-corruption measures, and pushed WTO negotiations to a successful conclusion in December 2011. A major government program to create a “Russian Silicon Valley” in Skolkovo, outside Moscow, was launched, and a new Direct Investment Fund with $2 billion state seed money was created to attract $100 billion in “venture funds” in support of Russian innovative development.23

The logic of the new growth model was laid out in a major set of ana- lytic reports in late 2011 by scholars largely from NRU-HSE under the title: Strategy 2020: New Model of Growth.24 This was to be a model of controlled innovation, innovation that avoided social disruption and up- heaval, while pursuing the progressive objectives of the Russian State and

20. This was the focus of his second state of the nation address. See Dmitry

Medvedev, Presidential Address to the Federal Assembly of the Russian Federa- tion (Nov. 12, 2009), available at http://archive.kremlin.ru/eng/speeches/2009/11/12/ 1321_type70029type82912_222702.shtml.

21. For the fullest statement of his approach, see Dmitry Medvedev, Go Russia! PRESI-

DENT RUSSIA (Sept. 10, 2009, 12:00 PM), http://eng.kremlin.ru/news/298. 22. Strategy 2020, INST. PUB. ADMIN. MUN. MGMT., http://www.ipamm.hse.ru/eng/au-

thorities/ (official web page for NRU-HSE program and discussion of its origins) (last visited Jan. 7, 2013). For the final summary report, see STRATEGY 2020, STRATEGY 2020: THE NEW GROWTH MODEL - A NEW SOCIAL POLICY, (2012), available at http://2020strategy.ru/data/2012/03/14/1214585998/1itog.pdf.

23. Skolkovo was announced on Nov. 12, 2009 by Dmitry Medvedev, to be headed by Russian oligarch Viktor Vekselberg and co-chaired by former Intel CEO, Craig Barrett. It is still developing with little payoff, despite international buy-in. See Irinia Mokrousovo, Who is earning off “Skolkovo”?, VEDOMOSTI (on file with the author). On the new Direct Investment Fund, see About RDIF, RUSSIAN DIRECT

INVESTMENT FUND, http://rdif.ru/Eng_Index/ (last visited Jan. 9, 2013); Gregory White, Russian Fund Seeks Foreign Investment, WALL ST. J., Apr. 5, 2011, at C3.

24. For access to the documents, see STRATEGY 2020, http://2020strategy.ru/ (last visited Jan. 9, 2013).


Society. Its key recommendations were: (i) emphasis/reliance on human capital and on innovation by the creative class; (ii) pursuit of institutional reform, removing barriers to economic growth, and improving the business and regulatory climate; and (iii) stimulation of economic competition through trade liberalization and integration in world manufacturing. Hence, a critical role is to be played by expanding trade relations, with particular focus on CIS and the EU.25

This pursuit of this new growth model, a more liberal economic system, appears now to be something of a mirage. Despite new anti-corruption laws, repeated anti-corruption campaigns, and the constant rhetorical push during the Medvedev Presidency, the patrimonial system, run by and for a politically connected elite revolving around Putin, remains fun- damentally unchanged.26 Reform measures and laws have been stalled in endless and repeated “consultations and negotiations” among state and government bodies—presidential, executive, and legislative—rarely emerging with any impact.27 The sole exception appears to be WTO membership, for which Russia received sufficient concessions to allow buy-out of the political opposition.28 For all but superficial changes, the need to maintain social and political stability and order, emphasized by both Putin and Medvedev, particularly in the wake of the economic crisis, has triumphed. The system and its leaders are united in blocking socially disruptive, unauthorized, economic change in pursuing the current leadership’s vision of managed “progress” to a technological frontier. Indeed, even the rhetoric of “Forward, Russia!” and a new growth model has vanished with the (evidently long planned) return of Putin to the Presidency, and the demotion of Medvedev to the role of an implementer of Putin’s initiatives.

25. Strategy 2020 Emphasises Economic Cooperation with CIS Countries and the EU, BOFIT WEEKLY (Bank of Fin., Helsinki, Finland), Mar. 30, 2012, at 1.

26. For a recent analysis of the imperviousness of corruption to reforms and campaigns in the patrimonial system, see Alena Ledeneva & Stanislav Shekshnia, Cor- porate Corruption in Russian Regions, 92 RUSS. ANALYTICAL DIG. 2, 3-5 (Feb. 22, 2011); Svetlana Tulaeva, How Anti-Corruption Laws Work in Russia, 92 RUSS. AN-

ALYTICAL DIG. 9, 9, 12 (Feb. 22, 2011). 27. This has been particularly true of Medvedev’s efforts toward legal reform

“decriminalizing” private economic activity, where the Interior Ministry and Procuratura have worked to delay and nullify the proposed and decreed legal reforms. See William E. Pomeranz, The Magnitsky Case and the Limits of Russian Legal Reform, 92 RUSS. ANALYTICAL DIG. 12, 13 (Feb. 22, 2011); Lilia Biryukova, President Popravili, VEDOMOSTI (Feb. 17, 2011), http://www.vedomosti.ru/newspa- per/article/255220/prezidenta_popravili (describing how administrative departments corrected Medvedev’s legal reforms).

28. See William Mauldin, Russia to Join WTO, WALL ST. J., Nov. 10, 2011, at A12. Russian attitudes toward WTO membership have been ambivalent, with serious opposition from some affected businesses and in the Duma. WTO Ministerial Conference approved Russian accession in mid-December 2011, but only on Au- gust 22, 2010, did Russia fully agree to join. Russia One Step Closer to WTO Membership, BOFIT WEEKLY (Bank of Fin., Helsinki, Finland) Nov. 18, 2011, at 1; Russia’s WTO Membership Brings Some Tariff Relief Important for Finland, BOFIT WEEKLY (Bank of Fin., Helsinki, Finland) Aug. 24, 2012, at 1.


V. THE FUTURE: PROBLEMS AND PROSPECTS

Russia remains the dominant economic power in its region, and a growing presence in the world economy. But can it be a driver of regional and world economic growth, and a significant part of an international investment portfolio, over the next two decades? The answer must depend not only on the ability of Russia to return to high rates of economic growth, but also on its ability to move to the world technological frontier. Medvedev and his advisors recognized this truth in the call for a qualitatively new economy, one based on innovation and human initiative and diversified across a broad range of new technologies and activities. But that is apt to require changes that the renewed administration of Vladimir Putin is unlikely to accept.

VI. OBSTACLES TO QUALITATIVELY NEW GROWTH

The primary obstacle to qualitatively new economic growth in Russia is

the nature of the economic system built by Putin since 2005. It is a highly dirigiste market economy, subject to a patrimonial system of governance. The patrimonial system, built around personalized authority and reward, remains strong and thriving. Its beneficiaries, both state and “private,” have no incentives to give it up, yet are the only ones with the power to carry out (non-revolutionary) change. They comprise the top political leadership, the burgeoning bureaucracy, and the owners and managers of the major firms, particularly in the leading sectors of the economy: natural resources and energy, banking and finance, transportation, and some critical manufacturing and strategic industries.29 Liberalizing and decen- tralizing institutional reform directly challenges their power, perquisites, and wealth, and hence such reform flounders in endless bureaucratic discussion, consultations, and reviews, only making it into a law in a highly watered down, ineffectual form.

Such has been the fate of reform attacking that essential lubricant of most Russian economic interaction, corruption. Legal reforms liberalizing economic law and decriminalizing unauthorized private economic initiative have similarly died between the Procuracy and Duma, and even administrative reorganizations, threatening the livelihood of current office holders, have faded away before passage and implementation.30 For example, state corporations are infamous for their wastefulness and non-

29. A list of eleven Strategic Sectors was codified by law on May 5, 2008, restricting

foreign investment in them. See Valery Fadeev, State and Business: Infantilism In- tellectuals, VEDOMOSTI (June 7, 2008), available at http://www.vedomosti.ru/news- paper/article/2008/06/07/150792. The list remains, but amendments to the law implemented in December 2011 eased some restrictions on foreign investment. Foreign Strategic Investment Law Continues to Evolve, BOFIT WEEKLY (Bank of Fin., Helsinki, Finland), Jan. 13, 2012, at 1.

30. Pomeranz, supra note 27; Tulaeva, supra note 26; Medvedev Reiterates Reform Goals at the St. Petersburg International Economic Forum, BOFIT WEEKLY (Bank of Fin., Helsinki, Finland), June 23, 2011, at 1.


transparency in operation.31 Medvedev announced an effort to eliminate the state unitary firm as a legal and administrative structure and to reform the “federal corporation” (e.g., Rostekhnologii, Rusnanotech) to introduce better control over, and greater efficiency in the use of, state property.32 To date, these reforms appear to have vanished into bureaucratic discussions and interdepartmental consultations. Indeed, the patrimonial governance structure is essential to the “rent redistribution” system that maintains social stability and fuels economic activity. Hence, it is critical to the maintenance of political stability and control. So, as in Soviet days, we see a “treadmill” of administrative reforms and anti-corruption drives ultimately doing little to alter the existing system.

Another obstacle arises from the need to mobilize the creative class, those capable of truly innovating, of creating a new technological basis for economic expansion, development, and growth. Such creativity, such innovation, requires substantial individual freedom. In particular, it relies on the freedom to step outside of existing structures and constraints, to experiment with new, unauthorized, and even hereto unimagined, activities, and on the ability to choose one’s own leaders and dispose of one’s own resources and incomes without political direction from above. Such people are naturally politically restive, and their innovative activity presents an inherent threat to “controllability” of the development process, as well as to existing political structures. Further, they pose a “flight risk” as they are readily employable in the more liberal market economies of the West. Thus, stimulating qualitatively new economic growth poses a danger to the foundations of the current political system, the patrimonial structures insuring social stability and the well-being of the current elite. And perpetuation of that system blocks true innovation and qualitatively new growth.

Further, new growth is undercut by the structural legacies of the Soviet economy, including an aged and obsolete capital stock, a stagnant working age population lacking appropriate skills for new technologies, an inefficient organization of production and distribution, and inadequate

31. See Goskorporatsii poimali na narusheniiakh [State Corporations Caught in Viola-

tions], INTERFAX, (Nov. 11, 2009, 12:46 AM), http://www.interfax.ru/business/txt. asp?id=109384.

32. See Changes Planned for State Companies, BOFIT WEEKLY (Bank of Fin., Hel- sinki, Finland), Jan. 5, 2012, at 1 (describing criticisms regularly made of state corporations). Medvedev ordered a review of the criticisms in 2009 and raised the issue of abolishing State Unitary Enterprises. Medvedev Orders Review of State Corporations, BOFIT WEEKLY (Bank of Fin., Helsinki, Finland), Sept. 18, 2012, at 1. Nothing appears to have come of Medvedev’s initiative. The Prime Minister has ordered the government to prepare suggestions for doing so. See Medvedev Wants Ideas to Make Cos Get Approval to Buy Assets, PRIME BUS. NEWS AGENCY

(Apr. 27, 2012), http://www.1prime.biz/news/_Medvedev_wants_ideas_to_make_ state_cos_get_approval_to_buy_assets/0/%7B19201595-CB1E-42EC-9593-0B33F4 BDEC74%7D.uif; see also Yana Vaziakova et al., Russia: Progress in Structural Reform and Framework Conditions 15 (OECD Econ. Dep’t, Working Paper No. 920, 2011), available at http://www.oecd-ilibrary.org/docserver/download/fulltext/ 5kg0k6zsbjbv.pdf?expires=1349882831&id=id&accname=guest&checksum=A98D A12501924E6BC318EF99F2FA802B.


infrastructure.33 These problems are aggravated by the inappropriate, and high-cost location of much production/manufacturing activity, a consequence of decades of economically irrational Soviet investment and the emigration of many of the highest educated skilled employees, a classic brain drain.

VII. DRIVERS OF CONTINUING GROWTH

Despite the obstacles to implementing a new growth model, there are factors that will help sustain continuing economic growth and Russian economic predominance in the region. Resource prices, and in particular the price of oil, are apt to remain high and rising. Indeed, Russia’s relatively rapid recovery from the financial crisis can be largely explained by the rapid recovery in the price of oil, generating sufficient state income to support recovery measures and replenish state financial reserves.34 Un- less there is a collapse of demand in Europe and/or China, energy and resource prices should continue rising, again generating an investable state surplus for development, infrastructure projects, and a substantial planned increase in military and social spending.35 The Russian government has also made a priority of restoring Russia’s prominence in science

33. See RICHARD E. ERICSON, LEGACIES OF COMMAND: THE RUSSIAN ECONOMIC

TRANSITION EXPERIENCE (forthcoming Summer 2013) (discussing Soviet legacies). The McKinsey Global Institute (1999 & 2009) studies the inefficiencies in ten critical economic sectors in Russia in 1997 and 2007, shows the impact of structural legacies in 1997, and both the improvements to 2009 and what needs to be done to reach western efficiency levels. MCKINSEY GLOBAL INST., UNLOCKING ECONOMIC

GROWTH IN RUSSIA, (Oct. 1999); MCKINSEY GLOBAL INST., LEAN RUSSIA: SUS-

TAINING ECONOMIC GROWTH THROUGH IMPROVED PRODUCTIVITY, (Apr. 2009). 34. Oil and natural gas export revenues provide over 40 percent to the state budget

revenues. Russ. CEIC Database Team, Russia’s Oil and Gas Revenues: Federal Budget Dilemma, ISI EMERGING MARKETS BLOG (May 16, 2011), http://blog.securities.com/2011/05/russias-oil-and-gas-revenues-federal-budget-dilemma/; Rus- sian Economic Report No. 14, WORLD BANK RUSS. ECON. REV. (World Bank, Moscow, Russ.), June 2007, at 9; Russian Economic Report No. 24, WORLD BANK

RUSS. ECON. REV. (World Bank, Moscow, Russ.), Mar. 2011, at 18; Russian Eco- nomic Report No. 26, WORLD BANK RUSS. ECON. REV. (World Bank, Moscow, Russ.), Sept. 2011, at 20-25; Russian Economic Report No. 27, WORLD BANK RUSS. ECON. REV. (World Bank, Moscow, Russ.), Apr. 2012, at 10-11, 26-28.

35. Stephen Blank, Lurching Toward Militarization: Russian Defense Spending in the Coming Decade, EURASIA DAILY MONITOR (Jan. 5, 2011, 4:13 PM), http://www. jamestown.org/programs/edm/single/?tx_ttnews%5Btt_news%5D=37318&tx_ ttnews%5BbackPid%5D=27&cHash=5c3c1d0a84; Pavel Felgenhauer, Voters Will Pay for a Military Buildup After Electing Putin, EURASIA DAILY MONITOR (Nov. 17, 2011, 4:08 PM), http://www.jamestown.org/single/?no_cache=1&tx_ttnews%5 Btt_news%5D=38683&tx_ttnews%5BbackPid%5D=7&cHash=f0ab715b475f2730 6279c57bec9c012e. The military build-up is a recently emphasized Putin- Medvedev priority. Spending on the power agencies is planned to rise from 24 percent to 30 percent, driven by defense spending rising from 15 percent to 20 percent. Social spending is to rise to 29 percent of the state budget. See Current Budget Framework Calls for Sharp Hikes in Spending on Defence and National Security, BOFIT WEEKLY (Bank of Fin., Helsinki, Finland) Oct. 14, 2011, at 1. The Finance Minister, Alexei Kudrin, lost his position in September 2011 after criticizing the planned 2.1 trillion ruble ($66 billion) increase in defense spending. See Tai Adelaja, A Laundry List for the Kremlin: Russia’s Former Finance Minister Alexei Kudrin Has Come up With a Plan to Help the Kremlin Maintain Fiscal Dis-


and technology, earmarking substantial budgetary resources to both fundamental and applied sciences and to R&D, reversing a two decade contraction, that will become available with continuing strength of resource and energy prices. Thus, rising energy prices should also help counter the brain drain of the past decades. Finally, increased business and state revenues from strong export prices will stimulate rising consumer demand and the development of both consumer and business services.

Another factor that should support continuing solid economic growth is Russia’s recent accession to WTO, negotiated and signed in December 2011 and ratified by the Duma August 22, 2012. The agreement opens eleven service sectors to foreign participation, introduces international technical and phytosanitary standards, requires a 50 percent cut in agricultural subsidies, and general tariff reductions spread across eight years, one-third immediately, one-third in three years, and the rest in eight years.36 This is apt to drive some further internal liberalizations and reforms and open more foreign markets to Russian goods, while increasing production efficiency by subjecting Russian manufacturers to (slowly, by design) increasing competition.37 It will also help foster greater openness to foreign investment and technological sharing, enhancing modernization of industry. And this boost to growth is apt to be reinforced by the announced renewed privatization drive, aiming to reduce the state share in many industries without sacrificing state control.38

Growth in the near term will also be driven by the continuing restruc- turing of inherited industrial capacities, investment in modernization, and in new technologies and equipment. Transportation and energy infrastructures are also the subject of state development plans, where massive investments are required, and in social service infrastructure, including housing. This “development” investment can be expected to provide a stimulus for increased industrial production and investment. There are also a number of major state investment projects that will stimulate economic activity, including the 2014 Olympics and 2018 World Cup facili-

cipline, RUSSIA PROFILE (Oct. 19, 2011), http://russiaprofile.org/business/47417. html.

36. WTO Accession Means Many Changes, MOSCOW TIMES (Nov. 10, 2011), available at http://www.themoscowtimes.com/sitemap/paid/2001/11/10.html.

37. For a summary of the World Bank’s detailed analysis of the impact of WTO accession on Russia, indicating its strongly positive potential, see Russian Economic Re- port No. 27, supra note 34. As noted above, this is a major part of Strategy 2020.

38. Further privatization is emphasized in all government discussions of reform, although its contours and specific content continue shifting and remain unclear. See Sale of State-Owned Enterprises Moving into New Phase, BOFIT WEEKLY (Bank of Fin., Helsinki, Finland) July 1, 2011, at 1; Cabinet Approves Latest Programme to Privatise State-Owned Enterprises; Exact Schedule and Scope Remain Unclear, BOFIT WEEKLY (Bank of Fin., Helsinki, Finland) June 15, 2012, at 1; Maxim Tovkailo, The Government is Preparing to Extend the Privitization Program, VEDOMOSTI (Aug. 3, 2011), http://www.vedomosti.ru/politics/news/2011/08/03/ 1332680; Ira Iosebashvili, Russian Privatization Plan Raises Questions, WALL ST. J., June 21, 2012, http://online.wsj.com/article/SB1000142405270230373420457746 8513760329818.html.


ties, and off-shore Siberian and Arctic energy field development, with its supporting oil/gas export infrastructure.

VIII. CAN RUSSIA HELP CARRY WORLD GROWTH TO A

HIGHER LEVEL?

For the structural reasons discussed above, it is doubtful that Russia will have the impact on world economic development of the other BRIC, especially China. Russia, however, is and will remain the dominant economy in Central Eurasia and an engine of growth for the former FSU countries of that region. Its forecast growth to 2015, largely driven by oil prices, is unimpressive but stable; most analyses see growth in the 3.5-4.2 percent range per year.39 But that is clearly inadequate for Russia’s ambitions and will be only mediocre in international comparisons, particularly with the other BRIC.

The government sponsored Russia-2020 program demands at least 5 percent per year to meet social needs, and provides three potential scenarios for Russian economic development.40 The first is what is called the Inertia scenario, without significant change in the structuring or functioning of the current system. It promises annual growth stagnation at 3-3.5 percent to 2020. The second is an Energy Resource Based scenario, where Russia focuses on fully exploiting its comparative advantage in energy resource development and export. In this scenario, annual growth steadies at 4-5 percent, but around 2020 begins tapering off. Finally, an Innovation Based scenario, built on economic liberalization and mobilization of the “creative class,” is outlined. Here, annual growth rises to over 6 percent, 2015-2020, and the foundation is built for high growth beyond that. Unfortunately, none of these scenarios begins to grapple with the patrimonial system that is the true obstacle to rapid economic growth, despite much talk of reforms to improve the business climate.41

Again for the reasons adduced above, the innovation based, and even the resource based scenarios are much less likely than inertia, barring a major political change in Russia. Russia will provide a steady source of growing demand on the world market, but not enough to call forth new growth in the way Chinese demand has and will.

Russia’s primary impact on world economic growth is far more likely to lie on the supply side. Russia will support world, especially Asian, eco-

39. At the end of 2011, all forecasts were lower: Russian domestic: 3.1-3.7 percent per

year; BOFIT: 3.5 percent per year; WB-Russia: 3.3-4.0 percent per year. Following 4.3 percent GDP growth in 2011, WB-Russia increased its forecast growth rate to this range, with high oil prices driving growth at the upper end.

40. See the preliminary report from August 2011 and the final report of January 2012 on the website: http://2020strategy.ru/. For an early analysis of the state assign- ment see ANDREW C. KUCHINS, AMY BEAVIN & ANNA BRYNDZA, RUSSIA’S 2020 STRATEGIC ECONOMIC GOALS AND THE ROLE OF INTERNATIONAL INTEGRATION

(2008). 41. The ambivalence about systemic reform was evident at the 2012 Davos Conference

in St. Petersburg. See Schumpeter, Davos on the River Neva, ECONOMIST, June 30, 2012, at 70.


nomic growth by providing energy supplies and raw materials, while maintaining a steady demand for finished products from other countries. And its biggest impact will undoubtedly be regional. Russia is a primary purchaser of raw materials and semi-fabricates from the FSU states of Eastern Europe and Central Asia, and is a primary supplier of energy and finished products. And Russia is apt to maintain that position for the next decade, despite the efforts of some of these countries to diversify their international economic interactions. This role will be enhanced by closer integration of the Eurasian Common Market, and customs union, and the Shanghai Cooperation Organization (SCO) where Russia shares leadership with China, now her primary competitor in Central Asia.42

Finally, we might expect greater Russian integration into, and impact on, northeast Asian development through both energy supply (new oil and gas pipelines and LNG supply) and attracting development investment and skilled labor into its underdeveloped far eastern and east Sibe- rian regions. While both political (Kuril/Northern Territory dispute) and psychological (Russian xenophobia) barriers remain, we might expect the natural economic benefits of such integration, the development of natural resources, and the opening of foreign markets, to overcome these barriers in the coming decade. But it is rather unlikely that Russia will become more than a regional economic engine in the coming decade, despite perhaps having the fifth largest (PPP) GDP in the world on the strength of its resource and energy export earnings.

REFERENCES

Ericson, Richard E. 2006. “The Russian Economy,” in Wolfgang Dan- speckgruber, (ed.) Perspectives on the Russian State in Transition. Princeton, NJ: Princeton University Press, pp. 112-162.

Ericson, Richard E. 2009. “The Russian economy in 2008: testing the ‘market economy’.” Post-Soviet Affairs 25.3: 209-231.

Gaddy, Clifford and Ickes, Barry W. 2011. “Putin’s Protection Racket,” in Iikka Korhonen and Laura Solanko (eds.), Soviet Plans to Russian Reality: Essays in Honor of Pekka Sutela (Helsinki: WSOYpro Oy, 2011).

Goldman-Sachs. 2003. Dreaming With BRICs: The Path to 2050.

42. Some of the difficulties in pursuing the Eurasian Union Project are discussed in the April 20, 2012 edition of the Russian Analytical Digest. See Gennady Chufrin, A Difficult Road to Eurasian Economic Integration, 112 RUSS. ANALYTICAL DI-

GEST 1 (2012).

I

THE POLITICS OF HUMAN DEVELOPMENT

IN INDIA AND CHINA: IT PAYS TO INVEST

IN WOMEN AND CHILDREN

Devin K. Joshi1

ABSTRACT

This article explores the attainments of China and India on measures of basic human development as ingredients of a long-term economic development strategy. It proposes that major differences in ideology and state capacity explain in part why India has fallen behind China. The analysis suggests that these relatively hidden political factors play an important role in transforming and advancing human development not only within India and China but also in other developing and emerging economies. The findings also support the notion that public investments in the capabilities of women and children have significant social and economic payoffs in both the short-term and in the long-run.

Keywords: China, Children, Democracy, Human Development, Ideol- ogy, India, Politics, State Capacity, Women.

N recent years, the India-China comparison has drawn attention from the mass media and academic scholarship as both countries have experienced tremendous economic and population growth over the last

two decades (Joshi 2011a). Together, China and India accounted for 37.5 percent of the world’s population and 12.1 percent of the world’s combined gross domestic product in 2010 (World Bank 2012). Between 1990 and 2010, based on exchange rate comparisons (using constant 2000 U.S. dollars), China’s gross national income increased almost eight-fold from $446 billion to $3.26 trillion while India’s economy grew more than threefold from $267 billion to $955 billion (ibid). Both states are armed with nuclear weapons and have been rapidly climbing up the technological

1. Devin Joshi is an Assistant Professor in the Josef Korbel School of International

Studies at the University of Denver. He researches and teaches about the international and comparative politics of development with a focus on Asia. His work concentrates on understanding how to build effective governments and inclusive democracies with special attention to the impact of governance on human development and the Millennium Development Goals. Professor Joshi is the recipient of multiple competitive research fellowships and has served as a visiting scholar in China, Germany, India, South Korea, and Sweden. His regional focus has been primarily in East Asia and South Asia although his interests are global. Prior to joining the University of Denver, he taught at the University of Washington, Uni- versity of Hawai’i and Ewha Womans University. He holds a B.A. degree from Stanford and a Ph.D. in political science from the University of Washington.

487


ladder. In 1996, China and India were ranked 28th and 31st in the world in the number of U.S. patents registered (USPTO 2010). By 2011, they were respectively ranked 9th and 16th (USPTO 2012). With their newly created wealth and uniquely large populations, India and China have improved their positions in international negotiations and diplomacy through the formation of blocs in cooperation with Brazil and Russia (BRIC) and together with Brazil and South Africa (BASIC). As their young populations enter the labor force and foreign investment increases, many expect China and India to sustain moderate to rapid economic growth over the coming decades and reap a “demographic dividend” as the younger population (labor force) outnumbers the elderly (depen- dents), especially in India (Mahtaney 2007; Wilson and Purushothama 2003). If these trends continue, India and China are slated to become major world powers by the middle of the twenty-first century (Drezner 2007; Mahtaney 2007).

While China and India are often seen as rising in tandem, a common perception still holds that on many economic performance measures, China has surpassed India and is likely to stay ahead of India for quite some time (Bardhan 2010; Dobson 2009; Engardio 2007; Winters and Yusuf 2007; Smith 2008). As Table 1 illustrates, according to the World Economic Forum’s Global Competitiveness Index (GCI), over the past seven years China has moved up from a rank of 49th in 2005 to become the 26th most competitive economy in the world in 2011. By contrast, over the same period, India declined from a rank of 50th in the world to 56th. Reflecting this trend, global attitude surveys find that almost 90 percent of Chinese express satisfaction with the direction their country is heading compared to less than 50 percent of Indians, as displayed in Fig- ure 1.

Table 1: Global Competitiveness Index Scores for India and China

Year India Score (Rank) China Score (Rank) 2011 4.30 (56) 4.90 (26) 2010 4.33 (51) 4.84 (27) 2009 4.30 (49) 4.70 (29) 2008 4.33 (50) 4.70 (30) 2007 4.33 (48) 4.57 (34) 2006 4.44 (43) 4.24 (54) 2005 4.04 (50) 4.07 (49) Source: World Economic Forum reports, various years.

2012] HUMAN DEVELOPMENT IN INDIA & CHINA 489

Figure 1: Satisfaction with the Country’s Direction (2002-2012) 100

90 80 70 60 50 China 40 India

30 USA

20 10

0

Data Source: Pew Global Attitudes Project 2012. Question #784: “Overall, are you satis- fied or dissatisfied with the way things are going in our country today?”

Although there are multiple possible causes of variation in economic

performance between China and India, much attention has focused on the countries’ differing attainments on basic human development (BHD) (Bhalla 1992; Acharya et al. 2001; Dreze and Sen 2002; Dummer and Cook 2008; Dobson 2009; Bloom et al. 2010), a key pillar of long-term economic growth performance (e.g., Sen 1999; Ranis et al. 2000; Suri et al. 2011). Examining BHD performance in China and India over the last half-century, this article proposes a partial explanation for why India has fallen behind China. Beginning with a brief discussion of “human development” as a currently influential approach to thinking about global development (Joshi 2012a; Joshi 2012b), the chapter focuses on two relatively hidden political variables that appear to have played a major role in the BHD divergence between China and India: ideology and state capacity. The analysis suggests that efforts to develop greater state capacity and promote a more egalitarian ideology are key ingredients to advance public investment in BHD, especially the capabilities of women and children, as a strategy to deliver significant social and economic payoffs in both the short and long-term.

I. THE HUMAN DEVELOPMENT PARADIGM

Since the end of the Cold War, the human development paradigm has become the dominant approach to international development among the United Nations system and has been highly influential in shaping global perceptions of what constitutes development (Jolly et al. 2004; Joshi 2012a; The rien 2012). The concept of human development (HD) which stems from the Nobel-prize winning Indian economist Amartya Sen’s “capabilities approach” can be defined as “a process of enlarging people’s


choices. The most critical ones are to lead a long and healthy life, to be educated and to enjoy a decent standard of living.” (UNDP 1990: 10) As Sen (1999: 291) argues, HD is a function of the capabilities people pos- sess, which can be evaluated by “the extent to which people have the opportunity to achieve outcomes that they value and have reason to value.” HD can be seen as intrinsically valuable because capabilities directly enhance people’s substantive freedoms. HD is also instrumentally valuable because enhancing people’s capabilities advances economic development.

Sen argues that, in all modern societies, certain fundamental capabilities are crucial to determining people’s choices and the ability to lead enjoyable lives. As displayed in Table 2, four of these capabilities can be seen as more or less universal. First, physical capabilities that enrich the body enable one to be healthy and have a long life. Second, intellectual capabilities acquired through education allow us to advance our minds and gain knowledge, understanding, reason, and wisdom. Third, financial capabilities, as influenced by opportunities for employment, income levels, and savings, impact one’s living standards. Fourth, the opportunity for individuals to participate on equal terms in the life of their community reflects important social capabilities fostered by respect for human rights and a democratic, non-discriminatory social environment (Sen 1999; Joshi 2012a).

Table 2: Fundamental Capabilities in the Human

Development Approach

Capabilities Focus Indicators 1) Physical Body Health, Longevity 2) Intellectual Mind Knowledge, Schooling, Education 3) Financial Living Standards Income, Employment, Savings 4) Social Equal Opportunity Rights, Participation, Non-Discrimination Source: Derived from Sen 1999.

HD is thus a broader way of thinking about development than a

shorter-term and narrower focus only on annual growth of per capita income. The latter approach has been criticized for undervaluing children, women, human health, and the environment (Waring 1999). It has also been criticized for not taking into consideration the distribution of wealth and problems of social inequality and discrimination (Streeten 2003). As Sen (1999: 291) points out, “income levels may often be inadequate guides to such important matters as the freedom to live long, or the ability to escape avoidable morbidity, or the opportunity to have worthwhile employment, or to live in peaceful and crime-free communities. These non-income variables point to opportunities that a person has excellent reasons to value and that are not strictly linked with economic prosperity.”


As shown in Table 3, the goal of advancing HD has formed the basis of the Millennium Development Goals (MDGs), which guide the work of the United Nations (Jolly et al. 2004; Joshi 2011b). In particular, the MDGs concentrate on BHD, a term referring to the health and education levels of children (both female and male) with attention to the fundamen- tals of child survival, immunizations, nutrition, literacy, numeracy, and compulsory education. From an economic perspective, BHD is vital because it forms the base from which more comprehensive human capital formation is made possible. Social investment in children and mothers is at the heart of BHD, because it can have multiple dividends for society. Sen (1999: 284), for example, has drawn much attention to the fact that “a child who is denied the opportunity of elementary schooling is not only deprived as a youngster, but also handicapped all through life (as a person unable to do certain basic things that rely on reading, writing and arithmetic).”

Table 3: The UN Millennium Development Goals (MDGs)

# Dimension Goal 2015 Targets Include: 1 Income/Food Eradicate Extreme Poverty 1/2 the 1990 proportion of people

and Hunger with hunger and incomes under $1/day

2 Education Achieve Universal Primary Primary school completion for all Education boys and girls

3 Education/Women Promote Gender Equality Gender parity at all levels of and Empower Women education (primary, secondary,

tertiary)

4 Health Reduce Child Mortality 1/3 the 1990 under-five mortality rate

5 Health Improve Maternal Health 1/4 the 1990 maternal mortality rate

6 Health Combat HIV/AIDS, Malaria, Halt and reverse the spread of and Other Diseases HIV/AIDS, malaria, other major

diseases 7 Environment Ensure Environmental Reverse loss of environmental

Sustainability resources, 1/2 the 1990 level of people without safe drinking water and sanitation, etc.

8 Aid Develop a Global Develop a non-discriminatory Partnership for Development trading and financial system,

reduce developing countries’ debt, make ICT available, etc.

Source: Adapted from Joshi 2011b.

II. WHY INDIA LAGS CHINA

Though many factors are involved, two relatively “hidden” political factors can explain in part why India has thus far made less progress on BHD than China. They can be described as “hidden” because they are a) not always visible, b) difficult to measure, and c) typically excluded from


quantitative statistical analyses. My focus here is on the underlying functioning of the state in building a human capital base and providing public goods (Joshi 2011b). By steering resources, channeling social forces, and guiding public thinking, politics play a key role in determining whether BHD is prioritized, emphasized, supported, and guaranteed (Dreze and Sen 2002). Among the political forces that matter, two of the most important (but often least observable) are ideology and state capacity.

A. THE ROLE OF IDEOLOGY

Ideology can be defined as a “comprehensive belief systems composed

of patterned ideas and claims to truth. Codified by social elites, these beliefs are embraced by significant groups in society . . . [they] are not merely justifications of economic class interests, but fairly comprehensive programs designed to shape and direct human communities” (Steger 2008: 5). Because ideologies play a major role in what and how people think, they are pivotal to HD. As relatively cohesive narratives limiting and directing language and thought, they influence what development methods and goals are believed to be possible and desirable both at the elite and mass level.

While ideologies vary across multiple dimensions, a number of prominent studies have found that societies with a relatively inclusive and egalitarian ideology are more successful in advancing BHD (Esping-Andersen 1990; Alesina and Glaeser 2004; Wilkinson and Pickett 2011). By contrast, divided and patriarchal societies reinforced by inegalitarian ideologies have notably fewer public goods, and therefore lower attainments overall on children’s health and education (ibid). On this point, Sen (1999: xii) has recognized the importance of collective action, stating, “[i]t is important to give simultaneous recognition to the centrality of individual freedom and to the force of social influences on the extent and reach of individual freedom. To counter the problems that we face, we have to see individual freedom as a social commitment” (emphasis added).

Regarding ideological emphasis on egalitarianism, China and India differ significantly despite having similarly sized territories, nearly identical population numbers, and large agrarian populations. India as a multi- party democratic system with a relatively free press has more ideological contestation than in China. Nevertheless, within India, the powerful ideological force of the caste system, supported by the dominant Hindu re- ligious tradition, legitimates a fragmentation and stratification of the population into groups viewed by many Indians as entitled to different degrees of human development based on the hereditary caste into which they are born (Weiner 1991).

Though caste-based inequality and patriarchy have long histories in most parts of the Indian subcontinent, the relative passivity of most In- dian political leaders to these cultural norms since Independence in 1947 has facilitated their perpetuation. During the first three decades (1947- 1977) after Independence, the ruling Indian National Congress (INC)


party paid lip service to the trio of “democracy,” “secularism,” and “socialism.” Regarding the latter, however, it advocated neither egalitarianism nor empowering the masses through radical land reforms, major literacy campaigns, gender equality, or extensive equalization efforts as took place in Maoist China (Acharya et al. 2001). During this period, India’s Socialist Party and Communist Party did support more egalitarian ideology and policies, but were marginal in influence, never gaining more than a quarter of the votes combined in national elections outside the state of Kerala (Hardgrave and Kochanek 2000: 236-37). The INC, a coa- lition of rural landowners and the educated urban middle-classes, generally condoned both the deep inequalities of India’s stratified caste system and the widespread ideology and practice of patriarchy (Guha 2007). Rather than pursuing caste, class, or gender equalization, the INC aimed for trickle-down growth through urban industrialization and state control of industry (Kohli 2004). Upper caste Hindus (UCH), comprising about one-fifth of the population, were dominant in political decision-making. They held on average 67 percent of Indian Cabinet positions from 1950 to 1980 and a strong majority of leadership positions in government and the private sector (Goyal 1989; Jayal 2006; Jaffrelot and Kumar 2009).

Although India’s 1950 Constitution introduced electoral and bureaucratic quotas for “scheduled castes” (SC) and “scheduled tribes” (ST), little else was done to provide greater equality of opportunity in practice (Guha 2007). Efforts to lift up the lower castes became more prominent after the INC was first defeated in national elections by the Janata party (1977-1980), and the government constituted the Mandal Commission to investigate caste inequality. Though the INC soon returned to power in 1980, it was defeated again in 1989, and the National Front government moved to implement the Mandal recommendation of adding 27 percent reservations in government jobs and educational institutions for “other backward castes” (OBCs) (Jayal 2006: 180). In response, the 1990s were “a period of intense caste-based political mobilization” (ibid: 156) as quotas for SCs, STs, and OBCs combined increased from 22.5 percent to 49.5 percent in central government jobs. Thus, it has only been, for the most part, in the 1990s and 2000s that the issue of cross-caste equalization has come to the fore. While this has coincided with some decrease in the ideology of caste stratification in urban areas, it has paradoxically reinforced caste consciousness, social fragmentation, and identity politics (ibid). As a result, India has yet to experience any major transformation towards a more egalitarian dominant ideology.

As a result, over the last half-century, public health and education gains in India have been modest in most states. With the notable exceptions of Kerala and, to a lesser extent, Tamil Nadu, the political parties in power in the central and state governments have for the most part not promoted an egalitarian ideology (Joshi 2012b). Ideas supportive of patriarchy and caste inequality continue to be prominent in attitudes towards public services for the poor, not only in public health, but also in


public education, nutrition, and sanitation (Weiner 1991; Sinha 2006). Evidence of this widely-held inegalitarian ideology of caste stratification is most clear in the treatment of the Dalits (also known as “scheduled castes”), who, along with indigenous peoples known as “scheduled tribes,” make up the bottom of the social pyramid and number between 150 and 200 million. Formerly known as “untouchables,” the Dalits are themselves divided into hundreds of sub-castes and often locked heredi- tarily into occupations that are dangerous, difficult, dirty, and dehumaniz- ing. A few examples of Dalit sub-castes include the Dom, who cremate dead bodies; the Pakhi, Bhangi, and Sikkaliar, who transport and clean human excrement; the Musahar, who hunt rodents; and the Chamar, who work with leather. Though conditions are typically better in urban areas, surveys conducted in Indian villages have found discrimination against Dalits to be widespread, even in recent years. Table 4 lists some of the most common prohibitions, including denied access to employment, food sharing, water facilities, health care facilities, places of worship, police stations, restaurants, hotels, residential housing, public transportation, and selling in markets.

As Human Rights Watch reports:

Caste-motivated killings, rapes, and other abuses are a daily occurrence in India. Between 2001 and 2002 close to 58,000 cases were registered under the Scheduled Castes and Scheduled Tribes (Pre- vention of Atrocities) Act – legislation that criminalizes particularly egregious abuses against Dalits and tribal community members. A 2005 government report states that a crime is committed against a Dalit every 20 minutes. Though staggering, these figures represent only a fraction of actual incidents since many Dalits do not register cases for fear of retaliation by the police and upper-caste individuals. . . . Exploitation of labor is at the very heart of the caste system. Dalits are forced to perform tasks deemed too “polluting” or degrad- ing for non-Dalits to carry out. According to unofficial estimates, more than 1.3 million Dalits – mostly women – are employed as manual scavengers to clear human waste from dry pit latrines. In several cities, Dalits are lowered into manholes without protection to clear sewage blockages, resulting in more than 100 deaths each year from inhalation of toxic gases or from drowning in excrement. (HRW 2007)

Compared to India, China has experienced less ideological fragmenta-

tion and less fragmentation of the population into separate and competing caste identities. Moreover, in China, the State and the ruling Chinese Communist Party (CCP) are the dominant sources of ideological influence. Though ideology has shifted over CCP generations, it has differed from India in the sense that it has continuously retained a certain degree of emphasis on collectivism and egalitarianism. Most notably, in the Maoist period from roughly 1949 to 1978, promotion of radical egalitarianism was coupled with serious efforts to raise the status of women and ensure child survival. The CCP’s Marxist-Leninist ideology heavily em-


Table 4: Common Forms of Discrimination Against Indian Dalits

Frequency Forms/Sites of Discrimination against Dalits (% of Villages) Over 50% Denied entry into non-Dalit houses, Prohibitions against food sharing,

Denied entry into places of worship, Ill-treatment of Dalit women by other women

45-50% Denied access to water facilities, Ban on marriage processions, Not allowed to sell milk to cooperatives, Denied barber services, Denied laundry services, Ill-treatment of women by non-Dalit men

30-40% Denied work as agricultural laborers, Cannot sell things in local markets, Denied visits by health workers, Separate seating in restaurants, Denied access to irrigation facilities, Separate utensils in restaurants, Discriminatory treatment in police stations, Separate seating in self-help groups

25-30% Denied entry into police stations, Denied carpenter’s services, Denied entry into Public Distribution System shops, Denied access to restaurants/hotels, Forced to stand before upper-caste men

20-25% Paid lower wage rates for the same work, Ban on festival processions on roads, Denied home delivery of letters, Segregated seating in schools, Denied entry into private health clinics, No access to grazing/ fishing grounds, Tailors refuse to take their measurements, Separate drinking water in schools

15-20% Discriminatory treatment in post offices, Cannot wear new/bright clothes, No touching in transactions at shops, Denied access to public roads/passage, Denied entry into primary health centers, Not allowed to use umbrellas in public, Schools segregated so that Dalit students have a non-Dalit teacher and Dalit teachers have non-Dalit students

10-15% Denied entry into village council office, Ban on wearing dark glasses, smoking, etc. No seating or must enter last on public transport, Separate lines at polling booth, Denied entry into polling booth, Cannot wear shoes/slippers on public roads, Discriminatory treatment in primary health centers

Under 10% Denied access/entry to public transport, Separate times at polling booth, Discriminatory treatment in private clinics, Compulsion to seek blessing in marriages, Forced to seek upper caste’s permission for marriages, Cannot use bicycles on public roads, Denied entry/seating in cinema halls

Source: Shah et al. 2006.

phasized both empowering the masses and persecuting the upper classes, as evident in the state’s propaganda and policy efforts. Soon after coming to power in 1949, the CCP launched massive literacy campaigns (sao wenmang), gender equalization laws (hunyin fa), and land redistribution programs (tudi gaige) to promote its egalitarian goals. State investment in public health and education was part of this egalitarian program.

Compared to the INC and India’s other major political party, the BJP, the CCP placed much higher prioritization on BHD in China’s poor and rural populations out of a professed commitment to a communist ideology of egalitarianism as well as to keep the poor loyal to the CCP and capable of fighting a potential war of resistance against foreign invasion. Following Confucian tradition, Chinese leaders took the role of ideology very seriously. Whereas print media was relatively uncensored and per-


mitted the exchange of different viewpoints within India, the CCP controlled the mass media in China and, during its first three decades in power, used it to adamantly propagate a Marxist and Maoist ideology (Schurmann 1968).

Motivated by an ideology glorifying the elimination of material and status gaps between socio-economic classes, China experienced several revolutionary changes that would mark a fundamental difference between its development trajectory and that of India in the early post-war period. Land reforms (tudi gaige) and the Marriage Law of 1950 enabled hundreds of millions of farmers and women across the country to escape from landlordism and patriarchy. These reforms were significant in ensuring that rural Chinese could own their own land, grow their own food, and choose their own marriage partners. Subsequently, general consoli- dation of state power in the early 1950s through rural penetration and anti-corruption campaigns, like the “Three-Antis” (sanfan yundong) against corruption, waste, and bureaucratic mentality, and the “Five-An- tis” (wufan yundong) against bribery, tax evasion, fraud, theft of government property, and stealing of state economic secrets reduced corruption (Lu 2000). It also concentrated power in the ruling party by eliminating or taming potentially opposing forces including warlords, industrialists, the landed bourgeoisie, and criminal organizations (Gong 1994).

These reforms also set the stage for major expansions of rural education and national health insurance over the next several decades during the “Great Proletarian Cultural Revolution.” On the one hand, these campaigns contributed to major advances in the health, education, and nutrition of children. On the other hand, these campaigns regularly involved harassment, torture, and brutal punishment of political dissidents and opponents. By contrast, the Indian government did not attempt to carry out major reforms in any of these areas.

The sharp divergence in political ideology between India and China in the mid-twentieth century was clearly reflected in patterns of government expenditure. In the early 1950s, Chinese public education expenditure (PEE), at 2.0 percent of GDP, was three times higher than in India, where it was only 0.6 percent of GDP. While spending increased in India, by 1960 China still spent double the proportion of national income (3.0 percent) on public education as India (1.5 percent) (MoE 2006; Tilak 2006). China also invested heavily in public elementary and secondary schools because its revolutionary ideology insisted that education was a right and a duty for all citizens. This trend partially reversed itself during the Cultural Revolution, a period of drastic cuts in Chinese higher education budgets. But even during the Cultural Revolution, China directed a larger share of its education budget towards elementary education than India (Pepper 1996; Tilak 2006). While this was a highly detrimental time for China’s urban schools and universities, there was a significant shift in resources to expand primary education in the countryside where most of


the population lived and where the unit cost of providing schooling was significantly lower (Han 2000; Andreas 2009).

In the health sector, there was also a clear cut divergence with China spending over twice as much on public health as a percentage of national income than India in 1960 (1.3 percent versus 0.5 percent), and between one and a half to two times as much as India in 1980 (3.0 percent versus 1.4 to 2.0 percent) (Bhalla 1992; Acharya et al. 2001). China’s public health budget also focused more on children and rural areas, whereas most of Indian health spending was in the private sector and not directed primarily towards the poor and rural majority of the population (WHO 1983).

Notably, in China, the dominant ideology promoted by the state shifted after Mao’s death. Ideological emphasis in the opening and reform (gaige kaifang) period had gradually turned away from communism and towards capitalism (1979-2003), until more recently, emphasizing the more ambiguous goal of developing a “socialist harmonious society” (shehuizhuyi hexie shehui) since 2004 (Joshi 2012a). During this period, the CCP has not only tolerated but also promoted increasing wealth and income inequality within China. Despite this major turnaround, its ideological slo- gans and public policies have nevertheless consistently emphasized setting a basic minimum floor for children, particularly when it comes to the implementation of maternal and child health programs and the expansion of compulsory education (Joshi 2012a). Ideologically, much propaganda has been directed towards the promotion of improving the “quality” (suzhi) of China’s population by encouraging smaller families with healthy, nourished, and well-educated children (Greenhalgh and Winckler 2005). Since 1979, this has been coupled with a national population policy restricting most families to having only two children in rural areas and one child in urban areas (ibid).

As shown in Table 5, much of the BHD gap between China and India can be traced to the earlier 1950-1980 period when ideological differences between the two countries were strongest. In 1950, the infant mortality rate (IMR) of China (175) was higher than in India (146), but by 1979, India’s IMR (125) and child mortality rate (CMR) (153), were roughly two and a half times higher than in China where, even by the highest estimates, the IMR (56) and CMR (62) had dropped significantly (Nanda and Ali 2006; Swamy 2003; World Bank 2012). Likewise, school expansion was much more rapid in China. Whereas in both countries roughly one out of six people were literate in 1950, by 1980 two out of three Chi- nese were literate, compared to only about one out of three Indians.


Table 5: Human Development Indicators in India and China (1950-1979)

Human Development Indicators China-

1950 China- 1979

India- 1950

India- 1979

Infant Mortality Rate 175 56 146 125 Literacy Rate 14 66 17 36 Primary School Enrollment 93 79 Secondary School Enrollment 51 28 Per Capita Income (2000 US$ PPP) $762 $1179 Human Development Index Score 0.132 0.550 0.119 0.407 Data sources: Nanda and Ali 2006; Swamy 1989, 2003; World Bank 1981, 2012. Note: the Human Development Index for 1950 was calculated by the author using data from Swamy (2003) for per capita income in US dollars (purchasing power parity), adult literacy rates, and life expectancy at birth, using the scaling norms of the 2005 UNDP methodology: (Income: Log $100 to Log $40,000; Life Expectancy: “Rate” refers to the share of the population that is literate; “Primary and secondary school enrollment rates” refer to the percent of the age-specific population enrolled in school.

B. THE IMPORTANCE OF STATE CAPACITY

Though a good portion of the gap between China and India can be traced to ideological differences in the pre-1980 period, variation in state capacity has also been a crucial factor in determining BHD achievements. Joel Migdal (1988: 8) has defined “state capacity” as the state’s ability to penetrate society, regulate social relations, extract resources, and appropriate resources in a determined way. It can also be understood as the state’s “ability to perform appropriate tasks effectively, efficiently, and sustainably” (Hildebrand and Grindle 1997: 34). State capacity is partly constitutional and partly a matter of whether public administration functions in a “Weberian” manner (Evans and Rauch 1999). State capacity is strong when the central government has enough power and efficiency to implement policies (Wang and Hu 1998). Strong states, for example, are able to conscript their populations to meet military or civil needs (Joshi 2011a). They are able to control their territories and prevent armed conflicts so that the government holds a legitimate monopoly over violence. This usually requires high levels of tax compliance and the elimination of untaxed and unregulated “informal sector” economic activities (Wang and Hu 1998). It also requires skilled, trained civil servants and uncor- rupt administrative management to effectively staff, promote, and supervise policy implementation and enforcement (Joshi 2011a). A state with strong capacity maximizes the impact of allocated resources to achieve programmatic goals, whereas corrupt, inefficient, and ineffective states waste resources and are less capable of accomplishing stated goals.

Though India and China both have various capacity deficits, India has generally been weaker than China in dimensions of state capacity relevant to fostering BHD. For instance, India has faced greater problems of public personnel deficits. Doctor, teacher, and nurse absenteeism have


been major problems in India (Chaudhury et al. 2006). A sizable portion of public health and education expenditures are wasted when salaries are paid to employees on Indian state government payrolls without services being delivered (ibid). Studies conducted over the past decade have found Indian health worker absenteeism rates to be the highest in the world at about 40 percent (ibid; World Bank 2008). Teacher absenteeism in India has also been high, averaging 25 percent across the country with rates as high as over 40 percent in the state of Bihar (Rogers and Vegas 2009).

State capacity today differs between China and India, but the gap was even wider in the past. Whereas federalism and administrative weakness often undermined India’s central government, the Chinese central government generally had more capacity to penetrate remote and rural areas. While this has enhanced China’s ability to implement BHD policies, it has also functioned as a double-edged sword. China has been more effective than India in mobilizing its population for sanitation campaigns, literacy drives, and rural development projects, but the Chinese government has also used this capacity to supervise, torture, and punish those out of favor with the regime during intensely politicized campaigns like the Anti-Rightist Campaign (fanyoupai) (1957), Four Cleanups Move- ment (siqing yundong) (1962-1965), and Cultural Revolution (1966-1976).

The strength of the Chinese state has stemmed in part from the personnel system of the CCP and its single-party control over the state. In the early years after coming to power, the CCP controlled personnel in a brute manner through constant, relentless, and dramatic anti-corruption and rectification campaigns like the “Three-Antis” and “Five-Antis,” aimed at reducing bribery, embezzlement, and other forms of malfea- sance. While these campaigns could not wipe out all forms of public abuse, they were successful in reducing corruption to the point that China under Mao had less corruption than in the post-Mao period (Lu 2000; Manion 2004).

In India, however, there was not even a single large-scale anti-corruption campaign launched after its independence. This left corruption almost completely unchecked (Vittal 2003). Where the CCP had stronger organizational capacity to monitor administrative personnel, the INC lacked such capacity. In India, the bureaucratic backbone, or “steel frame,” of the administration was the Indian Administrative Service (IAS), a carry-over from the Indian Civil Service that served the British during the colonial period. It was structured for the purpose of colonial extraction and to efficiently maintain order with a small number of officials. Rather than reforming the civil service, India kept the IAS, which many have seen as more of a “steal frame” for embezzling state resources (Quah 2008). This practice was most notable under the rule of Indira Gandhi, and has led to the corruption and politicization of the civil service into the twenty-first century (Godbole 2003).


China has had its share of politicized government officials, and faced problems of embezzlement, but the costs to officials of being in the CCP’s disfavor (i.e., imprisonment, struggle sessions, expulsion from the party, execution, etc.) have meant that, compared to India, there have generally been more substantial incentives for Chinese officials to comply with their superiors. Another tool used by the CCP has been to require cadres to demonstrate loyalty to the party’s ideology. By contrast, the Indian state has not engaged in comparable repertoires of detention and ideological motivation to control or deter corruption among civil servants. Within India, known incompetent and corrupt officials have typically been allowed to keep their posts in all sectors of public employment, including those impacting BHD. As one Indian school principal put it, “[t]he teachers in the government schools are indifferent . . . . Once teachers enter the school system they cannot be terminated. No one is ever terminated.” (Weiner 1991: 56) (emphasis added).

Turning to the state’s ability to accrue financial resources, Chinese revenue collection was close to one-third of its national income during the crucial 1950-1980 period, a very high level for a country with low percapita income. The accumulation of such financial resources enabled the Chinese government to fund and carry out a much wider array of programs than if it had fewer resources available to it. As shown over five- year intervals in Table 6, state revenue in China was significantly higher than in India for most of this period. Moreover, in India, the state could only extract limited taxation from the rural areas, in part due to a constitutional prohibition against central government taxation of agriculture. While this may have benefited some of the rural poor, it enabled large absentee landowners to be free of tax obligations, thereby reducing the public revenue available for public goods.

Table 6: Combined Revenue Collection in India and China as a

Percentage of GDP

Year India Revenue China Revenue 1950-1 8.6 NA 1955-6 10.4 27.4 1960-1 12.3 29.2 1965-6 16.5 27.6 1970-1 16.0 30.7 1975-6 20.0 27.2 1980-1 24.2 25.7 Average 15.4 28.0 Data source: Joshi 2007.

India’s actual revenue-to-GDP ratios were probably somewhat lower than these official figures due to the large size of the “informal” sector, or uncounted portion of the economy, which still today encompasses over 90


percent of the country’s labor force. Tax reforms and improved revenue collection in the late 1960s and 1970s did have positive payoffs for India in the post-1980 period, but, from a comparative perspective, it is likely that China’s higher revenue raising capacity and taxation levels in the initial years were an important force for laying down more extensive physical and social infrastructures to help spread public health and education throughout the country.

Similarly, where the three-tiered Indian rural governance system of village councils (gram panchayat), block councils (taluka parishad), and district councils (zilla parishad) was weak and inactive in most places between the 1960s and 1980s, the three-tiered Chinese system of com- munes (renmin gongshe), production brigades (shengchan dadui), and production teams (shengchan dui) actively carried out basic administration and support for national campaigns (Unger 2002). The Chinese state was also more capable of mobilizing manpower through mass conscription campaigns, including compulsory rural service for doctors and teachers through “sent-down” programs (xiaxiang). By contrast, various laws for public service conscription of youth and professionals were never implemented in India (Jeffery 1987). The inability of the Indian state to implement and enforce policies, both in the early years and later on, was prominently reflected in Jawaharlal Nehru’s own dislike of compulsion. Whereas most countries claiming to be socialist laid down imperative and compulsory conditions, Nehru “was unwilling even to use a measure of compulsion” (Dutt 1981: 251).

Based on 2010 standardized governance measures produced by the World Bank (2011), China (-0.77) and India (-1.31) continue to diverge on political stability and the absence of violence. China (0.12) also scores higher than India (-0.01) on government effectiveness (World Bank 2011). Although comparable data for China are not available, India has been plagued for a long time by major problems of police, judiciary, and administrative corruption (ibid). As shown in Table 7, in a major survey conducted by Transparency International, over 85 percent of Indians view the police as corrupt (CMS 2005). Similarly, over 75 percent view the judiciary as corrupt. While India has been commended for its efforts toward enacting the rule of law, rampant judiciary corruption, deficits in judicial appointments, court cases delayed for years, and people impris- oned for years awaiting trial reveal state capacity deficits in need of attention. For example, at the end of 2009, in Indian state high courts alone, over four million cases were pending (SWI 2010).

The impact of administrative corruption, however, is probably the most detrimental to BHD. As shown in Table 7, the public distribution system (PDS), which provides food grains to the rural poor in India to combat hunger and malnutrition, has failed in most states. Most designated households do not receive grains in large part because they are stolen by intermediaries. As displayed in Table 7, large scale corruption also plagues Indian parliaments and state legislative assemblies and many


members face criminal charges for murder, rape, and other serious crimes.

Table 7: State Capacity Deficits in Major States of India (2005)

State

Residents who Believe the Police are

Corrupt (%)

Residents who Believe the Judiciary is

Corrupt (%)

Lok Sabha MPs Charged with

Criminal Cases (%)

Proportion of Rural

Population Receiving PDS

Food Grains (%)

Andhra Pradesh 86 40 7 63 Bihar 96 94 33 4 Gujarat 88 81 27 42 Haryana 88 80 20 5 Karnataka 87 75 21 56 Kerala 70 48 42 80 Madhya Pradesh 94 88 24 11 Maharashtra 83 77 42 38 Orissa 85 80 14 5 Punjab 90 86 31 2 Rajasthan 91 85 16 16 Tamil Nadu 68 78 21 69 Uttar Pradesh 90 78 28 4 West Bengal 93 79 12 10 Data source: CMS 2005. Note: state acronyms are for Andhra Pradesh (AP), Bihar (BI), Gujarat (GJ), Haryana (HR), Karnataka (KN), Kerala (KR), Madhya Pradesh (MP), Orissa (OR), Punjab (PJ), Rajasthan (RJ), Tamil Nadu (TN), Uttar Pradesh (UP), and West Bengal (WB). Dreze and Sen 2002; SWI 2006.

Over the last three decades, Indian state capacity has also been weaker than China in preventing armed conflicts and urban massacres. Based on its 2005 National Human Security Index score of 30 out of a possible 100, India ranked seventh lowest in the world and slightly lower than China (35 out of 100) (Joshi 2009). As shown in Table 8, among recorded incidents of mass urban violence claiming at least one hundred lives during the post-1980 period, eight occurred in India and four in China. Though a problem for both countries, with the notable exception of Tiananmen in 1989, urban massacres in China have been primarily limited to the border provinces of Tibet and Xinjiang, whereas in India, mass killings have taken place in the major metropolises of Ahmedabad, Delhi, Mumbai, and Varanasi in addition to rural insurgencies and armed conflicts in dis- puted border areas. A border war with Vietnam resulting in 220 officially recorded fatalities was China’s only standing armed conflict in the post- 1980 period. By contrast, as detailed in Table 9, India had at least thirteen major armed conflicts resulting in an estimated 37,048 deaths between 1980 and 2010 (UCDP 2012). Comparably, the Indian state’s inability (or unwillingness) to guarantee the absence of violent conflict in its territory has obstructed its ability to provide health care and education


in conflict regions. Not only have these conflicts channeled general public spending away from HD and toward warfare, but lasting conflict has been a deterrent to foreign and domestic investment in conflicted areas.

Table 8: Mass Violence (over 100 deaths) in Urban Centers of India

and China (1980-2010)

Year Location/Incident Country Estimated Deaths 1984 Amritsar Massacre India Over 500 1984 Delhi Massacre India 4,000 to 12,000 1989 Tiananmen Massacre (Multi-city) China 1,000 to 4,000 1990 Srinagar Massacres India 100 1992 Ayodhya/Bombay Riots India 1,000 to 2,500 1993 Bombay Bombings India 250 2001 Shijiazhuang Bombings China 100 2002 Gujarat Genocide India 1,000 to 2,000 2006 Mumbai Train Bombings India 200 2008 Tibetan Protests/Crackdown China 50 to 150 2008 Mumbai Attacks India 150 to 200 2009 U ru mqi Riots China 200 Data Sources: Varshney 2002; Yagnik and Sheth 2005; Kaur and Crossette 2006; Shani 2007; UCDP 2012. Alternative estimates may also be available on Wikipedia. Note: In the aftermath of the Amritsar Massacre it is estimated that 20,000 to 30,000 Sikhs died during conflict in the Indian state of Punjab between 1984 and 1992 (Shani 2007).


Table 9: Armed Conflicts (Over 100 Deaths) in China and India (1980-2010)

Country Armed Conflict Years Estimated Deaths China China-Vietnam 1980-1988 220 India Assam 1990-2010 1158 India Bodoland 1989-2010 681 India Bodo-Santhal 1996-1998 292 India India-Pakistan 1984-2003 2119 India Kuki-Naga 1993-1998 432 India Kuki-Paite 1997 136 India Maoist Insurgencies 1990-2010 4264 India Kashmir 1989-2010 19006 India Manipur 1982-2009 682 India Nagaland 1992-2007 598 India NSCN-IM - NSCN-K 2005-2010 260 India Punjab/Khalistan 1983-1993 6899 India Tripura 1980-2006 521 Data Source: UCDP 2012. Notes: Numbers of deaths are based on the cumulative “best estimate” or only estimate of fatalities from UCDP. NSCN-IM stands for National Socialist Council of Nagaland-Isaac-Muivah faction. NSCN-K is the National Socialist Council of Nagaland-Khaplang faction.

III. COMPARING DEVELOPMENT OUTCOMES

Measuring BHD in terms of Human Development Index and MDG criteria, China has made considerable strides over India, as shown in Ta- ble 10. In 2010, infant mortality was three times lower in China (1.6%) than India (4.8%) while child mortality in China (1.8%) was about one- fourth the rate of India (6.3%). Literacy in China (94%) was much higher than in India (63%), and child malnutrition in India (44-48%) was very high compared to China (5-12%). Overall the poverty rate in India (69%), based on the two-dollar-per-day poverty threshold, was more than double the level in China (30%). China was also ahead in primary education. In 2009, only 4 percent of Chinese children had not reached the fifth grade of primary school compared to 30 percent in India (UNESCO 2012). Similarly, where child labor between ages five and fourteen was less common in China outside Tibet and its Western provinces, it was still common throughout India, estimated at about 28 percent (Jayaraj and Subramanian 2005).


Table 10: Comparing Basic Human Development in China and India (2006-2010)

Human Development Indicators Year China India Infant Mortality 2010 1.6% 4.8% Child Mortality 2010 1.8% 6.3% Youth Illiteracy 2009 1% 19% Adult Illiteracy 2009 6% 37% Female Illiteracy 2009 9% 49% Child Malnutrition (under-weight) 2006 5% 44% Child Malnutrition (under-height) 2006 12% 48% Poverty Rate (< $2/day) 2010 30% 69%

Data Source: World Bank 2012.

During the late 1990s, China also had twice the number of doctors per capita and triple the number of hospital beds per capita as India, with two out of every three child births in China taking place in hospitals, compared to only one in three in India (Dummer and Cook 2008). Although there were significant regional disparities in both countries, about 90 percent or more of China’s villages had functioning health care stations during this period with low rates of doctor and health worker absenteeism compared to India (West 1997).

In conclusion, India has been slower than China at improving BHD. Encouragingly, India’s infant mortality rate dropped by more than half, from 12.5 percent in 1980 to 4.8 percent in 2010, but Indian child malnutrition was still very high at 46 percent. When we tabulate the cumulative impacts over time the results are staggering. Table 11 depicts the number of child deaths under age five from 1970 to 2009, which was approximately 122 million in India compared to about 46 million in China. Thus, while India was able to escape a famine like that which occurred in China between 1958 and 1961 during its Great Leap Forward campaign, high rates of everyday mortality in India have claimed a considerable number of lives.

Table 11: Child Deaths in India and China (1970 to 2009)

Decade India China 1970-1979 38.61 Million 19.99 Million 1980-1989 34.17 Million 11.87 Million 1990-1999 28.16 Million 9.46 Million 2000-2009 20.73 Million 4.19 Million Total 121.67 Million 45.51 Million Data Source: Calculated from World Bank 2012 data.


IV. CONCLUSION

Today it is common to ask why India as a democracy has fallen behind China on measures of BHD. The partial answer offered here is that, among other factors, India has not yet succeeded in replacing the pervasive ideology of caste and social stratification with an ideology supportive of equal opportunity and guaranteed basic human rights. India is a country that continues to struggle with massive social inequality and dis- empowerment, whereas China, a country with significant regional and economic inequality, has neither a caste system nor the degree of gender discrimination present in India. Moreover, in many sectors crucial to BHD, corruption in India has been rampant, and state capacity is generally weaker than in China.

As shown in Figure 2, China has sustained economic growth rates after 1980 rapidly outpacing India. This is in part because of early investments in women and children starting in the 1950s. Both countries’ development strategies involved major tradeoffs. During the earlier period the Chinese government demonstrated outright cruelty to the rich and “capi- talist roaders” through sins of commission; while the Indian government displayed pervasive cruelty to the poor through sins of omission. Over the longer term, however, China’s BHD foundations have resulted in a labor force that is more skilled, literate, and mobile than India’s. This is especially true of young women, who are a major source of China’s manufacturing labor force (Dobson 2009). Many women in India are, by contrast, uneducated or under-educated and face other significant workplace obstacles, such as corrupt police who do not prevent rape and sexual harassment and social taboos prohibiting people of different caste origins from living, working, and eating together.

Figure 2: Per Capita Income Growth in China and India (1980-2010) 8000

7000

6000

5000

4000

3000

China

India

2000

1000

0 1980 1984 1988 1992 1996 2000 2004 2008

Data Source: World Bank 2012. Note: Per capita income refers to per capita GDP based on purchasing power in constant 2005 US Dollars.


In conclusion, the processes uncovered in this article challenge two commonly held assumptions about improving BHD. First, it is often assumed that economic growth primarily drives BHD (Swamy 2005). But, as demonstrated here, in the pre-1980 period, China experienced major BHD progress while still experiencing a lower level of per-capita income than India. Hence, although the relationship between economic growth and BHD may be mutually causal, this comparison supports the findings of several influential studies that BHD may contribute more to growth than growth contributes to BHD (Ranis et al. 2000; Suri et al. 2011).

Another assumption is that democracies have higher BHD than non- democracies (Przeworski et al. 2000; Haggard and Kaufmann 2008), but empirical studies have found that this is not always the case (Joshi 2009). A more nuanced understanding may show that the type of democracy is also important in determining how much the state invests in BHD, particularly when it comes to women and children (Lijphart 1999; Heller 2000; Persson and Tabellini 2003; Joshi 2009; Joshi 2012c; Joshi 2012d). Thus, while economic growth and democratization may be valuable in their own rights, analysis suggests that human and economic development in both China and India would benefit from moving toward more inclusiveness in ideology and practice and developing a more effective system of state administration to implement and enforce quality programs that benefit public health, education, and nutrition for all sections of the population.

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A

WORLD TRADE AND INVESTMENT: WHERE DO THE BRICS STAND?1

Thomas Osang*

ABSTRACT

This paper examines the absolute and relative contribution by Brazil, Russia, India, and China (BRIC) on world trade and foreign direct investment over the past three decades. In addition, we briefly discuss major achievements as well as remaining shortcomings of the international trade and foreign investment policy reforms implemented by the BRICs over the same period. Empirical estimates of the long-run equilibrium relationship in exports between the BRICs and the G3 (United States, Japan, and Ger- many) as well as the role of the BRICs’ economic performance within a larger cross-section time-series data framework are also presented.

I. INTRODUCTION

T the time of Mao Zedong’s death in 1976, very few, if any, political or economic commentators predicted that thirty-five years later, China would be a major economic player in the world mar-

ket for traded goods and services as well as a major recipient and an important contributor of international financial capital. Yet, this is precisely what has happened. After many economic reforms that created a large private sector with modest regulation by the government, China is now the largest exporter of goods in the world with merchandise exports valued at $1.58 trillion USD in 2010, the world’s second largest trading nation with a total trade volume (exports and imports of goods and services) valued at $3.35 trillion USD, the largest recipient of foreign direct investment among developing countries ($185 billion USD in 2010), and an important contributor to foreign investment abroad with a total value of $60 billion USD in direct investment abroad in 2010.2

1. I would like to thank S. Stuart Smith for excellent research assistance. * Thomas Osang is an Associate Professor & Altshuler Distinguished Teaching Pro-

fessor in the Department of Economics at Southern Methodist University. He also serves as Fellow at the John G. Tower Center for Political Studies. Professor Osang’s research is in the areas of international economics and economic development. His most cited papers include “Exchange-Rate Volatility and Foreign Trade: Evidence from Thirteen LDCs” Journal of Business & Economic Statistics and “Protection for Sale: An Empirical Investigation: Comment” American Economic Review. Dr. Osang received his PhD in Economics from University of California, San Diego.

2. Unless otherwise noted, here and throughout the remainder of the paper, trade data are taken from the WTO trade statistics data base, available online at

515


Similar but somewhat less dramatic changes have occurred in Brazil, Russia, and India over the past three and a half decades. In the mid- 1970s, Russia was still heavily engaged in fighting the Cold War with the West, both in Europe and in other regions of the world. Russia’s centrally-planned economy was skewed toward the production of investment goods, leading to an acute shortage of consumption goods. Moreover, its participation in the international division of labor was mostly confined to barter trade with other centrally-planned economies. In the 1970s, In- dia’s policy makers still believed in development through self-reliance, making it nearly impossible for foreign firms to gain access to India’s economy through trade or foreign investment. Brazil, though more open than India and Russia at the time, favored a development strategy known as import substitution, which required the imposition of high tariffs and other trade barriers on foreign exporters to protect nascent domestic industries from the harsh winds of the world market.

Since then, Russia has transformed its economy from centrally-planned to market driven; India has changed its insistence on self-reliance and opened its economy to foreign trade and investment; and Brazil has abandoned its import substitution doctrine by dramatically lowering trade and non-trade barriers on goods and services from abroad. As a result of economic and, often, political reforms, the BRICs are now more involved in the international division of labor than at any other point during the last one hundred years. And given the scale of each country, both in terms of population and geographic size, the BRICs have become major players at the world level in terms of economic output, trade, and foreign investment.

The purpose of this paper is threefold. First, we will describe and compare the major economic reforms in the areas of trade and foreign investment that transformed the BRICs from relatively closed to comparatively open economies. Second, we will analyze the absolute and relative changes in trade and investment flows that occurred over the past two to three decades in each of the BRIC countries and compare the BRICs’ performance in these areas to that of the G3. Finally, we tackle two empirical questions. First, we examine whether there exists a long-run equilibrium relationship between the export performances of the established leaders in globalization, the G3 on one hand and the BRICs on the other. Second, we investigate whether there is any evidence for a BRICs effect in economic performance within a sample of 120 countries and forty years of observations.

www.wto.org, while the foreign investment data are from the World Bank’s World Development Indicators data base, available online at www.worldbank.org.

2012] WORLD TRADE & INVESTMENT 517

II. REFORM OF TRADE AND INVESTMENT POLICIES IN THE BRICS

Since the mid-1970s, each BRIC country has undergone a number of major economic reforms that have had a long-lasting impact on trade and investment flows with the rest of the world.

A. TRADE POLICY REFORMS

The Brazilian case is unique in that the country has had fairly liberal policies with regard to foreign investment flows since the 1970s, while at the same time restricting the importation of goods and services in accordance with the country’s import substitution policy. Once Brazil realized that these restrictive policies did not yield the expected progress in terms of economic development, the country embarked on a radical paradigm shift. Between 1987 and 1997, major economic reforms drastically removed much of Brazil’s trade barriers so that by the end of this reform period, the level of import tariffs was only one-tenth of that in 1987 (Fer- reira and Rossi, 2003). Despite these impressive reforms, there is room to push the trade liberalization process even further. According to the recent World Bank estimates of the Overall Trade Restrictiveness Index (OTRI)—an index that measures both tariff and non-tariff barriers to trade—for the period 2006 through 2009, Brazil had the worst performance of the BRICs and was ranked 88th out of 125 ranked countries in the sample (see Table 1, Panel A).3 If only tariff barriers are considered (Table 1, Panel B), Brazil’s ranking is even worse (93rd), with an average tariff of 9.3 percent.

For many decades after independence in 1948, India pursued a development policy that favored self-reliance over international specialization of production. Trade barriers were substantial and import tariffs were among the highest of any in the world. But starting in 1991, India embarked on a path that would lead the country away from the idea of autarkic development and towards greater openness with respect to foreign trade and investment. At the center of these reforms were substantial reductions in import tariffs (Ahluwalia, 2002). Nevertheless, given that India began its trade policy reform from such high levels of protec- tionism, it may not be surprising that its openness to trade today is still falling short of that of many other countries. In terms of the OTRI, India ranks 78th in the world today, ahead of Russia and Brazil but way behind the G3 and China (see Table 1, Panel A). The main reason for this poor ranking is that India’s tariff rates are still very high. India’s average import tariff stands currently at 12 percent (ranked 102nd in the world), far above those in the G3 and the other BRICs (see Table 1, Panel B).

The changes in Russia’s trade policy since 1992 have been dramatic and far reaching but also more volatile than in the other BRIC countries over

3. For details on the construction of the OTRI and related trade restrictiveness indi-

ces, Kee et al. (2009).


the same time period (Bessonova et al., 2002; Tarr and Volchkova, 2010). Until 1992, international trade was centrally planned and consisted mainly of barter trade with other command economies of the Eastern Bloc. This changed radically in 1992 when the state monopoly on foreign trade was replaced with market driven trade. But, in the same year, the government introduced export taxes to generate revenues and granted import subsidies to protect struggling domestic industries. A year later, import tariffs were introduced as an additional protective measure. Im- port subsidies, however, were eliminated in 1994. The years 1995 and 1996 saw the reduction of certain import tariffs and the elimination of all export taxes in the context of the IMF-led stabilization programs. But two years later, the government reintroduced an export tax on oil exports, mainly as a way to increase its overall tax revenues.

In the early 2000s, there were more reductions in import tariffs that coincided with a movement toward a more uniform tariff rate. As Figure 1 demonstrates, the ups and downs of Russia’s movement toward freer trade continued throughout the first decade of the new millennium. The tax rate on all types of international transactions (imports, exports, etc.) appears to increase through most of the decade before falling again after 2006. Russia’s two-decade-long struggle with trade reforms and trade liberalization culminated in the approval of its WTO membership application in December of 2011. Similar to Brazil and India, Russia has substantial room for further rounds of trade liberalizations. It is currently ranked 84th in terms of its overall trade restrictiveness and 70th in terms of the restrictiveness of its import tariffs (Table 1, Panels A and B).

The economic reforms that gradually transformed China into an outward oriented economy began at least a decade earlier than in the other BRICs (Panagariya, 1993; Naughton, 2007). As a result, China enjoyed a substantial globalization head start, which may explain why the country plays a more important role in the world market for traded goods and investment than the other BRICs, as we will see below. Nevertheless, the Chinese trade miracle did not really begin until 1992, more than a decade after the first round of trade reforms. Compared to the other BRICs, China has also been more serious about the removal of trade barriers, both tariff and non-tariff. As Table 2 shows, this is particularly true for the 2000s. Whereas China was ranked 72nd in terms of its overall trade restrictiveness at the beginning of the decade, its ranking improved to 55th between 2005 and 2008, and even further to 28th by the end of decade. Not only did China distance itself from the other BRICs whose OTRI rankings remained more or less the same throughout the decade, China also moved ahead of Japan and Germany, leaving the United States as the only G3 country that restricts trade less than China (see Table 1, Panel A). China still has room to improve in terms of MFN tariff levels. At 5.3 percent between 2006 and 2009, they are still higher than those in the G3 and only marginally lower than those in Russia.


B. REFORMS OF FOREIGN INVESTMENT POLICIES

In contrast to its protectionist trade policies, Brazil’s policies toward foreign investment inflows have been fairly liberal for a long time (Motta Veiga, 2004). During the 1990s, further reforms led to the opening of the IT sector to foreign investors and a simplification of the registration procedure for foreign direct investments. In the mid-1990s, a constitutional reform ended the state monopoly in the oil, gas, and telecom industries. As shown in Table 3, Brazil is by far the most open BRIC country with regard to foreign direct investment today. Brazil’s overall FDI index in 2010 stood at 0.116, with 1 indicating a completely closed and zero a completely open economy with regard to FDI. Brazil’s FDI index is even more impressive when compared to the average FDI index for all OECD countries, which, at 0.095, stands only slightly below that of Brazil.

Russia’s policies toward FDI changed dramatically when the country began its transition toward a market economy (Bessonova et al., 2002; Tarr and Volchkova, 2010). Joint ventures were allowed as early as 1989, while fully foreign-owned enterprises became legal in 1991. During the process of privatization of government assets that began in the 1990s, foreign investors were officially allowed to participate, but faced significant levels of discrimination in the process. This ambiguous attitude toward foreign direct investment is reflected in the data (see Table 3). Russia’s overall FDI index was 0.384, more than four times above the OECD average. Russia’s index is pushed up due to a combination of equity and operational restrictions.

India’s policies toward foreign direct investment changed along with their policies regarding foreign trade (Panagariya, 2008). Throughout the 1990s and 2000s, the country gradually opened more and more sectors to foreign investors, but often kept certain equity restrictions in place. To- day, the country is second among the BRICs in terms of openness toward foreign direct investment, with an overall FDI restrictiveness index of 0.220 in 2010, about twice the level of Brazil but half that of China. The reason for the relatively high index number is due solely to equity restrictions. In the other dimensions that contribute to the overall score (screening, key personnel, and operational restrictions), foreign investment flows into India are essentially unrestricted. While India’s FDI policies may be less proactive than those in China (see Huang and Tang, 2012), it has pursued comprehensive domestic reforms through explicit privatization and deeper financial liberalization, a fact that is often as important for foreign investors as the removal of direct investment barriers.

China has pursued a process of gradual foreign investment liberalization since the 1980s, but linked its reform process to two distinct FDI objectives: export promotion and technology transfer (Long, 2005). While export promotion was mandatory initially, today it is mostly neu- tral or even voluntary. From the perspective of investors from the advanced economies, the main issues with China’s current FDI policies are its insistence on “indigenous innovation policies, forced technology trans-


fer requirements, [and a] porous intellectual property enforcement regime.”4 While public criticism of China’s FDI policies from Western policy makers or business leaders is rare, the following statement by Rob Atkinson, president of the Information Technology and Innovation Foun- dation, a Washington based think tank, appears to reflect the current sen- timent of many foreign investors with ties to China: “There’s been a significant shift in top-level Chinese economic strategy away from attracting multinational foreign direct investment to unfairly supporting Chinese-owned companies.”5 Given the current level of restrictions that China imposes on foreign investors, it is not surprising that China’s FDI restrictiveness index, at 0.457, is by far the highest among the BRICs (see Table 3). The overall score is high due to comparatively large values in all four subcategories.

III. CHANGES IN THE INTERNATIONAL DIVISION OF

LABOR OVER TIME

There is no doubt that the international division of labor has changed dramatically over the past three decades, and much of it has to do with the emergence of the BRICs as a major player in the global market place.

A. INTERNATIONAL TRADE

The BRICs have increased their value of total trade (exports and imports of goods and services) from $615 billion USD in 1996 to $4.5 trillion USD in 2010, a more than sevenfold increase. Over the same time span, world trade increased from $10 trillion USD to $30.1 trillion, a mere threefold gain (see Figure 2). Also, trade by BRICs fared better during the world financial crisis of 2008 and 2009. In 2009, BRIC trade shrunk by 18 percent, compared to a 23 percent decline for world trade. When trade rebounded in 2010, BRIC trade increased by 34 percent compared to a worldwide rise of 21 percent.

An even more impressive picture emerges if one compares total trade shares6 for the BRICs with those for the G3 countries (Figure 3). All G3 countries have seen a more or less continuous decline in their trade shares over the past fifteen years. The United States’ share fell from 18 percent to 11 percent between 1996 and 2010, while Germany’s share declined more modestly from 10 percent to 8 percent. Japan saw its share tumble by about a third, from 7.5 percent to 5 percent. In contrast, the BRICs’ share in world trade has improved steadily since 2000 and reached an all-time high of 15 percent in 2010, while the G3 share hit an all-time low of 23 percent. If the BRIC-G3 shares continue to move in

4. D.J. Ikenson, “Trade Policy Priority One: Averting a U.S.-China ‘Trade War,’”

Free Trade Bulletin No. 47, The Cato Institute, March 5, 2012. 5. “Focus shifts from China’s currency to its other trade policies,” Los Angeles

Times, February 14, 2012. 6. The total trade share is defined as the ratio between a country’s total trade volume

and the volume of total trade of the world.


opposite directions, the two country groups will eventually reach parity in terms of their contribution to word trade.

As Figure 4 reveals, the trade performance of the BRICs was by no means uniform. While Brazil, Russia, and India improved their total trade volume from around $50 billion USD each in the early 1990s to around $500 billion USD each in recent years, their performances were dwarfed by the Chinese trade miracle. In 1992, China’s total trade stood at $165 billion USD, compared to a combined total for India and Brazil of $103 billion USD, a ratio of 1.6 in favor of China. By 2010, the combined trade value for India and Brazil had increased to $947 billion USD, but China’s trade value had risen to $2.974 trillion USD, three times that of India and Brazil.

But the BRICs are heterogeneous in other dimensions as well. When total trade is scaled by population size, three different patterns emerge (see Figure 5). Russia, the BRIC country with the highest per capita income, also has the highest trade per capita (also referred to as trade intensity) values over the past decade and a half. On the low side is India, whose trade intensity is substantially below that of the other BRICs. In the middle are Brazil and China, whose trade-per-capita ratios have been close to each other for the last ten years, but for very different reasons. While Brazil’s trade intensity is driven by a fairly high per capita income but a low trade-to-GDP ratio, the exact opposite is true for China where a high trade share is combined with a relatively low GDP per capita.

When compared to the G3, the BRICs’ trade intensity is still extremely low, despite the enormous increase in trade over the last fifteen years. In 2010, Germany’s trade-per-capita ratio stood at $28,600 USD compared to an average of $1,600 USD for the BRICs, different by a factor of eighteen. Nevertheless, in 1996, Germany’s trade intensity was forty-eight times larger than the average trade intensity of the BRICs, which amounted to only $250 USD at the time. Despite this remarkable catch- up process, it will take a long time, if ever, for the BRICs to reach the trade intensity of the German economy. The per capita trade values of the United States and Japan are in between those of Germany and the BRICs, with the U.S. numbers higher due to the large value of U.S. imports. In terms of exports per capita, the ordering between Japan and the United States is reversed.

B. FOREIGN DIRECT INVESTMENT

Given the number of policy reforms in the financial sector that oc-

curred in the BRICs over the last three decades, we should expect the BRICs to become more and more attractive destinations for foreign investors, in particular those who seek longer-term investments that include the elements of ownership and control (foreign direct investment). But, as shown in Figure 7, this is only partially the case. Between 1994 and 2000, the BRICs’ share of FDI inflows fell from 14.9 percent to 4.8 percent. Since then, the FDI inflow share of the BRICs has risen steadily,


but it was not until 2008, when the share reached almost 18 percent, that it exceeded the 1994 level. So what happened? It turns out that the U- shaped graph in Figure 7 has little to do with investor confidence or a lack thereof in the BRICs; rather, it has to do with boom and bust periods in the advanced economies. During the 1990s, the technology and dot-com investment mania in the OECD countries caused an incredible rise in FDI inflows. Between 1994 and 2000, worldwide FDI inflows rose from $259 billion USD to $1.62 trillion USD, a six-fold increase. FDI into the BRICs rose steadily as well over the same time period, but it merely doubled, from $38.5 billion USD in 1994 to $77.5 billion USD in 2000.

As a result of this relative “underperformance” of the BRICs, their share of worldwide FDI inflows shrunk by two-thirds between 1994 and 2000. But within the next five years, the BRICs were able to double their FDI inflows again, to $153 billion USD in 2005. With the bursting of the technology bubble in 2000, foreign investment in the advanced economies fell substantially, and in 2005, it stood at only 75 percent of its 2000 level. As a result, the BRICs share in worldwide FDI was able to gain ground fast, reaching 12.6 percent in 2005. Finally, the bursting of the housing bubble in some of the advanced economies and the subsequent worldwide financial crisis of 2008 and 2009 was another blow to foreign direct investment in the OECD countries. As a result, worldwide FDI inflows increased by only 8 percent between 2005 and 2010. In contrast, the BRICs, whose economies remained relatively unaffected by the boom and bust cycle in the rich countries, continued to grow along their trend line and were able to double their FDI inflows again over the next five year period, reaching $300 billion USD in 2010.

Once again, it is important to know whether FDI inflows were more or less homogeneous across the four BRICs. The answer is given in Figure 8. As is the case with international trade flows, China is also the biggest recipient of foreign direct investment among the BRICs.7 China’s share of worldwide FDI inflows varied from a low of 2.4 percent in 2000 to a high of 13.9 percent in 2010. China’s average annual share of FDI inflows over the 1994 through 2010 period was 8 percent, compared to 4.5 percent for the other BRICs (the BRIs). But these averages hide the substantial convergence in FDI inflows between China and the BRIs that occurred during this period. In 1994, China’s FDI inflow share was more than seven times that of the BRIs, while by 2008 the two shares were close to parity. Given its longstanding openness to FDI, it is not surprising that Brazil is the second largest recipient of FDI among the BRICs, with an average share of 2.3 percent over the sample period. But with the beginning of the natural resource boom in the mid-2000s, Russia has attracted more and more foreign investment, and between 2006 and 2009 surpassed Brazil as the second largest recipient of FDI among the BRICs. India, whose openness to FDI is a more recent phenomenon, is by far the

7. It is noteworthy that China’s FDI inflows would be even larger if its foreign direct

investment policies were less restrictive (see infra Part II.B).


smallest FDI recipient among the BRICs, with an average share of less than 1 percent between 1994 and 2010.

The importance of Brazil and, in recent years, Russia as destination countries for foreign investors becomes even more apparent when we scale FDI inflows by population size (Figure 9). Since 2003, Brazil and Russia have outperformed China and India in terms of FDI per capita. Over the sample period, foreigners invested $125 USD per Brazilian each year, about the same as in Russia ($124 USD). The corresponding numbers for China and India are $61 USD and $10 USD, respectively. This gap in FDI intensity between the more advanced economies of Russia and Brazil on the one side and the less developed economies of China and India on the other is quite striking.

As Figure 10 shows, the BRICs are not yet major players in the world market in terms of direct investment abroad (DIA) or FDI outflows. This is not unexpected because all four of the BRICs are classified as developing countries by the World Bank, and as such should be major destinations and not sources of international direct investment. On average, the Eurozone countries and the United States account for close to 60 percent of worldwide DIA over the sample period, compared to 4.4 percent for Japan and 3 percent for the BRICs.8 Interestingly, while Japan’s share has been fairly constant between 1994 and 2010, the share of the BRICs has increased steadily and has exceeded the Japanese share since 2003. The rise in DIA by the BRICs has been driven by Russia and China. In the case of Russia, this partly reflects the rising capital flight by the nation’s oligarchs in response to uncertainty about the country’s political and socio-economic stability in the near future.9 In contrast, resource-scarce China has stepped up its foreign investment into resource rich economies in Africa, South America, and Australia in recent years to secure the necessary raw materials for its fast-growing energy and manufacturing sectors.10

IV. EMPIRICAL INVESTIGATION

This section tackles two different empirical questions related to the BRICs. First, we investigate whether there exists a long-run equilibrium relationship in exports between the G3 countries and the BRICs (see Fig- ure 11).11 If such an equilibrium were to exist, it would be further evi-

8. These numbers appear to contradict the large-scale purchases of U.S. Treasuries by

China and other Asian, as well as Middle Eastern, countries over the past fifteen to twenty years. But these international investments are classified as foreign portfolio investments, which are tracked separately from foreign direct investments.

9. “Russia’s Capital Flight Intensifies,” The Wall Street Journal, January 13, 2012. 10. “China’s Investment in Africa to Increase to $50 Billion by 2015, Bank Says,”

Bloomberg, February 22, 2011. 11. We are also interested in the related issue of the existence of a long-run equilib-

rium relationship in FDI between the G3 and the BRICs. Unfortunately, to investigate this hypothesis requires longer time series data for FDI than are currently available for the BRICs. But some time series evidence on FDI in the BRICs has recently begun to emerge (see, e.g., Vijayakumar et al., 2010).


dence that the BRICs have been able to hold their own when compared to the world leaders in globalization. Second, we test the hypothesis that the BRICs, as a group, made a larger contribution to economic performance (measured by GDP per capita) than other countries in the world over a forty-year period. Finding such an effect would strengthen the belief that the BRICs will indeed be the engine of growth in the world for the foreseeable future.

A. LONG-RUN TRADE EQUILIBRIUM BETWEEN BRICS AND G3

In order to test the hypothesis of a long-run equilibrating relationship in exports between the BRICs and the G3, we first need to determine whether the two time series variables are stationary or non-stationary. That is, whether the autoregressive process that characterizes their movement over time contains a unit root (non-stationary) or not. To do this, we perform two tests that are frequently used in the unit root literature: the augmented Dickey-Fuller test (ADF) and the Phillips-Peron test (PP).12 Both test statistics show that we cannot reject the null hypothesis of non-stationarity for both time series at the 1 percent significance level. We then transform the data by taking first differences and retest both time series. This time, both test statistics reject the unit root null hypothesis for both time series. Based on the unit root tests, we conclude that both export time series are best characterized as I(1) processes.

We can, therefore, proceed to our next question, namely whether there exists a combination of these two non-stationary time series such that the combined time series is stationary. To find out, we need to estimate the long-run (cointegrating) relationship between the two variables using a cointegration estimation procedure. Among the many possible choices, we report the widely used parametric estimation method by Johansen (Johansen, 1991; Johansen and Juselius, 1990). The results are given in Table 4. With two time series, there are three possible outcomes. The tests’ results of the Johansen approach may reveal that no cointegration vector exists, the existence of a single cointegrating vector, or the existence of two cointegrating relationships (two cointegrating vectors). The last case implies that the two variables are not integrated of order 1, while the first one reveals that the non-stationary variables are not cointegrated. Therefore, the only case that provides evidence for the existence of long-run equilibrium in exports between G3 and BRICs is the single cointegrating vector outcome. There are two Likelihood Ratio (LR) tests, the max eigenvalue (or max lambda) test and the trace test, each of which is used to determine the number of cointegrating vectors in our two time series system.

As shown in Table 4, both tests reject the null hypothesis of no cointegrating vectors in favor of the alternative (1 or 2 cointegrating vec-

12. All estimations in section IV.A were performed using EasyReg International

(Bierens, 2012). The unit root test results are available from the author upon request.


tors) at the usual levels of significance (20%, 10%, 5%). Furthermore, both LR tests cannot reject the null hypothesis of a singly cointegrating vector (compared to the alternative of 2 cointegrating vectors). We thus conclude that the empirical test results of the Johansen procedure point to the existence of a single cointegrating vector and in turn a long-run equilibrium relationship in exports between the G3 and the BRICs. The estimate of the cointegrating relationship coefficient, based on the simple regression of G3 exports and BRIC exports (with heteroscedasticity consistent t-statistics in parentheses), is given at the bottom of Table 4. It implies that for every additional dollar in exports by the BRICs the G3 increase their exports by $1.43.

B. BRICS AND ECONOMIC PERFORMANCE

Given the strong and well-documented economic performance of the BRICs, it should be straightforward to demonstrate a “BRICs effect” on economic development using a data set comprised of more than one hundred and twenty countries and covering more than forty time periods. The dependent variable is GDP per capita (in constant USD) and the regressors comprise a list of variables covering the quality of government institutions, the economy’s connection to the rest of the world (globalization), and measures of geography. To estimate the full model, we use both random effects (RE) and Hausman-Taylor (HT) estimators.13 In addition, we use the fixed-effect (FE) estimator to control for unobserved time-invariant country-specific effects. Note that in this case the coefficient estimates of the time invariant regressors—such as the geography measures—are lost. The data set covers the period from 1960 to 2000, with the annual data transformed into decadal averages to account for business cycle and other long-term time effects.

The results are presented in Table 5. The first three columns show the RE, FE, and HT estimation results, respectively, for the full empirical model including the BRICs dummy. As noted above, in the FE model the time-invariant BRICs dummy must be dropped from the regression due to the inclusion of the country dummies. While the estimated coefficients of the variables measuring institutions, globalization, and geography are statistically significant at the 5 percent level and carry the expected signs, the BRICs dummy coefficient estimates in columns two and three are not significant and carry a negative sign. We therefore conclude that for the full sample period and after controlling for important determinants of development, there is no evidence that the BRICs performed better or worse than the rest of the countries in the sample.

At first glance, this result is somewhat surprising; after all, Brazil, Rus- sia, India, and China became the BRICs due to their high-growth per-

13. For a discussion of the Hausman-Taylor estimator, as well as variable definitions

and data sources used in the panel model estimations, see Jacob and Osang (2011; available at http://www.faculty.smu.edu/tosang/pdf/jacob_osang.pdf). Estimates are generated using the STATA11 statistical software.


formance, which made them attractive destinations for international investors. But because the sample period begins in 1960 and the BRICs’ high-performing years are skewed toward the end of the sample, a BRIC dummy that covers all four decades may not be able to capture the uneven growth performance of the BRICs over the sample period. There- fore, in columns four through six, we replace the overall BRICs dummy with a dummy that only measures the impact of the BRICs in the 1990s, a decade where the BRICs’ economic growth rate was clearly more notice- able. While the HT estimator in column six still shows a negative, insignificant effect, the results from the other two panel estimators now exhibit a positive and statistically significant coefficient estimate for the BRICs during the 1990s.

V. SUMMARY AND CONCLUSIONS

Several results emerge from our investigation. First, we find that despite dramatic changes toward greater openness in trade and investment, the BRICs can push their trade and investment reforms even further, although the degree of future changes in openness varies from country to country. Second, we find that the absolute and relative growth rates in trade and investment flows that occurred over the past two to three decades in each of the BRIC countries have been substantial and appear to be sustainable. Third, we find evidence for a long-run equilibrium relationship in exports between the BRICs and the established leaders in globalization—the G3; this is further evidence that the BRICs are on their way to a shared leadership in world trade with the G3. Finally, we find no evidence for a BRICs effect in explaining GDP per capita using panel data models covering the 1960 to 2000 period. But if the BRICs dummy is restricted to the last decade in the sample, there is evidence that the effect is positive and statistically significant, thus lending credibility to the view that the BRICs will be the growth engine of the world economy for years to come.

REFERENCES

Ahluwalia, M.S., 2002, “Economic Reforms in India since 1991: Has Gradualism Worked?,” The Journal of Economic Perspectives, Vol. 16(3), pp. 67-88.

Bessonova, E., Kozlov, K., and K. Yudaeva, 2002, “Trade Liberaliza- tion, Foreign Direct Investment and Productivity of Russian Firms,” unpublished manuscript.

Bierens, H. J., 2012, “EasyReg International,” Pennsylvania State Uni- versity (http://econ.la.psu.edu/~hbierens/EASYREG.HTM).

Ferreira, P.C. and J.L. Rossi, 2003, “New Evidence from Brazil on Trade Liberalization and Productivity Growth,” International Economic Review, Vol. 44(4), pp. 1383-1405.


Huang, Y. and H. Tank, 2011, “FDI Policies in China and India: Evi- dence from Firm Surveys,” The World Economy, Vol. 35(1), pp. 91-105.

Jacob, J, and T. Osang, 2011, “Institutions, Geography and Trade – A Panel Data Study,” unpublished manuscript.

Johansen, S., 1991, “Estimation and Hypothesis Testing of Cointegra- tion Vectors in Gaussian Vector Autoregressive Models,” Econometrica, Vol. 59, pp. 1551-80.

Johansen, S. and K. Juselius, 1990, “Maximum Likelihood Estimation and Inference on Cointegration – With Application to the Demand for Money,” Oxford Bulletin of Economics and Statistics, Vol. 52, pp. 169- 210.

Kalinova, B., Palerm, A., and S. Thomsen, “OECD’s FDI Restrictive- ness Index: 2010 Update,” OECD Working Papers on International In- vestment No. 2010/3, OECD Investment Division, www.oecd.org/daf/ investment/workingpapers.

Kee, H.L., Nicita, A., and M. Olarreaga, “Estimating Trade Restrictive- ness Indices,” The Economic Journal, Vol. 119, pp. 172-199.

Long, G., 2005, “China’s Policies on FDI: Review and Evaluation,” in Does Foreign Direct Investment Promote Development? Moran, T.H., Graham, E.M., and M. Blomstrom (eds.), Institute for International Eco- nomics, Washington, D.C., Chapter 12, pp. 315-36.

Motta Veiga, P. da, 2004, “Foreign Direct Investment in Brazil: Regula- tion, Flows and Contribution to Development,” unpublished manuscript.

Naugton, B., 2007, The Chinese Economy: Transitions and Growth, MIT Press.

Panagariya, A., 1993, “Unraveling the Mysteries of China’s Foreign Trade Regime,” The World Economy, Vol. 16 (1), pp. 51-68.

Panagariya, A., 2008, India – The Emerging Giant, Oxford University Press.

Tarr. D, and N. Volchkova, 2010, “Russian Trade and Foreign Direct Investment Policy at the Crossroads,” Policy Research Working Paper 5255, The World Bank, Development Research Group.

Vijayakumar, N., Sridharan, P., and K.C. Sekhara Rao, 2010, “Deter- minants of FDI in BRICs Countries: A panel analysis,” International Journal of Business Science and Applied Management, Vol 5(3), pp. 1-13.

World Development Indicators CD-ROM, 2009, The World Bank, Washington, D.C.


Table 1: Trade Restrictiveness Indicators: G3 and BRIC, 2006-2009

Panel A: Ranking by OTRI* Country OTRI Rank U.S. 15 China 28 Germany 30 Japan 59 India 78 Russia 84 Brazil 88 Number of ranked countries: 125 Panel B: Ranking by MFN Tariff**

MFN Tariff MFN Tariff Country Rank Rate U.S. 9 2.20% Germany 25 4.10% Japan 57 4.80% China 63 5.30% Russia 70 6.10% Brazil 93 9.30% India 102 12% Number of ranked countries: 125 *OTRI: overall trade restrictiveness indicator; ** MFN tariff: most favored nation tariff Source: World Trade Indicators 2009/10, The World Bank, online database.


Figure 1: Russia’s Taxation of International Trade (1999-07)

0.18

0.16

0.14

0.12

0.1

0.08

0.06

0.04

0.02

0

1999 2000 2001 2002 2003 2004 2005 2006 2007

Source: Word Development Indicators 2009, The World Bank, CD-ROM.

Table 2: OTRI Ranking of BRIC, 2000-2009

2000-04 2005-08 2006-09 Latest Brazil 82 86 88 Russia 81 85 84 India 88 84 78 China 73 55 28 Source: World Trade Indicators 2009/10, The World Bank, online database.

Table 3: FDI Restrictiveness Ranking of BRIC in 2010 (1=closed, 0=open)

Country Equity

Restrict.

Screening Key

Personnel Operational

Restrict. Total FDI

Index Brazil 0.08 0 0.005 0.033 0.116 Russia 0.216 0.04 0.005 0.122 0.384 India 0.191 0.025 0.005 0 0.22 China 0.226 0.135 0.048 0.069 0.457 OECD 0.059 0.024 0.001 0.013 0.095 Source: OECD’s FDI Restrictiveness Index (Kalinova et al., 2010).


Tri

llion

s

Figure 2: BRICs and World: Total Trade (in trillion USD)

$35

$30

$25

$20

$15

$10

BRIC Trade

World Trade

$5

$0

1996 1998 2000 2002 2004 2006 2008 2010 Source: WTO, Trade Statistics, 2011.

20.0% 18.0% 16.0% 14.0% 12.0% 10.0%

8.0% 6.0% 4.0% 2.0% 0.0%

Figure 3: BRICs and G3: Total Trade (as % of World)

BRIC

USA

Japan

Germany

Source: WTO, Trade Statistics, 2011.


Bill

ions

$3,500

Figure 4: BRICs: Total Trade (in billion USD)

$3,000

$2,500

$2,000

$1,500

$1,000

Russia

Brazil

China

India

$500

$0

1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Source: WTO, Trade Statistics, 2011.

6000

Figure 5: BRICs: Total Trade per Capita by Country (in USD)

5000

4000

3000

2000

Russia

China

Brazil

India

1000

0 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Source: WTO Trade Statistics 2011; World Development Indicators 2012, World Bank.


Figure 6: BRICs and G3: Total Trade Per Capita (in USD) $35,000.00

$30,000.00

$25,000.00

$20,000.00

$15,000.00

$10,000.00

Germany

USA

Japan

BRIC

$5,000.00

$0.00

1994 1996 1998 2000 2002 2004 2006 2008 2010 Source: WTO Trade Statistics 2011; World Development Indicators 2012, World Bank.

25.0% Figure 7: BRICs: Total FDI Inflows (as % of World)

20.0%

15.0%

10.0%

5.0%

0.0% 1994 1996 1998 2000 2002 2004 2006 2008 2010

Source: World Development Indicators 2012, World Bank.


0.160 Figure 8: BRICs: FDI Inflows by Country (as % of World)

0.140

0.120

0.100

0.080

0.060

0.040

China

Brazil

Russia

India

0.020

0.000

1994 1996 1998 2000 2002 2004 2006 2008 2010 Source: World Development Indicators 2012, World Bank.

Figure 9: BRICs: FDI Inflows per Capita by Country (in USD)

$600.00

$500.00

$400.00

$300.00

$200.00

Brazil

Russia

China

India

$100.00

$0.00 1994 1996 1998 2000 2002 2004 2006 2008 2010



Figure 10: BRICs, Euro Area, US, Japan: FDI Outflows (as % of World)

70.00%

60.00%

50.00%

40.00%

30.00%

20.00%

Euro Area

US

Japan

BRIC

10.00%

0.00% 1994 1996 1998 2000 2002 2004 2006 2008 2010


Figure 11: BRIC and G3: Exports of Goods and Services (in constant 2000 USD)

4000

3500

3000

2500

2000

1500

BRIC

G3

1000

500

0 1978 1983 1988 1993 1998 2003 2008



Table 4: Johansen’s Cointegration Analysis

LR test (Lambda Critical Critical Critical max test) values values values

Test At 20% Conclusion At 10% Conclusion At 5% Conclusion statistic level level level

Null: r=0 coint 14.4 10.1 Reject 12.1 Reject 14.0 Reject vectors Null Null Null

Altern: r=1 coint vectors

Null: r=1 coint 1.0 1.7 Accept 2.8 Accept 4.0 Accept vectors Null Null Null


LR test (trace test)

Test 20% Conclusion 10% Conclusion 5% Conclusion statistic

Null: r=1 coint 1.0 1.7 Accept 2.8 Accept 4.0 Accept vectors Null Null Null


Null: r=0 coint 15.4 11.2 Reject 13.3 Reject 15.2 Reject vectors Null Null Null


*No cointegrating restrictions on the intercept parameter imposed; Var(p) order: p=2 Estimated cointegrating (long-run) relation (heteroscedasticity-consistent t-stats in parenthesis): G3 = 9.4E11 (13.5) + 1.43 (16.4) BRIC.


Table 5: Panel Estimates with Dummy for BRICs

Dependent Variable: log GDP per Capita (in 1996 PPP Dollars)

VARIABLES FE RE HT FE RE HT

log Nbr Veto Players (it) 0.039 0.054 0.039 0.032 0.046 0.045

(2.60)** (3.66)*** (2.61)*** (2.10)** (3.09)*** -1.56

Rule of Law (i) 0.71 0.894 0.722 0.882

(12.37)*** (7.81)*** (12.59)*** (6.62)***

log Trade Share (it) 0.241 0.076 0.241 0.229 0.078 0.252

(4.94)*** (2.32)** (4.96)*** (4.72)*** (2.41)** (4.34)***

Malaria Ecology (i) -0.037 -0.03 -0.036 -0.03

(-4.64)*** (-2.77)*** (-4.52)*** (-2.66)***

Dummy for BRICs -0.412 -0.104

(-1.26) (-0.26)

Dummy for BRICs in 90s 0.365 0.348 -0.308

(2.35)** (2.20)** (-0.26)

Constant 5.591 5.031 7.255 7.899

(10.35)*** (8.47)*** (38.17)*** (55.94)***

Observations 340 340 340 340 340 340

Number of countries 122 122 122 122 122 122

R-squared 0.13 0.983 0.151 0.982

t-statistics in parentheses

*** p<0.01, ** p<0.05, * p<0.1

O

OBSERVATIONS ON INNOVATION AND

TECHNOLOGY USE IN THE BRICS

Keith E. Maskus*

I. INTRODUCTION

NE of the primary questions of this conference, arising from both widely held concerns and hopes, is whether the BRICS–Brazil, Russia, India, China, and South Africa – along

with other prominent emerging economies such as Mexico, Argentina, Malaysia, and Indonesia, can sustain their recent remarkable growth records. The concerns relate to continued prospects for offshoring US manufacturing and service jobs, with possibly negative consequences for lower-skilled and medium-skilled Americans. The hopes reflect the increasing recognition that Europe, Japan, and the United States face years of slow growth or economic stagnation, leaving to key emerging countries the critical role of driving increases in world demand for the medium- term.

Many important factors will determine whether the BRICS will continue to rack up significant growth gains. The most immediate forces are global and national macroeconomic elements, such as fiscal austerity, monetary expansion, energy and materials prices, and interest rate and exchange rate fluctuations. The large sizes of the BRICS economies, especially China’s, have made economic conditions there increasingly important for world stability. Perhaps for the first time in recent history, analysts in the developed world must pay close attention to how these nations are faring in order to understand prospects for their own markets.

If macroeconomics dominates in the short run, structural microeconomic factors determine growth prospects over longer time ho- rizons. Among the most important conditions are demographic trends, educational attainment, policy transparency, infrastructure, trade liberalization and deregulation, and the ability to innovate and adapt technologies. The various BRICS have registered different performance records on these basic factors in recent decades. Some have succeeded in moving underemployed labor and capital to more efficient uses (China, India, and South Africa). Others have taken advantage of increasing commodity prices (Brazil and Russia). Some have invested heavily in education

* Keith E. Maskus is a Professor and Associate Dean for the College of Arts and

Sciences at the University of Colorado Boulder. E-mail: Keith.Maskus@colorado. edu. This paper was prepared for the Tower Center Conference on the BRICS at Southern Methodist University on March 2012.

537


and infrastructure (China) while others lag behind (Russia, Brazil, and India).

The prevailing story of the BRICS to date has been their seemingly rapid “catching up” of productivity, wages, and percapita incomes to levels in richer nations. These factors have been important in pushing these countries from being highly inefficient in resource allocation and investments toward a more productive frontier. With many of these gains now growing more difficult to achieve, the BRICS must turn to the next, and perhaps most significant, factor: how well situated are they to foster domestic innovation and the effective acquisition and transformation of foreign technologies? Its importance cannot easily be overstated; economic evidence finds that technical change is the key driver of productivity gains and long-term economic growth (Keller 2004; Maskus 2012).

In this paper I review the recent performance of some key emerging economies in terms of their innovativeness and use of technological improvements. The focus generally is on China, however, because it has taken perhaps the greatest strides in this regard and its sheer size makes the most difference for global structural transformation. After a discussion of performance and policy regimes, the paper turns to an assessment of potential roadblocks limiting future growth in this area. Overall, the view here is that these roadblocks are significant and, unless addressed effectively, could limit the prospects of substantial growth in innovation and ultimate convergence with more advanced countries, except in specific areas. Of course, there will continue to be considerable heterogeneity among the emerging economies in this regard, as there always has been, and the likelihood of long-run success for at least some of the BRICS seems high.

II. INNOVATION PROFILES

It is useful to set the stage by looking at recent indicators of innovation

performance in the BRICS. Basic data on important factors are provided in Table 1. The top panels consider measures of technology inputs: R&D as a percentage of GDP and research personnel per million persons of population. In the decade from 1997 to 2007 virtually all of these countries saw increases in these ratios but there was marked variability among them. Russia’s share of R&D in GDP rose only 7.7%, in line with the proportionate increase in the United States, but it saw a decline in the skill ratio of its population. Brazil began from about the same level as Russia in terms of R&D but saw somewhat more rapid growth, with such investments now over 1% of output. Brazil’s ratio of research personnel nearly doubled in the period. India’s growth in the R&D performance measure was similar to Brazil’s but it retains a lower overall ratio. India saw modest growth in its share of technical researchers. South Africa experienced a rise of over 50% in the share of R&D in GDP and a doubling of research personnel, indicating a growing domestic investment in the sources of technological change. Finally, China registered by far the

2012] OBSERVATIONS ON INNOVATION 539

greatest growth performances in these measures. By 2007 the country had reached an R&D to GDP ratio of 1.44%, around half that in the United States, and more than doubled the ratio of R&D researchers in the population.

A similar message of heterogeneity is delivered by the innovation output measure of patent grants issued by the US Patent and Trademark Office (USPTO). This is a useful comparative measure because the USPTO applies the same standards to applicants from all countries, while the need to pay associated fees implies that foreign firms generally register only inventive ideas. Listed in the bottom panel of Table 1 are the absolute numbers of grants and the shares of total patents approved by the USPTO for inventors from each nation. For example, despite the increase in its relative R&D share, South African inventors saw virtually no increase in patenting in the United States. Brazilian and Russian inventors were similarly unresponsive in this regard, with no increase in their shares of American patents. In contrast, the number of Indian patents went up by a factor of ten, with that country raising its share of US grants from 0.08% to 0.55%. China’s growth was even more remarkable in this area. Its patent grants rose by a factor of almost thirty and its share of approvals increased from minimal to over 1.4%. This ability to capture a rising proportion of US patents during a period of mushroom- ing global growth in patenting is truly noteworthy.

Direct innovation measures are useful but do not capture the extent of technology transfer, a critical form of learning and structural change. Of course, these two concepts are closely related, for inward technology flows can precipitate domestic spillovers, imitation, and ultimately provide a basis for local innovation (Keller 2004; He and Maskus 2012). Put differently, countries that receive significant amounts of technology, and have enterprises that are capable of both deploying the technology effectively in domestic production and adapting it into localized uses, are generally capable of building on this information to develop competing innovations (Chen and Puttitanun 2005; Moran et al. 2005; Maskus 2004a). After some lag, these countries may become significant technology exporters as well as importers.

In this context, one reasonable measure of developing innovation capacity is the growth of two-way technology transfer flows, as detailed in Table 2. For example, in 1995 each of the BRICS had a significant share of high technology goods in manufacturing imports, ranging from 13.9% in India to 23.8% in South Africa.1 With the exception of China, these shares were much lower in manufactured exports in 1995, indicating a largely one-way high technology flow in traded goods. All of these nations saw a rise in the high technology share of imports between 1995 and 2005, with the proportions in India and China doubling. But China was the only one with a similarly sharp rise on the export side (and, indeed,

1. For this purpose, high technology goods are defined as pharmaceuticals and

medicines, electronic equipment, and aerospace products.


ran a trade surplus in these goods in the latter year), although Brazil increased its share of high technology exports by 4.1 percentage points. This share actually declined in Russia and was static in South Africa. On this simple measure, then, China stands out among the BRICS as a country that has seen its trade structure migrate heavily toward higher-technology goods, with substantial two-way exchange going on.

A second measure of technology flows is the inward and outward stocks of foreign direct investment (FDI). As economists note, multinational enterprises are properly thought of as more conduits of technical improvements across borders than as sources of financial capital (Markusen 2002). Thus, rapidly growing stocks, which are measures of cumulative FDI flows, should, in some degree, capture emerging two-way investments in technology transfer.2 As noted in the bottom panel of Ta- ble 2, all the BRICS remained net recipients of FDI between 2000 and 2008 but there was remarkable growth in the outward direction in all cases. China’s outward stock grew from $28 billion to $148 billion, while India’s expanded by a factor of over thirty. Much of this outward expansion reflected investments in other developing countries. Indeed, the relatively new phenomenon of growing South-South FDI is attracting increased scrutiny by international economists. But a sizeable proportion of it, especially from China, Brazil, and India, has been aimed at take- overs and greenfield investments in the developed world (He and Maskus 2012).

A similar point may be made from the data on payments and receipts of royalties and licensing fees in the final panel. These figures, taken from balance-of-payments data, primarily account for net flows of licensed technologies, brand names, and copyrighted materials, such as software, and are the most direct measure of cross-border information transactions. As may be seen, the amount of payments made by the BRICS mushroomed between 1995 and 2008, growing from over $500 million for China (in 2007) to $10.3 billion. All of the BRICS remain significant net importers of technology by this measure. But, with the exception of South Africa, the BRICS’ gross receipts of such technology fees also grew extremely rapidly.

To summarize, all of the BRICS remain significant net recipients of formal technology flows, whether through trade, FDI, or licensing of intellectual property. This is true whether measured as absolute dollar values or relative to some activity benchmark, such as GDP or manufacturing trade. In virtually all cases, these countries have increased their relative investments in innovation inputs and now receive more patent grants at the USPTO. But there are considerable differences across countries in these measures and only China stands out as a major growth locus in all these dimensions. That is particularly true with our measures

2. It should be noted that the UNCTAD data from which these stocks were taken refer to total stocks, not just manufacturing.


of two-way technology trade, which anticipate the emergence of China as a significant international competitor in new products and technologies.

The data suggest that a process of technological catch-up is underway in the BRICS. This is especially the case in China, but there are clear hints of it in Brazil and India as well. The following section will offer further perspective on this question with regards to China. It is worth pointing out that any conclusions drawn from such figures should be treated cautiously as statistical measures may capture quite different factors across countries. For example, the definition of what constitutes a researcher, and the nature of her credentials, varies widely. China’s educational system produces a great many scientists and engineers, but, at least to this point in time, their productivity in research lags that of most developed countries.

Similarly, a significant amount of what is considered R&D spending in China occurs in either public laboratories or state-owned enterprises (SOEs), which may limit the productivity of that spending in innovation. Further, the statistics on growth in patents granted reflect many factors, including most importantly the sectors in which economies tend to spe- cialize. In the case of China, for example, these USPTO patents are over- whelmingly in software and microelectronics, industries where it is common for firms to register patents on small slivers of innovation (Hu and Jefferson 2009). Indeed, the bulk of these patents were granted to just six Chinese enterprises, such as Huawei and Hong Fu Jin Precision Industries—a major assembler of the iPhone3—and Microsoft, which actively engages in software development in China. Finally, the prominence of consumer electronics assembly in China’s production structure itself explains much of the growth in China’s high technology imports and exports. These goods are counted in trade on the basis of gross value, rather than value added. As has been well documented, the value added contributed by Chinese enterprises in such sectors remains small, though it is growing as a share of exports (Koopman et al 2008). China’s exports in other high technology industries, such as pharmaceuticals, precision machinery, and aerospace equipment, remain relatively small (OECD 2007).

With this kind of uncertainty from basic data it may be more informa- tive to consider independent measures of each country’s overall engage- ment with innovation, research, and knowledge. Thus, Table 3 lists the World Bank’s Knowledge Economy Index (KEI) for each of the BRICS plus the United States in 2000 and 2012. The KEI is designed to measure “whether the environment is conducive for knowledge to be effectively used for economic development.”4 It is the average score of four “pil-

3. See http://www.uspto.gov/web/offices/ac/ido/oeip/taf/asgstc/cnx_ror.htm. More

perspective may be found in Maskus (2012). 4. KI and KEI Indexes, World Bank, http://web.worldbank.org/WBSITE/EXTER-

NAL/WBI/WBIPROGRAMS/KFDLP/EXTUNIKAM/0,,contentMDK:20584278~ menuPK:1433216~pagePK:64168445~piPK:64168309~theSitePK:1414721,00.html (last visited Jan. 19, 2013).


lars” of the knowledge economy: economic incentives and institutional regime, education, innovation, and activities in information and communication technology (ICT).

This index offers a rather different picture than the transactions data above. Specifically, nearly all of these countries have been relatively stagnant in their rankings in the early years of the twenty-first century, according to the World Bank. India saw its index level decline and it lost three spots in the global rankings, with similar results in Brazil. South Africa’s performance was the least attractive of the group, falling fourteen places in the rankings. Russia experienced a small improvement in its index, with associated gains in the rankings. Again, the largest improvement was in China, with its index rising over 11% and a rise of ten spots relative to other countries. Nonetheless, its absolute index still lags behind those in Brazil and South Africa, while barely reaching half that in the (declining) United States. Put briefly, China’s economy may be catching up to the West, but it has a long way to go. Innovation and technical change are still in their initial phases in both China and India. Other national innovation measures are available but would tell a similar story (Maskus 2012).

III. MEDIUM-TERM INNOVATION PREPAREDNESS

The relatively low positioning of the BRICS in these KEI indexes, and the apparent recent stagnation of some of these countries in this context, raise two important questions. Specifically, what essential national factors determine the capability of enterprises to become more engaged over time in creativity, innovation, and the use of science and technology? And how well positioned are these BRICS to build and take advantage of a robust system of innovation over the next ten years or so? The discussion here will focus on China, the country that Western observers seem most worried or optimistic about, with additional commentary offered for other BRICS where relevant.

A. BASIC CONDITIONS

For purposes of describing pro-innovation national characteristics it is

useful to follow the categorization set out by the OECD in its periodic surveys (OECD 2007). As that organization notes, the strongest determinants of innovation capabilities come from the country’s framework conditions or economic environment. The first framework condition is the pervasiveness and quality of the educational system and the opportunities it gives students to think creatively. Here, China has made considerable strides, seeing its secondary enrollment rate (secondary enrollment as a percentage of associated age group) rise from 58% in 1997 to 81% in 2010. In contrast, India’s rate was 47% in 1997 and rose to just 63% in


2010.5 The other BRICS already had high secondary enrollment rates in 1997, including 99% in Brazil (unchanged by 2010), 92% in Russia (down to 89% in 2010), and 90% in South Africa (up to 94% in 2010). At the tertiary level, enrollment rates reached 26% in 2010 in China, with corresponding figures of 27% in Brazil, 18% in India, and 76% in Russia (data unavailable for South Africa). For comparison, the tertiary enrollment rate in 2010 for the United States was 95%.

On these simple indicators, China is rapidly gaining on the other BRICS nations, if not the major developed economies, in achieving universal secondary education. University enrollments, which remain limited to successful performers on standardized examinations, lag well behind in China, while India faces structural problems in expanding such access for students from rural and impoverished backgrounds. Of course, rising enrollments do not necessarily imply improving quality. It is common to argue that China’s focus on rote learning and standardized examinations diminishes the ability of its students to think creatively and, ultimately, to contribute to national innovation (OECD 2007). Still, China’s students have registered unmistakable gains in global academic performance measures. For example, in 2009, high school students from Shanghai finished first on all three key PISA assessments.6 In comparison, Russian students were thirty-eighth in mathematics and thirty-ninth in science and Brazilian students were fifty-seventh in mathematics and fifty-third in science. Again, for comparison it is worth noting that US students finished thirty-first in mathematics and twenty-third in science.

It is also important to note that when it comes to building a human capital stock from which scientific and engineering skills may be deployed, absolute scale matters considerably. In this context, while China has seen a rise in most of its proportionate measures of education and science, the sheer size of its investments dominates the other BRICS. For example, China is engaged in an ambitious program to build a large number of research-oriented universities, while expanding its science and engineering (S&E) enrollments at existing institutions (Maskus 2012). Perhaps the best measurement of China’s large scale ambitions is simply the fact that China is easily the largest source of international doctoral students in American S&E programs (Stuen et al. 2012). It is also significant that a rapidly increasing share of Chinese students earning a technical Ph.D. abroad return home to work in enterprises, public research institutes, or universities, in part because the opportunities in science and innovation have improved (Kerr 2008).

Thus, while the overall picture is mixed, it is reasonable to expect that China will achieve a human capital base within the next generation that will be the foundation for significant global competition in innovative industries, even if they amount to a small share of the total economy. The

5. World Bank, World Development Indicators, http://data.worldbank.org/indicator/

SE.SEC.ENRR (last visited Jan. 19, 2013). 6. http://ourtimes.wordpress.com/2008/04/10/oecd-education-rankings/.


outlook for the other BRICS appears to foretell stasis or limited growth in this context.

A second major determinant of national innovation capacity is the competitiveness of product and capital markets (OECD 2007). The BRICS all have undergone significant liberalization of trade and investment barriers in recent years, with China now perhaps the most open of all the BRICS in the wake of its entry into the WTO in 2001 (Maskus 2012). One simple measure of this openness is the weighted-average tariff rate across all industrial sectors, which in China fell from 12.3% in 2001 to 3.7% in 2009.7 Comparable tariff rates for Brazil were 10.4% (2001) and 9.9% (2009), for India 21.0% (2004) and 7.2% (2009), for Rus- sia 8.9% (2001) and 6.6% (2009), and for South Africa 4.9% (2001) and 4.6% (2009). Thus, by 2009 China had the lowest average tariff rate and had cut its import taxes by a far larger proportion than the other BRICS, though all five had achieved relatively low industrial tariffs by the end of last decade. Similarly, according to expert opinion at the World Eco- nomic Forum, China reduced its protection against imports and restrictions against FDI between 1995 and 2008 by considerably more than did India, Brazil, and numerous other emerging economies (Maskus 2012). All of this liberalization has expanded external competition in these markets, while bringing in significantly larger amounts of international technology, ultimately stimulating more innovation.

Still, while trade and investment openness are important, they may have little impact if not accompanied by strongly competitive forces in internal markets. Here, the BRICS have made considerably less progress, including China (OECD 2007). China retains significant internal distortions in labor and capital markets, experiences extensive market intervention by federal and provincial authorities, protects inefficient SOEs, and has little tradition or experience with anti-monopoly regulation. So far, at least, its universities, public research institutions, and enterprises have been ineffective at commercializing new knowledge to create and introduce innovative goods. Brazil and India have fared somewhat better in this regard, at least in particular sectors, though entry of new firms in India remains a daunting prospect. These difficulties may be seen by the “ease of doing business” indicators published by the World Bank.8 On this score, in 2011, Singapore ranked first, Hong Kong second, and New Zealand third. In contrast, China was ninety-first, Brazil 126th, India 132nd, Russia 120th, and South Africa thirty-fifth. Thus, with the possible exception of South Africa, dealing with corruption, red tape, and other barriers to entry continues to restrain competition in the BRICS.

Moreover, in China, significant problems remain with corporate governance regarding innovation (OECD 2007). For example, the cautious and political orientation of SOEs offers few incentives for long-term in-

7. Data from World Bank, WITS data source, at http://wits.worldbank.org/wits/. 8. World Bank, World Development Indicators, http://data.worldbank.org/indicator/

IC.BUS.EASE.XQ (last visited Jan. 19, 2013).


vestments in risky R&D projects, especially aimed at foreign markets or meeting rapid changes in consumer demand. Additionally, China suffers from limited development of private financial markets for funding innovation and there is only a fledgling venture capital market. These two problems – uncompetitive domestic markets and poorly structured innovation incentives and supports – remain the primary medium-term block- age to the development of domestic innovation societies, especially in China and India.

A final major framework condition is the structure of intellectual property rights (IPRs). Innovative economies strive to ensure effective protection for new inventions, technical secrets, creative ideas, and brand names, while striking a balance between the needs of firms to profit from their creative investments and users to access new knowledge. The period from 1995 to 2010 saw remarkable increases in the scope of legal protections for patents, trademarks, and copyrights in all emerging economies, especially the BRICS (Maskus 2012). Brazil, India, and China all adopted significantly updated patent laws in this period, partly in response to the need to meet WTO obligations. China, in particular, enacted major changes in all forms of intellectual property in the wake of its entry into the WTO in 2001 and now has a legal framework for protection that is not much different from that in the United States. Brazil re- vamped its patent laws in the late 1990s, also adopting significant new protective norms. India enacted its latest patent law in 2005, clarifying that pharmaceutical products and agricultural chemicals are eligible for protection. Each country also has extensive copyright regimes, though both patents and copyrights are subject to important limitations and exceptions. For example, all three nations assert an active role for compulsory licensing of critical patented goods, especially new essential medicines. Brazil and India implicitly require domestic production to sustain a patent in force, and India offers broad scope for educational use of copyrighted materials.

Of course, while legal reforms are important, they are not very meaningful if the laws are enforced poorly or on a discriminatory basis. In this context, China still faces considerable obstacles in achieving a transparent and effective IPRs regime (Suttmeier and Yao 2011). Beyond the obvi- ous problems of endemic trademark counterfeiting, widespread copying of digital products, and websites posting copyrighted goods are several structural difficulties. Among the more important problems are inadequate investments in enforcement, especially of infringing exports, regional differences in levels of protection, administrative mismanagement, and insufficient provision of judicial procedures, which may seem tilted against international companies (Mertha 2005; Maskus 2012). Such problems plague both foreign firms and innovative domestic enterprises, which react in strategic ways that limit China’s ability to benefit from access to new technologies. Survey results find that the situation makes innovative firms more reluctant to transfer their frontier technologies to


domestic partners or licensees, reduces the willingness of domestic innovators to commercialize their knowledge, damages the quality reputation of Chinese enterprises, and limits investments in global quality (OECD 2007; Maskus 2004b). China is now investing more resources in enforcement, which should reduce these problems, but infringement of patents and loss of trade secrets remain a severe challenge for international enterprises.

B. INNOVATION POLICIES

Where China clearly outstrips the other BRICS is in the clear strategic

priority it places on building a modern national innovation system (NIS) and facilitating the emergence of a globally competitive, technology- based economy. All emerging economies recognize that, in order to support competition and growth, it is important to create a system of institutions, markets, enterprises, and consumers that turn knowledge into innovation and effectively absorb technologies into production processes. Only a few, however, such as Singapore, South Korea, Taiwan, and, most recently, China, have elevated this objective into a national policy obses- sion, albeit with different models.

Thus, in the mid-1990s, the government of China stated the development of domestic science and technology as a major economic priority. Several initiatives were launched to build innovation capacity in such high technology sectors as biotechnology, advanced materials, and ICT (Xue and Liang 2010). Central to this effort was a major and ongoing investment in establishing high-level research universities and facilitating commercialization of their research through linkages to SOEs and creation of spinoff companies. Similarly, there are extensive public supports for domestic R&D centers, with over 2300 existing in SOEs today. Re- lated incentives for multinational enterprises to establish R&D facilities in China have borne fruit, with over 1000 of them in key cities.

Correspondingly, Chinese enterprises and public authorities have increased investments in research, with the R&D/GDP ratio rising from 0.6% in 1995 to nearly 1.5% in 2007, as noted earlier. Such major enterprises as Haier, Lenovo, and Huawei grew larger and more focused on technological change and innovation in this period. Still, these figures should be kept in perspective. A large portion of the increase in R&D came from public investments in science and the establishment of research centers owned by foreign concerns (Xue and Liang 2010). Rela- tively little investment has emerged in SOEs or small Chinese firms. Further, even large firms, such as Lenovo and Huawei, disproportion- ately bought or licensed technologies and production rights rather than invested in new global technologies. In China’s high technology sectors, domestic enterprises still lag significantly behind their competitors in the advanced economies. As the OECD (2007) puts it, there is far more “D” than “R” in the country’s R&D investment, with little evidence of much shift to date. For such reasons, Chinese authorities remain concerned


that even larger domestic enterprises are well below the frontiers of technology competitiveness. Despite solid gains in productivity, many—especially among Chinese thought leaders—still think of the country as a location for assembly factories rather than a source of new technology.

Recognizing such problems, in February 2006 the State Council published a document setting out guidelines and principles for developing scientific and technological capacity in the Chinese economy. These principles run the gamut of government actions that could support, or even mandate, the development of a full national innovation system. Addi- tional incentives were offered for supporting university research, technology transfer of research results to private and public enterprises, and even filing patent applications.

The central element of the new policy was the requirement that promoting “indigenous innovation” would become the most important element of S&T policy at all levels of government. Such encouragement had long been a policy objective but never elevated to this level. Government procurement programs at the national and provincial levels were targeted as a primary instrument for supporting innovation by Chinese enterprises (Ernst 2010; Suttmeier and Yao 2011). Thus, in November 2009 the Min- istry of Science and Technology (MOST) and two other agencies defined terms under which products could be certified as developed by indigenous innovators in six industries: software, telecommunication products, office equipment, computer and application devices, alternative energy technologies, and high-efficiency energy-saving products. The policy defined criteria under which a Chinese enterprise could have a certified product put into a public catalogue of goods approved for government procurement.

It should be noted that the original guidelines amounted to a particularly discriminatory policy biased against international technology developers. Of greatest concern were the draft rules regarding IPRs. There were requirements that qualifying enterprises must own or acquire IPRs developed in China and that trademarks must be originally registered there. This rule in essence tied procurement-market access to intellectual property ownership. Foreign IPRs holders would have to transfer those rights, or even the R&D done under their protection, to a domestic enterprise. Under the guidelines, the certified technologies had to achieve recognized levels of global standards, meaning that the associated IPRs would be valuable. A further condition stated that use or improvement of intellectual property could not be restricted by foreign firms. This policy would prevent original IPRs owners from issuing standard contract terms regarding local sales, ownership of follow-on technologies, or licensing of local rights.

Obviously, these procurement rules, especially in connection with complementary policies encouraging or requiring the surrender of Chinese patent rights to domestic business partners within a given period of time, were controversial for technology developers. Many foreign businesses


and, interestingly, larger Chinese enterprises objected strongly to the procurement policy and its implications for IPRs ownership. Under this pressure, in 2010, MOST issued a new document that considerably soft- ened the procurement conditions, essentially abandoning the Chinese-origin IPRs requirement and the limitations on contract terms. Still, the basics remain in place, and time will tell whether this heavy-handed bit of industrial policy will be implemented.

Whether it will be effective in promoting domestic innovation also remains unclear, based on recent history. For example, China’s efforts to develop domestic—and inherently discriminatory—ITC standards have met with mixed success (Ernst 2010). The government has successfully promoted a domestic 3G standard that is commonly used in cell phones sold in China, an example of using the large market to foster a home technology. But at this time there are no Chinese-developed standards that have made successful international inroads.

To summarize, China continues to target innovation and S&T policy as a high priority for public policy. Undoubtedly, the country will continue to make large public and private investments in education and research infrastructure and will pursue incentives for encouraging domestic innovation, while working within its rules and international obligations to foster rapid acquisition of international technologies. Already it is possible to see signs of increasing innovation, both in terms of quantity and quality, in such sectors as solar panels, biofuels, automobile parts, appliances, and biotechnology. Still, structural problems remain that will take some time to overcome, suggesting that China’s emergence as a full global competitor in the knowledge arena is perhaps a generation away.

The other BRICS certainly have innovation policies in place, but they are not as extensive or centrally directed as China’s strategy. India invests heavily in public research institutes, but the ability of those entities to transfer new technologies seems limited by numerous factors (Maskus 2012). Brazil has strong technology orientations in a few industries, such as sugar, biofuels, and small aircraft. Its government has also taken several recent steps to build a stronger national innovation system, including incentives for commercialization of research done in universities and public research laboratories. So far, however, the country has largely failed to establish an overall culture of innovation (Mazzoleni and Povoa 2010).

IV. SUMMARY AND CONCLUSIONS

The discussion to this point suggests that, while there are clear signs of

growing innovation and technology use in the BRICS, there remain significant structural difficulties that must be addressed to establish fully competitive cultures of innovation and creativity. China has proceeded furthest in terms of policy reforms, investments in research infrastructure, and incentive systems, but continues to be plagued by problems of weakly enforced IPRs, corruption, favoritism, and misallocated capital for R&D. India has made considerable strides in software and ITC services and has


spawned some major private global corporations, such as Tata Industries and Dr. Reddy’s (Jonsson 2008). But few of these originate globally competitive innovation, while much of India’s economy has barely touched the modern technological sector. Brazil, Russia, and South Africa all fea- ture the existence of technologically oriented companies in specific sectors, but do not score very highly on global innovation scales. Each of those economies is dominated by development and exports of primary commodities, which are less likely to spawn rapid technological increases, contrasted with the microelectronics industry in China.

In brief, the BRICS all share some features and successes in their technological catch-up processes, but their experiences have been quite varied in terms of industry mix, capital markets, R&D, and public policy. None of them is currently a consistent contributor to global technical advances, and only China (and possibly Brazil) seems poised at this time to enter that competition anytime soon. Put differently, catch-up is a real phenomenon, which ultimately will make most or all of today’s BRICS a significant source of innovation, but that emergence remains more a long- term than a medium-term prospect.

Nor should we lose sight of further potential roadblocks for technological growth in the BRICS. For example, there are already signs of dimin- ishing returns to R&D investments in China, as the easily attainable gains from imitation and acquisition of technologies give way to the hard work of original invention (Maskus 2012). Further, to some degree, China and Brazil seem caught in an emerging “middle income trap,” which means that wages and costs have risen in labor-intensive manufacturing, but the shift of activity into higher-skilled and innovative sectors is insufficient to absorb these costs. It will be interesting to see if China in particular can manage this transition effectively before its ongoing demographic problem of rapid aging inevitably diverts resources from R&D to social programs. Finally, endemic problems of corruption and concentrated political power continue, which tends to channel resources in directed and inefficient ways rather than through channels that respond to market demands. Each of the BRICS, but especially China and Russia, must come to grips with this fundamental problem.

These are significant roadblocks to further development of innovative societies, but they must be kept in perspective. Other, now developed, economies, including South Korea, Singapore, Japan, and even the United States, have been described in similar terms at various points in history. Each of the BRICS faces strong challenges which can be overcome with a firm vision and appropriate policies. Betting on technological failure in the long run, especially for China, seems unwise at this point.


Table 1. Broad Technology Indicators in the BRICS and United States

Researchers in R&D per R&D as a share of GDP million population

Country 1997 2007 % change 1997 2007 % change

Brazil 0.96 1.10 14.6 340 657 93.2

China 0.64 1.44 125.0 477 1,071 124.5

India 0.69 0.80 15.9 110 145 31.8

Russia 1.04 1.12 7.7 3,598 3,305 -8.1

S. Africa 0.60 0.92 53.3 199 396 99.0

USA 2.58 2.72 5.4 4,179 4,745 13.5

Patent grants at USPTO

Country 2000 (%) 2011 (%)

Brazil 98 (0.06) 215 (0.09)

China 119 (0.08) 3,174 (1.41)

India 131 (0.08) 1,234 (0.55)

Russia 183 (0.12) 298 (0.13)

S. Africa 111 (0.07) 123 (0.06)

USA 85,068 (54.0) 108,626 (48.4)

Sources: World Bank, World Development Indicators and United States Patent and Trademark Office.

Table 2. Measures of Two-Way Technology Transfer in the BRICS

High technology Imports High technology Exports

1995 2005 1995 2005

Country $billion % of $billion % of $billion % of $billion % of mfg. mfg. mfg. mfg.

Brazil 8.7 22.3 16.3 29.0 2.4 9.0 8.4 13.1

China 22.0 20.7 209.4 41.0 24.4 19.2 284.8 40.0

India 2.9 13.9 20.1 26.8 1.5 6.5 5.5 7.4

Russia 5.2 19.3 17.3 24.2 1.3 4.3 1.9 3.3

S. Africa 5.0 23.8 10.8 28.2 0.7 5.1 1.7 5.1

Outward FDI Inward FDI Stock Stock Royalties and License Fees

2000 2008 2000 2008 1995 1995 2008 2008

Country $billion $billion $billion $billion Payments($m) Receipts($m) Payments($m) Receipts($m)

Brazil 122.3 287.7 51.9 155.7 529 32 2,697 465

China 193.3 378.1 27.8 147.9 543a 55a 10,319 571

India 16.3 125.2 1.7 63.3 90 1 1,529 148

Russia 32.2 215.8 20.1 205.5 34 4 4,595 453

S. Africa 43.4 68.0 32.3 50.0 293 45 1,676 54

Sources: UN Comtrade database, UNCTAD STAT database, and World Bank, World Development Indicators. a Data are for 1997.


Table 3. World Bank Knowledge Economy Index for the BRICS

Knowledge Economy Index

Country 2000 (rank) 2012 (rank) Brazil 5.55 (58) 5.56 (60) China 3.92 (94) 4.37 (84) India 3.17 (107) 3.06 (110) Russia 5.41 (64) 5.78 (55) South Africa 5.73 (53) 5.21 (67) USA 9.32 (6) 8.77 (12) Source: http://info.worldbank.org/etools/kam2/KAM_page5.asp

EXPLAINING THE ENERGY CONSUMPTION

PORTFOLIO IN A CROSS-SECTION

OF COUNTRIES: ARE THE

BRICS DIFFERENT?1

David M. Arseneau2*

ABSTRACT

This paper uses disaggregated data from a broad cross-section of countries to empirically assess differences in energy consumption profiles. We find empirical support for the energy ladder hypothesis, which contends that as an economy develops, it transitions away from a heavier reliance on traditional fuel sources towards an increase in the use of modern commercial energy sources. We also find empirical support for the hypothesis that structural transformation — the idea that as an economy matures, it transforms away from agriculture-based activity into industrial activity and, finally, fully matures into a service-oriented economy — is an important driver for the distribution of end-use energy consumption. But, even when these two hypotheses are taken into account, we continue to find evidence suggesting that the patterns of energy consumption and generation in the BRIC economies are importantly different from those of other economies. But these differences are not systematic; in fact, there appear to be large differences in the energy consumption portfolios of each of these four rapidly growing economies.

JEL Classification: Q41; Q43

Keywords: Energy and development; Energy ladder hypothesis; Struc- tural transformation

* David Arseneau is a Senior Economist in the Division of International Finance at

the Federal Reserve Board of Governors, where he covers international energy markets. Prior to that, he worked in the Division of Research and Statistics on the Board’s main macro econometric forecasting model. Dr. Arseneau is also an adjunct professor at The Johns Hopkins University and Georgetown University. His broader research interests are in monetary economics and macroeconomics, in particular the implications of real rigidities for optimal monetary and fiscal policy prescriptions. He received his Ph.D. from the University of Virginia.

1. This paper has benefited from helpful comments from Neil Ericsson, as well as from seminar participants in the 2011 IAEE conference in Stockholm, Sweden.

2. The views expressed in this paper are those of the author and do not represent those of the Board of Governors of the Federal Reserve System or other members of its staff. E-mail address: [email protected].

553


O

I. INTRODUCTION

NE of the defining characteristics of global energy markets over the past decade is the rapid growth of energy consumption in the emerging market economies. The latest Annual BP Statistical

Review of World Energy shows that over the past ten years the average annual growth rate of global total final energy consumption was just under one percent. Over this period, energy consumption in OECD economies declined slightly (see Figure 1). In contrast, the emerging market economies experienced a collective growth rate of roughly two percent, making it clear that the developing world has been the primary engine for global energy consumption growth. Moreover, much of this growth was concentrated in just four countries — the so-called BRIC economies of Brazil, Russia, India, and China (see Figure 2). Taken together, these four economies accounted for approximately half of the growth in emerging markets taken as a whole over the past decade.

This growth differential has potentially important implications for global energy markets going forward. Existing research suggests that the dynamics of energy consumption in emerging market economies are significantly different than the dynamics of energy consumption in the developed world.3 If the growth differentials observed over the past ten years persist, the resulting shift in the distribution of global consumption could give rise to a markedly different energy landscape, one that is much more heavily weighted toward developments in the emerging markets (see Figure 3). In light of this, understanding the behavior of energy consumption in the emerging markets—and in the BRICs in particular—is an increasingly pressing priority for energy economists. While existing literature has made strides in this direction, understanding differences in energy consumption profiles across countries very much remains an open area of research.

This paper takes a step in this direction by using disaggregated micro- level data to examine energy consumption patterns in a wide cross-section of countries. We construct a dataset detailing energy usage in thirty- five different countries that, taken together, comprise roughly 80 percent of global total final energy consumption. These data are then used to empirically assess two alternative theoretical explanations for why energy consumption portfolios differ across countries.

We examine these data from two separate dimensions. The first is what we refer to as the “fuel intensity profile,” which describes the fraction of energy consumption either at the aggregate level or disaggregated at the sectorial — or industry — level, derived from a given source fuel. Here, we are interested in identifying characteristics that make a country more (or less) reliant on a specific fuel source for energy generation. The so-

3. See, for example, Gately and Huntington (2002) and Dargay, Gately and Hunting-

ton (2007), (documenting notable differences in oil and/or energy consumption dynamics across different subsets of countries).

2012] ARE THE BRICS DIFFERENT? 555

called “energy ladder hypothesis” offers a theoretical guide around which we organize our empirical investigation. This hypothesis contends that as the level of economic development in a country rises, a substitution takes place away from using traditional biomass, including wood, agricultural, and animal waste, as a primary fuel source and into more modern, cheaper, and cleaner (less polluting) energy sources, such as natural gas, oil and petroleum products, and electricity.4 This transition along the energy ladder occurs not only in residential usage, but also in industrial, commercial, and agricultural usage as technologies and physical infrastructure for energy generation using these fuels become more widespread. 5

To test this hypothesis we exploit the systematic cross-sectional vari- ance between fuel intensity profiles and the level of economic development. In particular, the fuel intensity profile should vary in such a way that higher income countries tend to rely more heavily on higher quality, cleaner fuels. In fact, this is exactly what we find — both in the aggregate data as well as the disaggregated data at both the sector and industry level. Thus, the first main result of this paper is that there is strong empirical support for the energy ladder hypothesis as a determinate of a country’s fuel intensity portfolio.

The second dimension we explore is a country’s “end-use consumption profile,” which describes the fraction of total energy consumed in a given sector of the economy or, at a more disaggregated level, in a given industry within a sector. Along this dimension, the goal is to identify characteristics that lead a country to consume a higher (or lower) fraction of total energy in one particular sector of the economy relative to the consumption in other countries. Our empirical investigation here is guided by the so-called “structural transformation hypothesis,” which keys off the widely accepted view that an economy’s industrial structure changes endogenously as it undergoes the process of economic development.6 Ec- onomic activity in underdeveloped countries tends to be focused mainly in agriculture. But as a country develops, agricultural activity gives way to industry. At later stages of development, once industrialization is complete, industrial activity tends to decline as the process of development transforms the economy toward more service-oriented activity.

This shift in the composition of the economy implied by the process of structural transformation has implications for patterns of end-use energy

4. Hosier (1984), Hosier and Dowd (1987), Leach (1992), Barnes and Floor (1996), and Heltberg (2004) all examine the energy ladder hypothesis using micro data on residential usage.

5. Gru bler (2004), Bashmakov (2007), Marcotullio and Schulz (2007) all provide de- scriptive evidence of how the energy mix changes with economic development. Burke (2010a, b) explicitly tests this hypothesis in two contributions, concentrating on the total energy mix and on the electricity mix, respectively.

6. The link between economic development and structural change is owed to Kuznets (1971).


consumption.7 We test these implications at both the sector and industry level and we find that, in general, the data are supportive of the structural transformation hypothesis. Thus, the second main result of the paper is that the process of structural transformation is an important driver of cross-country differences in end-use consumption profiles.

Backed with these two empirically-relevant theoretical explanations for why and how energy consumption profiles might differ across countries, we next ask the question: Are the BRICs different? In short, we find that they are, although apparently not in a systematic way. With regard to the fuel intensity profile, Russia and Brazil tend to rely more heavily on combustibles, renewables, and waste, while China relies more heavily on coal usage — even beyond what can be explained by the endowment effect. Oil and petroleum products make up significantly less of the energy mix in both China and India than is typical in other countries. In terms of end-use consumption profiles, with the exception of Brazil, all the BRICs have significantly less transportation usage relative to other countries. In addition, China has unusually heavy usage of energy in energy-intensive industry as well as commercial activities. One way to interpret the results for China is that the use of lower quality primary fuels for energy generation and, in turn, the consumption of that energy in primarily industrial usage is indicative of a country undergoing a structural transformation out of agricultural and into industrial activity.

This is an important finding both from the perspective of energy economists trying to understand ongoing market developments as well as from the perspective of policymakers who ultimately need to deal with the consequences of these developments. As noted above, the BRICs have been a significant engine of growth for global energy consumption and are likely to remain so in the future. Accordingly, structural change and the pace with which the BRICs climb the energy ladder will be crucial for shaping the energy landscape of the future. The results of this paper highlight the need for future research to shed more light on energy consumption dynamics — both in the long run as well as at cyclical frequen- cies — in the emerging markets in general and the BRICs in particular. A key aspect of this research will inevitably involve delving further into the data at an even more disaggregated level, suggesting that continuing to improve the depth, scope, quality, and ease of dissemination of energy usage statistics should be a top priority.

Regarding related literature, one paper in particular deserves explicit discussion. Using a panel dataset, Burke (2010b) also finds evidence in favor of the energy ladder hypothesis. Along this dimension, we reach a broadly similar conclusion; as such, the results here can be viewed as complimentary to Burke (2010b). Nevertheless, there are a number of

7. Judson, Schmalensee, and Stoker (1999), Medlock and Soligo (2001), and Scha fer

(2005) all examine the implications of structural change for energy demand from an empirical standpoint. See Arbex and Perobelli (2010) and Stefanski (2010) for some recent theoretical contributions.


important differences across the two papers. For example, the two papers reach similar conclusions despite the use of different data. While the country coverage in our data is smaller and there is no time series dimension, we exploit data at a more disaggregated level than does Burke (2010b). Data differences notwithstanding, the key point of differentia- tion between the two papers stems from the focus here on behavior of the BRIC economies as outliers.

The remainder of the paper is organized as follows. The next part discusses the data and presents the empirical methodology. The main results are presented in Part III. Part IV investigates whether or not the energy consumption profiles of the BRIC economies are significantly different from that of other countries beyond what can be explained by the core hypotheses. Finally, Part V offers some concluding comments as well as some suggested areas for further research.

II. DATA AND EMPIRICAL METHODOLOGY

The data used in the analysis consists of the 2007 annual energy con-

sumption portfolios of thirty-five different countries, listed in Table 1, from various geographic regions and levels of economic development. Taken together these thirty-five countries constitute 80 percent of global total final energy consumption. In what follows, let n be an integer that indexes country, where n∈[1,35]. All data are obtained from the Energy Balances of OECD and Non-OECD countries published by the Interna- tional Energy Administration (IEA).

These data are presented along two primary dimensions for each of the n countries in the sample. The first dimension is energy usage by primary fuel source. We consider two cuts of the data, one in which electricity is considered a primary fuel source and one in which it is not. Let the integer f index primary fuel source, where f1∈[1,5] indicates energy generated from: combustibles, renewable energy sources, and waste (f1=1); coal and peat (f1=2); crude oil and petroleum products (f1=3); natural gas (f1=4); and electricity (f1=5). Alternatively, f2∈[1,7] indicates energy generated from: combustibles, renewable energy sources, and waste (f2=1); coal and peat (f2=2); crude oil and petroleum products (f2=3); natural gas (f2=4); nuclear (f2=5); hydroelectric (f2=6); and geothermal (f2=7). Thus, f1 is the index for primary fuel source under the first cut of the data and f2 is the index under the second cut. Details are given in Table 2. Both cuts of the data are considered in the analysis because it is likely that each yields valuable information about the energy ladder hypothesis.

The data are also presented along a second dimension of end-use consumption broken out by sector as well as by industry within a given sector. In terms of notation, let the integer s index sector, where s∈[1,4] indicates energy consumed in the following sectors: industrial sector (s=1); transportation sector (s=2); residential and commercial sector (s=3); and agricultural sector (s=4). Moving down one level of aggrega-


tion, let the integer i index industry within sector s. In the raw data presented by the IEA the upper limit of the index i is conditional on the sector of interest. For example, the data for the industrial sector can be disaggregated into thirteen separate industries. Similarly, there are six industries within the transportation sector and three within the residential and commercial sector, excluding agriculture, forestry, and fishing, which we have chosen to break out as a separate category.

When all is said and done, at the most disaggregated level the dataset

consists of either a (23×5) or a (23×7) matrix for every country in the sample, totaling either 4,025 or 5,635 individual data points across the entire sample, depending on whether or not electricity is broken out separately. These data are sufficiently detailed to describe, for example, energy derived from coal and peat that is consumed in the iron and steel industry expressed as a fraction of aggregate energy consumption for country n.

In the interest of simplicity, as well as for the ease of presentation, we aggregate the industry-level data into just two industries per sector, so that i∈[1,2] regardless of s. For the industrial sector, we group industries into those that are more energy intensive and those that are less energy intensive based on classifications presented by the U.S. Department of Energy (DOE).8 The transportation sector is grouped into road transportation and non-road transportation.9 Finally, both residential and commercial energy usage are broken out as separate industries. The agricultural sector is not disaggregated further. Details are given in Table 3. The resulting condensed dataset is a (6×5) or (6×7) matrix of data for each country in the sample, consisting of either 1,050 or 1,470 individual data points, again depending on whether or not electricity is broken out separately.

Our goal in the analysis is to explain cross-country differences in energy consumption portfolios broken out along the two dimensions of fuel source and end-use consumption. Before we provide formal definitions of the metrics that we will use to empirically describe these two dimensions, some additional notation is useful.

At the lowest level of aggregation, let cn,f,s,i denote consumption for country n of fuel f in industry i of sector s. At the other extreme, at the highest level of aggregation, let Cn,•,•,• denote aggregate energy consumption for country n across all fuels and end-use sectors and industries, where Cn,•,•,• is defined as:

8. The following industries are classified as “more energy intensive”: iron and steel, chemical and petrochemical, non-ferrous metals, non-metallic minerals, and paper pulp and printing. The remainder—transportation equipment, machinery, mining and quarrying, food and tobacco, wood and wood products, construction, and textile and leather—are classified as “less energy intensive.”

9. Road transportation consists of both private and commercial transportation. Non- road transportation consists of domestic aviation, rail, pipeline transport, and domestic navigation.


Thus, our notation has a consumption aggregate denoted by an upper-

case Cn,•,•,•. The subscript n,•,•,• reveals that the aggregate is for a given country, n, while the (lack of) dots (•) reveals the level of (dis)aggregation. Generally speaking, a dot in place of a given subscript n, f, s, or i means that we have aggregated over that dimension, so more dots in the subscript implies a higher level of aggregation. For example, Cn,•,•,• is aggregate consumption summed over all fuels, f, sectors, s, and industries, i; Cn,f,•,• is consumption by fuel f aggregated across all sectors, s, and industries, i; Cn,•,s,• is consumption by sector s aggregated across all fuels, f, and industries, i; Cn,f,s,• is consumption by fuel f in sector s aggregated across all industries, i, and so forth.

With this notation in mind, we turn now to a formal definition of the variables of interest and a description of the empirical models that will be used to explain them.

A. FUEL INTENSITY PORTFOLIO

The empirical metric used to summarize the energy portfolio along the

fuel source dimension is fuel intensity. We aim to explain the cross-country variation in fuel intensity at three different levels of aggregation: the aggregate as well as sector and industry level.

Aggregate fuel intensity is simply a measure of the share of aggregate energy consumption accounted for by fuel f aggregated across all sectors and industries for country n. A formal definition is as follows:

where AFI denotes aggregate fuel intensity; Cn,f,•,• denotes aggregate energy consumption accounted for by fuel f across all sectors and industries; and Cn,•,•,• is aggregate energy consumption across all fuels, sectors, and industries.

Disaggregating one level gives sector-level fuel intensity, which measures the share of energy consumption in sector s accounted for by fuel f, formally defined as:

where SFI denotes sector-level fuel intensity; Cn,f,s,• denotes energy consumption in sector s accounted for by fuel f across all industries, i; and Cn,•,s,• is energy consumption within sector s across all fuels and industries.


Finally, the lowest level of aggregation gives industry-level fuel intensity, which measures the share of energy consumption in industry i of sector s accounted for by fuel f. A formal definition follows:

where IFI denotes industry-level fuel intensity; Cn,f,s,i denotes energy consumption in industry i of sector s accounted for by fuel f; and Cn,•,s,i is energy consumption within industry i of sector s across all fuels.

Note that the three indices, AFI, SFI, and IFI, are each normalized differently. The aggregate index is created by normalizing with total energy consumption. It measures the intensity of coal usage in aggregate energy consumption, for example. The sectorial-level index is created by normalizing by total energy consumption within the sector. It measures the intensity of oil usage within the industrial sector, for example. Fi- nally, the industry-specific index is created by normalizing by total energy consumption within an industry specific to a given sector. It measures the use of renewables and waste in the non-energy intensive industrial sector, for example.

1. Empirical Model

The goal is to explain the fuel intensity portfolio at each of three levels

of aggregation for a given country. At the aggregate level, our analysis aims at explaining, for example, why India is more reliant on combustibles, renewables, and waste for energy generation than is either Brazil or Germany. At lower levels of aggregation, the point of our analysis is to identify country characteristics that can help to explain the difference between the fuel intensity portfolios in two different countries at the sector level—why Mexico uses more energy generated from oil and petroleum products and less energy generated from coal and peat than does the United States, for example. Going one step further, we would also like to explain cross-country differences at the industry level within a given sector.

There are two primary hypotheses for structural factors that might be important in determining the fuel intensity profile for a given country, regardless of the level of disaggregation of the data. First, resource endowment is likely to be important. All else equal, countries that are rich in coal reserves, such as the United States, are likely to use coal more intensely to meet domestic energy demand at all levels of aggregation relative to countries where coal is relatively scarce. A similar case can be made for oil; recent experience in Saudi Arabia, where the use of crude oil for electricity generation is increasingly frequent, stands out as a case in point. A less dramatic, but equally relevant, example is the extensive use of natural gas in Russia. In the simplest terms, exploiting domestically abundant energy resources is desirable for both economic as well as


n

political reasons and we would expect a country’s fuel intensity profile to reflect this.

The second hypothesis for determining a given country’s fuel intensity profile relates to the level of economic development. Existing research has drawn links between economic development and the development of energy infrastructure. This is commonly referred to in the literature as the “energy ladder,” whereby economic development leads to maturation in the technology available for energy provision. As a country develops it cycles from relatively inefficient fuels, such as combustibles, to more efficient fuels, such as coal, and eventually matures to the current technological frontier in energy provision, exploiting refined fuels derived from petroleum as well as natural gas and electricity.

We test these two candidate hypotheses to explain cross-country differences in fuel intensity profiles using the following regression framework:

(1.)

where FI is a fuel intensity measure defined at one of the three levels of aggregation (that is, in our empirical analysis FI is given by one of the three variables AFI, SFI, or IFI, defined in the previous section, depending on the level of disaggregation desired) for fuel f in country n; EN- DOWn,f is the share of global proved reserves for fuel f held by country n, which is intended to capture resource abundance for that particular fuel; RGDPn is (log) real per capita GDP for country n, which is a direct measure of the level of economic development; finally, REGIONn is a vector of dummy variables, each of which takes on a value of one if country n is classified as a European, Developed Asian, Latin American, Emerging Asian, or Emerging Other economy, respectively, and takes on a value of zero otherwise. Accordingly, the estimated coefficients on the regional dummies are interpreted as the regional effect relative to North America. The specific regions are chosen based on existing literature, which shows that these country groupings are relevant for explaining cross-country differences in oil consumption. The dummies are intended to control for all other unobserved factors within a given region that may help to determine the fuel intensity profile. Finally, the error term is assumed to be independent and identically distributed, en~N(0,s 2). The equation is estimated using simple ordinary least squares (OLS).

Within this regression framework we test the following two hypotheses:

and


The first tests the statistical validity of the endowment hypothesis. If the hypothesis is valid we would expect that the aggregate fuel intensity of fuel f in country n is increasing in the resource endowment of that fuel and thus the coefficient estimate for b2 should be positive and significantly different from zero.

The second tests the validity of the energy ladder hypothesis. Here, we would expect the aggregate fuel intensity of lower quality fuels such as combustibles, renewables, and waste, (f1,2=1), coal, and peat (f1,2=2) to decrease as a country becomes more developed and makes its way “up the energy ladder” as it ada/opts more efficient, cleaner technologies for energy generation. Hence, for these fuels we would expect the coefficient estimate for b2 to be negative and significantly different from zero. In contrast, for the higher quality fuels such as oil (f1,2=3), natural gas (f1,2=4), and electricity (f1=5), or alternatively when electricity is not broken out separately, as in nuclear (f2=5), hydroelectric (f2=6), and geothermal (f2=7), we expect that aggregate fuel intensity should increase with the level of development. We would expect the coefficient estimate for b2 to be positive and significantly different from zero for these fuels.

B. END-USE PORTFOLIO

The second dimension of the energy portfolio that we would like to

explain is the cross-country variation in end-use consumption. We summarize this aspect of the energy portfolio with the metric energy usage, defined at two levels of disaggregation.

Sector-level energy usage measures the share of aggregate energy consumption accounted for by sector s aggregated across all fuels and industries for country n. A formal definition is as follows:

where SEU denotes sectorial energy usage; Cn,•,s,• denotes aggregate energy consumption accounted for by sector s across all fuels, f, and industries, i.

Similarly, moving down one level of aggregation, industry-level energy usage measures the share of aggregate energy consumption accounted for by industry i aggregated across all fuels, f, for country n. We formalize this as

where IEU denotes industrial-level energy usage; Cn,•,s,i denotes energy consumption accounted for by industry i within sector s, aggregated across all fuels, f.


1. Empirical Model

With regard to end-use consumption, our analysis aims to explain why, for example, consumption in the industrial sector comprises a larger fraction of total energy consumed in Argentina (41.1 percent) as opposed to Hong Kong (28.6 percent). At a higher level of disaggregation, road transport (consisting of both passenger and commercial transport activity) comprises 33.1 percent of aggregate energy consumption in Spain, but only 21.7 percent in Canada. What can explain the difference? In short, as with fuel intensity above, the point of the analysis here is to identify characteristics that can help to explain cross-country differences in end-use consumption portfolios at both the sectorial and the industry level.

We examine three hypotheses. The first two relate to sector size and the energy efficiency of the sector in question, respectively. All else equal, as the economic size of a given sector increases we might expect energy consumption within that sector to grow as a fraction of total energy consumption. On the other hand, as the energy efficiency of a given sector increases we might expect energy consumption within that sector to decline as a fraction of total energy consumption.

Beyond size and efficiency, we also explore the structural transformation hypothesis. There is a well-known, established literature dating to Kuznets (1971), which contends that a country’s industrial structure changes endogenously as it undergoes the process of economic development. Initially, for countries at low levels of development, agricultural production constitutes the largest share of economic activity. But as an economy begins to develop, industrialization causes the share of industry in total output to rise as economic activity moves away from agriculture and into heavy industry. Later phases of development tend to be characterized by a decline in manufacturing activity as industrialization eventually gives way to a transformation toward a more service-oriented economy.

Transformation of the industrial structure, of course, has implications for energy usage. For countries at low levels of economic development, the structural transformation hypothesis suggests that end-use consumption profiles should be weighted toward greater energy usage in the residential and agricultural sectors and relatively low weights on industry. As a country develops and undergoes the process of industrialization, industries’ share of total energy usage should rise at the expense of agriculture and residential usage. Finally, at high levels of development, after industrialization has occurred and the transformation toward a more service-oriented economy is underway, the share of residential and commercial usage should rise at the expense of industry.

Thus, there are two empirical implications of the structural transformation hypothesis for energy usage that can be tested, both of which exploit the compositional shift of economic activity implied by the process of structural transformation. The first keys off the change in industries’


n

share of total energy usage, which according to the structural transformation hypothesis should be increasing with income for relatively low levels of economic development — reflecting the effect of industrialization on energy usage—and then decreasing for sufficiently high levels of development — reflecting deindustrialization as the economy transforms into service-oriented activity. The second keys off the change in residential and commercial usage. According to the structural transformation hypothesis, residential usage should be declining with income at low levels of development and then increasing, along with commercial usage, at sufficiently high levels of development.

We test the three candidate hypotheses to explain cross-country differences in end-use energy consumption profiles using the following general regression framework:

(2.)

where EUn is the end-use consumption measure defined at one of the two levels of aggregation (either SEUs,n or IEUs,I,n as defined in the previous section depending on the level of disaggregation desired) for fuel s in country n; SIZEn,s is the value added (expressed in percentage terms) to sector s in total output for country n, as in the previous subsection; EF- FICIENCYn,s is the total energy consumed in sector s, measured in units of thousands of tons of oil equivalent, expressed per United States dollar of real GDP; RGDPn is (log) real per capita GDP for country n which, for reasons discussed below, enters quadratically into the regression framework to capture the non-linear response of the sectorial and industry shares to income at different stages of a structural transformation; finally, as above we include the vector of regional dummies, REGIONn, to control for other unobserved factors. The error term is assumed to be iid and normally distributed, en~N(0,s 2). In order to address possible en- dogeneity between our metric for end-use consumption and the proxy for sectorial energy efficiency, the equation is estimated using two stage least squares (2SLS), using aggregate energy efficiency as an instrument for energy efficiency at the sectorial level.

Within this regression framework, we examine whether or not sector size is an important determinate of the end-use energy consumption profile by testing the following hypothesis:

We expect that the share of total energy consumption in sector s is

increasing in the economic size of the sector as measured by value added in GDP, so that the coefficient estimate for b1^{s} should be positive and significantly different from zero.


3

4

3

4

Next, we test the validity of the hypothesis that increased energy effi-

ciency in sector s leads to a decrease in that sector’s share of aggregate energy consumption.

If sectorial-level efficiency is an important determinate for the end-use

energy consumption profile, we would expect the coefficient estimate for b2^{s} to be negative and significantly different from zero.

Finally, we test the validity of the structural transformation hypothesis as follows:

As discussed above, the hypothesis predicts that industries’ share of

total energy usage will have an inverse U-shaped relationship with the level of income, which should be captured by the quadratic income term with b s=1

> 0 and b s=1 < 0. In contrast, commercial and residential usage

should have a U-shaped relationship with the level of income, falling for low levels of development and then growing at a sufficiently high level of development, which should be captured by the quadratic income term with b s=3

< 0 and b s=3 > 0. For the final two sectors, we expect transporta-

s=2

tion’s share to increase with income, so that b3 s=4

> 0, and agriculture’s share to decrease, so that b3 < 0, but do not necessarily have reason to think that either should enter into the regression in a non-linear way.

III. MAIN RESULTS

The main results are presented in the following two subsections. The

first examines cross-country differences in fuel intensity profiles, while the second examines differences in end-use consumption.

A. FUEL INTENSITY PROFILE

Table 4 presents summary statistics for the share of total energy usage

by source, broken out with electricity (panel A) and without electricity (panel B). The Table shows that the dominate energy source comes from crude oil and petroleum products, which alone accounts for nearly half of all energy consumed globally. Panel A shows that electricity accounts for about 20 percent of global energy consumption, followed by natural gas at roughly 15 percent. The remaining share is comprised of combustibles, renewables, and waste as well as coal and peat, which accounts for under 15 percent of global energy consumption. Panel B shows that when electricity usage is broken down into source fuels, the share of coal, peat, and natural gas in global energy usage rises (indicating that these are two important sources of electricity generation). Additionally, nuclear, hydroe-


lectric, and geothermal power, taken together, account for a relatively small fraction of global energy usage.

Comparing the developed economies to the emerging market economies hints at some key differences when energy usage profiles are broken out by primary source. The data show that, relative to emerging market economies, developed economies tend to rely more heavily on petroleum products, natural gas, and electricity as primary sources of energy. In contrast, developing economies tend to rely more heavily on coal and peat as well as combustibles, renewables, and waste. Thus, even a cursory glance at the data suggests that there may be some systematic difference in the energy usage portfolio between the two sets of countries.

A more formal assessment can be found in Tables 5a and 5b, which present the regression results for Equation 1 with and without electricity broken out, respectively. The Tables show a set of results for each fuel, with one set corresponding to the regression without the regional dummies (first column of numbers) and the second set corresponding to the regression with the dummies (second column).

Concentrating on the first column of numbers for each fuel in Table 5a, we see that there is strong support for the energy ladder hypothesis across nearly all the fuels when electricity is included. For all five fuels the estimated coefficient has the predicted sign and is significantly different from zero at the 90 percent confidence level. As real per capita GDP rises, countries shift their aggregate fuel intensity portfolios away from lower quality, more polluting fuels, such as combustibles, renewables, and waste as well as coal and peat, into higher quality, cleaner fuels, such as refined petroleum products, natural gas, and electricity. Moreover, in looking at the quantitative magnitude of the coefficients and the precision with which they are estimated, the evidence in favor of the energy ladder hypothesis is clearly strongest at the two extremes of the ladder. There is a large, highly significant, negative correlation between income and the lower end of the quality ladder — the usage of combustibles, renewables, and waste — while the opposite is true at the higher end of the ladder, as reflected in electricity usage. The coefficients for the intermediate fuels tend to be smaller in magnitude, and, although many are statistically significant, taken as a whole, they tend to be more imprecisely estimated. When electricity is broken out into source fuels, Table 5b shows that while there is still evidence in favor of the energy ladder hypothesis, it is somewhat weaker. This is likely due to the fact that energy sources higher on the ladder — nuclear, hydroelectric, and geothermal — tend to comprise only a small fraction of total energy usage.

In contrast to the energy ladder hypothesis, there is only mild support for the endowment hypothesis. Although the estimated coefficients have the correct sign for all three fuels for which we have an empirical proxy for endowment available, only in the case of natural gas do we find a robust significant correlation between proved reserves and the share in total energy usage (the endowment effect on coal is sensitive to whether


or not electricity is broken out separately). Natural gas, more so than coal or oil and petroleum products, may be particularly susceptible to the endowment hypothesis given the relatively large capital expenses associated with international trade in natural gas either via pipeline or in lique- fied form.

Moving to the regressions with the regional dummies, we find that support for the energy ladder hypothesis is largely robust to controlling for unobserved region-specific characteristics. With regard to the country dummies themselves, two things stand out. First, the Asian economies — both developed and developing — tend to rely heavily on coal for energy generation relative to other countries in the sample. Importantly, this is true even when controlling for resource endowment. Second, the other emerging category, which includes Israel, Russia, and Saudi Arabia, stands out for its high reliance on electricity usage.

Extending the analysis to disaggregated data on fuel usage at the sectorial and industry levels reveals that much of the support for the energy ladder hypothesis stems from the industrial as well as the residential and commercial sectors. Fuel intensity in the transportation and agricultural sectors does not, in general, fit well into our hypothesized determinates, likely reflecting the relative lack of substitutability in fuel usage in both of these sectors. For the sake of brevity, I do not present the full set of disaggregated regression results and, instead, simply highlight some of the interesting insights.10

Support for the energy ladder hypothesis comes primarily from the industrial as well as the residential and commercial sectors, and, much like the aggregate data, tends to be strongest at the two extreme ends of the energy ladder. Specifically, usage of combustibles, renewables, and waste falls significantly with income in both residential as well as commercial usage and also in non-energy intensive industries. At the other extreme of the energy ladder, electricity usage rises significantly in both residential and commercial usage as well as in both energy-intense and non-intense industrial usage. The evidence is somewhat more mixed for the intermediate fuels in these sectors. Coal usage falls with income amongst energy-intensive industries. Industrial usage of oil and petroleum products is interesting because it falls with income for energy-intense industries, but rises with income for energy non-intense industries, suggesting that there is fuel switching within industries’ usage itself. Natural gas usage rises with income in non-energy intensive industrial usage as well as in both residential and commercial usage, although these results are not robust to the inclusion of regional dummies. Finally, there is very little, if any, evidence for the energy ladder hypothesis in the transport sector, while oil and petroleum product usage declines with income in the agricultural sector.

10. The full set of results would require a set of tables describing results from sixty

different regressions, which is too cumbersome to include in this paper. But the results are available upon request.


B. END-USE PROFILE

Table 6 presents summary statistics for the share of total energy usage by sector. For the sample as a whole, industrial usage accounts for the largest share of global energy consumption at 37 percent, while transportation and residential and commercial usage each account for roughly 30 percent. Agricultural energy usage accounts for the remaining 2.5%. Al- though not shown, this distribution carries over to the industry-level within each sector as well. Moreover, in contrast to aggregate fuel intensity, a cursory glance at the data reveals very little difference in the sectorial distribution of energy usage between developed and emerging market countries.

Regression results for Equation 2 are presented in Table 6 at the sectorial level. Again, we present two sets of results for each end-use sector, one with regional dummies (first column for each sector) and one without regional dummies (second column). Generally speaking, the results are robust across both specifications. There is little evidence that either sector size or sector-specific efficiency is a robust determinate of energy usage.11 There is, however, some support for the structural transformation hypothesis. For industrial usage, the coefficient on (logged) real GDP is positive and significant while the coefficient on the log real GDP squared is negative and significant. This indicates that the share of industrial energy usage starts out at a low level for relatively undeveloped economies. As these economies grow, the industrial share of energy usage increases reflecting the process of industrialization which is a key component of economic development. But, once a country reaches a certain level of development, deindustrialization occurs as the economy transforms into more service-oriented activity; hence, industry share of total energy consumption begins to fall once an economy has reached a certain level of development. In our estimates, this peak occurs at a real per capita level of roughly USD $10,500, about the level of development of Brazil. This inverse U-shape for the share of industrial energy usage is very much in line with the structural transformation hypothesis.

For residential and commercial energy usage, we see the opposite pattern. The coefficient on (logged) real GDP is negative and significant while the coefficient on the log real GDP squared is positive and significant. This is also in line with the structural transformation hypothesis in the sense that at low levels of economic development residential usage carries a large fraction of total usage, but this declines as an economy grows and industrialization occurs. Eventually, the economy hits a point at which the emergence of the service sector causes the share of commercial usage to increase. In addition, the share of residential usage increases as the demand for energy-intense consumer durables begins to

11. We do find that higher efficiency in the residential and commercial sectors leads to

less energy usage in those sectors, but only when the regional dummies are included. Also, a larger agricultural sector appears to be associated with a larger share of energy usage in that sector.


pick up at sufficiently high income levels. The net effect gives rise to a U- shaped pattern for the share of residential and commercial usage taken as a whole. According to the regression results reported in Table 7, the turning point at which residential and commercial usage stops declining and begins to rise is roughly USD $14,000, about the level of Mexico or Argentina.

In contrast with industrial usage and residential and commercial usage, neither the transportation nor the agricultural sector fit neatly into the structural transformation hypothesis. For both, the estimated coefficients on the level of income are positive while the squared term is negative, but both are insignificant. While the size of the agricultural sector helps to explain cross-country variation in the agriculture share of total energy usage, we did not have much success in explaining cross-country variation in energy usage with the transportation sector.

Table 8 shows regression results for the industry-level data. Support for the structural transformation hypothesis is not robust at the disaggre- gate level, but as we will see in the next section, the BRIC economies have a lot to do with this finding. In particular, we do not find evidence of a U-shaped pattern in industrial usage. For the residential and commercial sector, disaggregation reveals that the nonlinear relationship at the sectorial level is driven primarily by residential usage. In contrast, commercial usage, like agricultural usage, appears to be driven by sector size.

IV. ARE THE BRICS DIFFERENT?

Much of the impetus for the shift toward emerging market economies

and away from developed economies as the primary driver of global energy consumption growth has come from the so-called BRIC economies of Brazil, Russia, India, and China. Not surprisingly, these economies have garnered a lot of attention from energy and financial market participants as well as from policymakers interested in understanding commodity market developments. Given that the BRIC economies are playing a larger and larger role in global energy consumption, it seems natural to ask whether there is something inherently different about the consumption patterns in these countries.

Methodologically, we answer this question by simply introducing dummy variables into the regression Equations 1and 2 for the BRIC economies individually. If energy usage in the BRICs is different in some way not already addressed by the hypotheses laid out in the previous section, then the dummies will capture this difference.

We are interested in answering two questions. First, how does the inclusion of the BRIC dummies influence our conclusions regarding our hypothesized determinates of the energy consumption portfolio? Second, given that we control for these hypothesized determinates, do the BRICs themselves have systematically different consumption portfolios from other countries? Results are reported below in two subsections.


A. FUEL INTENSITY

Referring back to Table 4, the fuel intensity profiles of the BRIC economies stand out in two respects. First, they tend to rely more heavily on combustibles, renewables, and waste, as well as coal, for energy generation relative to other economies. Taken together these two fuel sources constitute nearly 35 percent of total energy consumption, whereas comparable numbers for the developed economies and non-BRIC emerging market countries are 9 and 15 percent, respectively. Second, they tend to rely less heavily on oil and petroleum products, which constitute 31 percent of the fuel intensity profile in the BRIC economies as opposed to 48 percent and 52 percent, respectively, in the developed and non-BRIC emerging markets. Thus, a preliminary look at the data suggests that the BRICs may indeed be different with respect to the fuel intensity profile.

Tables 9a and 9b present regression results from Equation 1 estimated with the separate BRIC dummies, which are directly comparable to what was reported above in Tables 5a and 5b both with and without electricity, respectively. The Tables reveal that the high share of combustibles, renewables, and waste in the BRIC economies is largely driven by non- electricity related usage primary in Brazil and Russia. A look at the disaggregated data (not shown) reveals that for Brazil the high share of combustibles, renewables, and waste comes from non-energy intensive industries as well as both road and non-road transportation. For Russia, the high share stems primarily from commercial usage. The strong coal usage amongst the BRICs is driven by China, which uses coal more intensely than the other countries in all four sectors. Importantly, this is true even after controlling for China’s relatively large endowment of coal. On the other hand, the relatively low share of oil and petroleum products in the fuel intensity profile of the BRIC economies appears to be largely due to India and China. In summary, even after controlling for some hypothesized determinates of the fuel intensity profile, the BRIC economies still seem to be different from other countries in the sense that they have an over-reliance on lower quality fuels and an under-reliance on oil and petroleum products relative to other countries.

With respect to the main conclusions regarding the determinates of the fuel intensity profile the inclusion of the BRIC dummies appears to have little impact. Even after allowing for a country-specific effect for each of the BRIC economies, we continue to see strong support of the energy ladder hypothesis, principally at the two extremes of the energy ladder. For the intermediate fuels, the evidence is weaker. For oil and petroleum products, support for the energy ladder hypothesis is not robust to the inclusion of the BRIC dummies due to the low usage in India and China. Instead, controlling for each of these two countries separately strengthens empirical support of the endowment hypothesis.

Disaggregating data to the sectorial and industry level offers little in the way of new insights. The results are essentially unchanged relative to those discussed in the previous section.


B. END-USE CONSUMPTION

Table 6 shows that although there do not appear to be any Table differ-

ences between developed and developing countries with respect to end- use consumption, there do appear to be big differences in the BRIC economies. In particular, the BRICs stand out as different in nearly every sector and also within industries in a given sector. The BRICs tend to have a larger share of industrial energy usage — nearly 10 percent higher than either developed economies or the non-BRIC emerging market economies — and this extends down to both energy-intensive and non- energy-intensive industries. The BRICs also have a higher percentage of energy use in agricultural activity — nearly double that of either developed or non-BRIC emerging market economies. In contrast, transportation does not play as large a role in the BRICs as it does in other economies. When we look at the disaggregated industry data we can see that this is primarily due to low energy usage in road transport. Finally, residential energy usage carries a larger share in BRIC energy consumption relative to the rest of the world, while commercial energy usage plays a smaller share.

Regression results from Equation 2 estimated with separate BRIC dummies are presented in Table 10 and are directly comparable to results presented in Table 7. At the sectorial level, it turns out that once we control for the hypothesized determinates of the end-use consumption profile, industrial energy consumption in the BRICs is not significantly different from other countries. Thus, contrary to the impression created by the unconditional data in Table 6, it appears that there is nothing different about industrial energy usage in the BRICs per se; instead, they simply tend to have higher shares of industrial usage primarily because these economies are undergoing a period of rapid industrialization. This sectorial-level result does not necessarily apply, however, when the data are disaggregated down to the industry level. Table 11 shows that China, in particular, is importantly different in that it has a very high share of energy-intense industrial energy usage.

Interestingly, whereas we had little success in explaining cross-country differences in transportation usage in Table 7, once we control for the BRIC economies the picture changes. The BRICs — and, in particular, Russia, India, and China — are light in transportation usage relative to other countries. Moreover, once we control for the BRICs, we find that sector size appears to be the main determinate of cross country consumption differences in this sector. A look at the disaggregated data in Table 11 reveals that low Russian transportation usage is driven by non-road industries, while low Chinese and Indian transport consumption is driven by road transportation (likely due to the relatively low number of automobiles per capita in these economies). Interestingly, once we control for the BRICs we see that economic development has an inverse U-shaped relationship with energy consumption in road transportation.


Tables 10 and 11 indicate that the BRICs really don’t stand out in a robust systematic way in terms of residential and commercial or agricultural usage.

V. CONCLUSION

This paper used a dataset detailing energy usage in a broad cross-section of countries to test two hypotheses regarding determinates of the differences in consumption portfolios across countries—the energy ladder hypothesis and the structural transformation hypothesis. We found statistical evidence to support both of these hypotheses. Moreover, the paper also showed that even when these theoretical determinants of the energy consumption portfolio are taken into account, the energy consumption portfolios of the BRIC economies are still notably different from those of other countries. The BRICs tend to rely more heavily on lower quality fuel sources — combustibles, renewables, and waste, as well as coal and peat — then predicted by the energy ladder hypothesis and, in terms of end-use consumption, tend to under consume energy in the transportation sector. It is also clear that China consumes an unusually large fraction of its total energy consumption in energy-intensive industrial activity — even more than what can be explained by the structural transformation hypothesis.

The policy implications of this paper are relatively straight-forward. From the perspective of energy analysts and policymakers, the empirical results presented here suggest that understanding global energy market developments requires a more intense focus on developments at the country and industry-specific levels. In this sense, this paper is very much in line with the broad conclusions of Stefanski (2009) and Arbex and Per- obelli (2010), which emphasize that microeconomic foundations are important for understanding global energy developments. Future empirical work should concentrate on examining how far the systematic differences in energy consumption portfolios can go in explaining differences in the dynamics of energy consumption over the business cycle.


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Figure 1: Total primary energy consumption growth in advanced

foreign versus emerging market economies

8%

6%

4%

2%

0%

-2%

-4% Advanced Foreign Economies Emerging Market Economies

-6%

10%

Figure 2: Total Primary Energy Consumption Growth in EMEs BRIC

vs. non-BRIC Economies

8%

6%

4%

2%

0%

-2%

-4%

-6%

Brazil Russia India China Other EMEs


Figure 3: Share of Total Primary Energy Consumption

0.75

0.8

0.65

Left axis

0.7 0.6

0.55

0.45

Advanced Foreign Economies Emerging Market Economies BRIC Economies

Left axis

0.5 0.4

0.3

0.35

Right axis

0.2

0.25

1965 1970 1975 1980 1985 1990 1995 2000 2005 0.1

Table 1. Countries in sample, by region

Developed Economies Emerging Market Economies

Europe

North America

Developed Asia

Latin America

Emerging Asia

Emerging Other

BRICs

Austria Canada Australia Argentina Hong Kong Israel Brazil Belgium Mexico Japan Chile Indonesia Saudi Arabia China Finland US South Korea Colombia Malaysia India France Venezuela Philippines Russia

Germany Singapore Ireland Thailand

Italy Netherlands

Portugal Sweden Spain

Switzerland UK


Table 2. Energy usage by primary fuel source

Cut One Cut Two (with electricity) (without electricity)

f1 ∈ (1,5) f2 ∈ (1,7)

Combustibles, renewables, and waste Combustibles, renewables, and waste Coal and peat Coal and peat

Crude oil and petroleum products Crude oil and petroleum products Natural gas Natural gas

. Nuclear

. Geothermal

. Hydroelectric Electricity and heat .

Table 3. Energy usage by end-use consumption category

Sector Industry Sector Industry

Industrial Sector Transportation Sector (s = 1) (s = 2)

Energy intensive Chemicals and petrochemicals Road Road (i = 1) Iron and steel (i = 1)

Non-ferrous metals Non-metallic minerals Paper pulp and printing Non-energy intensive Construction Non-road Domestic aviation

(i = 2) Food and tabacco (i = 2) Rail Machinery Pipeline transport Mining and quarrying Domestic navigation Textile and leather Non-specified Transprot equipment Wood and wood products Non-specified

Residential and commercial Sector Agricultural Sector (s = 3) (s = 4)

Residential Residential Agricultural Agricultural (i = 1) (i = 1) Forestry

Commercial Commercial and public service Fishing (i = 2)


orld

Mean Median St. Dev. Min. Max. N 0.039 0.019 0.048 0 0.151 30

Developed Economies 0.039 0.017 0.049 0 0.146 19 BRIC Economies 0.055 0.026 0.064 0.019 0.151 4 Non-BRIC Emerging Markets 0.034 0.010 0.045 0 0.128 11

Table 4. Data summary for fuel intensity profile

Panel A: With Electricity Panel B: Without Electricity

Combust., Renew., and Waste Combust., Renew., and Waste

(f1 = 1) (f2 = 1) Mean Median St. Dev. Min. Max. N Mean Median St. Dev. Min. Max. N

World 0.091 0.045 0.105 0 0.409 30 0.101 0.050 0.110 0 0.409 30

Developed Economies 0.058 0.045 0.051 0.007 0.169 19 0.075 0.050 0.075 0.013 0.259 19

BRIC Economies 0.213 0.218 0.172 0.006 0.409 4 0.216 0.222 0.171 0.012 0.409 4

Non-BRIC Emerging Markets 0.102 0.037 0.119 0 0.351 11 0.104 0.038 0.120 0 0.351 11

Coal and Peat Coal and Peat


World 0.047 0.026 0.062 0 0.330 34 0.112 0.077 0.113 0 0.518 34


BRIC Economies 0.131 0.080 0.138 0.035 0.330 4 0.220 0.161 0.210 0.039 0.518 4

Non-BRIC Emerging Markets 0.048 0.029 0.052 0 0.144 11 0.112 0.080 0.128 0 0.448 11

Crude Oil and Petroleum Products Crude Oil and Petroleum Products


World 0.479 0.478 0.118 0.232 0.763 34 0.495 0.487 0.129 0.251 0.812 34


BRIC Economies 0.308 0.276 0.097 0.232 0.446 4 0.316 0.281 0.094 0.251 0.451 4

Non-BRIC Emerging Markets 0.523 0.517 0.127 0.332 0.763 11 0.547 0.524 0.145 0.351 0.812 11

Natural Gas Natural Gas


World 0.144 0.128 0.107 0 0.363 30 0.217 0.206 0.131 0.024 0.556 30


BRIC Economies 0.111 0.052 0.130 0.036 0.305 4 0.179 0.060 0.252 0.039 0.556 4

Non-BRIC Emerging Markets 0.102 0.084 0.112 0 0.363 11 0.196 0.172 0.118 0.061 0.447 11

Electricity and Heat Nuclear Power


World 0.228 0.217 0.089 0.072 0.447 30 0.028 0.004 0.045 0.000 0.173 30


BRIC Economies 0.236 0.202 0.127 0.124 0.416 4 0.009 0.004 0.010 0.003 0.023 4

Non-BRIC Emerging Markets 0.197 0.171 0.094 0.072 0.439 11 0 0 0.003 0 0.010 11

Hydroeclecrtic Power

(f2 = 6)

W

Geothermal Power (f2 = 7)

World

Mean Median St. Dev. Min. Max. N 0.007 0.003 0.012 0 0.058 30

Developed Economies 0.008 0.005 0.006 0 0.022 19 BRIC Economies 0.002 0.002 0.002 0 0.004 4 Non-BRIC Emerging Markets 0.008 0.000 0.018 0 0.058 11


Table 5a. Cross-country differences in aggregate fuel intensity profiles (AFI), with electricity

Combustables,

Renewables and Waste

(f1 = 1)

Coal and Peat (f1 = 2)

Oil and Petroleum Products (f1 = 3)

Natural Gas (f1 = 4)

Electricity and

Heat Generation (f1 = 5)

Constant 1.05 1.22 0.42 0.27 0.004 -0.18 -0.26 -0.02 -0.3 -0.43 (7.12) (5.78) (3.85) (1.86) (0.02) (-0.48) (-1.23) (-0.07) (-1.81) (-1.70) Europe . 0.04 . 0.04 . -0.09 . -0.004 . 0.05 . (0.92) . (1.29) . (-1.05) . (-0.06) . (1.06) Developed Asia . -0.01 . 0.07 . -0.02 . -0.06 . 0.06 . (-0.24) . (1.85) . (-0.21) . (-0.75) . (0.85) Latin America . -0.02 . 0.02 . 0.01 . 0.01 . 0.03 . (-0.33) . (0.39) . (0.11) . (0.84) . (0.47) Emerging Asia . -0.01 . 0.09 . -0.01 . -0.1 . 0.08 . (-0.23) . (2.38) . (-0.14) . (-1.34) . (1.32) Emerging Other . -0.09 . -0.004 . 0.01 . -0.14 . 0.12 . (-1.66) . (-0.09) . (0.11) . (-1.56) . (1.85) Economic Development -0.22 -0.26 -0.09 -0.06 0.11 0.16 0.09 0.05 0.12 0.14 (6.53) (-5.64) (-3.48) (2.01) (1.94) (1.92) (1.92) (0.68) (3.20) (2.50) Resource Endowment . . 0.23 0.32 0.6 -0.17 0.83 1.25 . . . . (1.63) (2.22) (0.62) (0.13) (2.03) (2.49) . . R2 0.56 0.67 0.33 0.57 0.11 0.18 0.18 0.37 0.24 0.35 s 2 0.005 0.004 0.003 0.002 0.013 0.014 0.010 0.009 0.006 0.006 Nobs 35 35 35 35 35 35 35 35 35 35

Notes: The estimated regression, equation (1) in the text, is estimtaed using OLS using 2007 annual data from 35 different countries and is given by

f + b f ENDOW

+ b f RGDP + b fREGION + e where e ~ N(0,s 2)

AFI = b0 1 n,f 2 n 3 n n n n

Table 5b. Cross-country differences in aggregate fuel intensity profiles (AFI), without electricity

Combustables, Oil and

Renewables Petroleum Hydroelectric Geothermal and Waste Coal and Peat Products Natural Gas Nuclear Power Power Power

(f2 = 1) (f2 = 2) (f2 = 3) (f2 = 4) (f2 = 5) (f2 = 6) (f2 = 7) Constant 0.99 1.21 0.36 -0.05 0.002 -0.2 -0.4 -0.39 -0.18 0.013 0.06 0.1 0.002 0.03

(5.60) (4.81) (1.61) (-0.15) (0.01) (-0.48) (-1.73) (-1.10) (-2.09) (0.10) (0.61) (0.78) (0.09) (0.87)

Europe . 0.06 . 0.06 . -0.09 . 0.02 . 0.03 . -0.01 . 0.01

. (1.17) . (0.89) . (-0.98) . (0.30) . (1.13) . (-0.24) . (0.92)

Developed Asia . -0.01 . 0.15 . -0.01 . -0.05 . 0.02 . -0.04 . -0.001

. (-0.20) . (1.90) . (-0.09) . (-0.50) . (0.59) . (-1.14) . (-0.05)

Latin America . -0.02 . 0.03 . 0.02 . 0.04 . -0.02 . 0.05 . -0.01

. (-0.24) . (0.42) . (0.17) . (0.49) . (-0.68) . (1.39) . (-0.65)

Emerging Asia . -0.01 . 0.19 . -0.01 . -0.02 . -0.02 . -0.04 . -0.002

. (-0.21) . (2.48) . (-0.09) . (-0.17) . (-0.75) . (-1.38) . (-0.18)

Emerging Other . -0.09 . 0.06 . 0.04 . -0.1 . -0.02 . -0.04 . 0.02

. (-1.39) . (0.81) . (0.37) . (-1.02) . (-0.52) . (-1.28) . (1.61)

Economic Development -0.21 -0.26 -0.06 0.01 0.11 0.17 0.14 0.14 0.05 0.003 0.01 -0.01 0.001 -0.01

(-5.04) (-4.68) (-1.18) (0.19) (1.84) (1.84) (2.61) (1.73) (2.42) (0.10) (-0.23) (-0.41) (0.20) (-0.79)

Resource Endowment . . 0.56 0.62 0.91 -0.08 1.58 2.06 . . . . . .

. . (1.89) (2.07) (0.87) (-0.05) (3.52) (3.49) . . . . . .

R2 0.44 0.58 0.14 0.43 0.11 x.xx 0.36 0.43 0.15 0.31 0.002 0.39 0.001 0.22

s 2 0.007 0.006 0.012 0.009 0.016 0.017 0.012 0.012 0.002 0.002 0.002 0.002 0.0001 0.0001

Nobs 35 35 35 35 35 35 35 35 35 35 35 35 35 35

Notes: The estimated regression, equation (1) in the text, is estimtaed using OLS using 2007 annual data

from 35 different countries and is given by f + b f ENDOW

+ b f RGDP + b fREGION + e where e ~ N(0,s 2)

AFI = b0 1 n,f 2 n 3 n n n n


Table 6. End-use consumption profile

Industry Transportation

(S = 1) (S = 2)

Mean Median St. Dev. Min. Max. N Mean Median St. Dev. Min. Max. N

World 0.371 0.390 0.097 0.198 0.545 35 0.290 0.294 0.093 0.104 0.522 35


BRIC Economies 0.454 0.441 0.071 0.390 0.545 16 0.184 0.163 0.096 0.104 0.307 16

Emerging Market Economies 0.356 0.375 0.112 0.198 0.508 4 0.318 0.317 0.099 0.168 0.522 4

Residential and Commercial Agriculture

(S = 3) (S = 4)

Mean Median St. Dev. Min. Max. N Mean Median St. Dev. Min. Max. N

World

0.314 0.306

0.097 0.143 0.534 35 0.025

0.024 0.021

0.000 0.099 35 Developed Economies 0.317 0.316 0.073 0.194 0.475 19 0.025 0.024 0.020 0.006 0.099 19 BRIC Economies 0.320 0.328 0.122 0.166 0.461 16 0.041 0.042 0.010 0.028 0.052 16 Emerging Market Economies 0.306 0.267 0.128 0.143 0.534 4 0.020 0.007 0.024 0.000 0.059 4

Table 7. Cross-country differences in end-use energy consumption, by sector (SEU)

Sector

Residential and

Industrial (S = 1)

Transportation (S = 2)

Commercial (S = 3)

Agriculture (S = 4)

Constant -3.83 -6.61 -2.52 -0.55 7.70 8.61 -0.65 -0.43 (-1.71) (-2.64) (-1.13) (-0.19) (4.00) (3.92) (-1.48) (-0.79) Europe . 0.04 . -0.11 . 0.06 . 0.004 . (0.79) . (-1.77) . (1.34) . (0.37) Developed Asia . 0.11 . -0.11 . 0.008 . -0.01 . (1.65) . (-1.47) . (0.14) . (-0.64) Latin America . 0.004 . -0.02 . 0.03 . 0.001 . (0.06) . (-0.27) . (0.49) . (0.07) Emerging Asia . 0.05 . -0.07 . 0.04 . -0.02 . (0.77) . (-0.98) . (0.69) . (-1.24) Emerging Other . -0.14 . -0.03 . 0.19 . -0.09 . (-1.96) . (-0.42) . (2.98) . (-0.63) Economic Development 2.11 3.45 1.32 0.36 -3.62 -4.07 0.29 0.19 (1.91) (2.81) (1.21) (0.25) (-3.87) (-3.79) (1.43) (0.74) Economic Development (Squared) -0.26 -0.43 -0.15 -0.03 0.44 0.49 -0.03 -0.02 (-1.95) (-2.86) (-1.15) (-0.18) (3.89) (3.79) (1.34) (-0.67) Sector Size 0.06 0.06 -0.48 -0.84 0.17 0.32 0.31 0.37 (0.32) (0.34) (-0.52) (-0.85) (0.51) (0.98) (2.19) (2.41) Efficiency 0.64 1.28 0.14 0.02 -1.08 -1.68 0.32 0.37 (0.61) (1.31) (0.13) (0.02) (-1.24) (-2.06) (0.15) (0.15) R2 0.24 0.52 0.11 0.25 0.41 0.61 0.21 0.36 s 2 0.008 0.006 0.009 0.009 0.006 0.005 0.001 0.001 Nobs 35 35 35 35 35 35 35 35

Notes: The estimated regression, equation (2) in the text, is estimtaed using 2SLS using 2007 annual data from 35 different countries and is given by

sSIZE

+ b sEFFICIENCY

+ b sRGDP + b RGDP 2 + b sREGION + e ~ N(0,s 2)

SEU = b0s + b1 n,s 2 n,s 3

s n 4 n 5 n n n

2012] A

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? 579

Table 8. Cross-country differences in end-use energy consumption, by industry within sector (IEU)

Industrial Sector Transportation Sector Residential and Commercial Sector

Energy Intensive Industries

Non-energy Intensive Industries

Road Industries

Non-road Industries

Residential

Commercial

(S = 1; I = 1) (S = 1; I = 2) (S = 2; I = 1) (S = 2; I = 2) (S = 3; I = 1) (S = 3; I = 2) Constant

-2.31 -1.84

-1.10 -0.64

-4.50 -5.15

-0.64 0.50

7.42 8.32

1.39 0.26

(-0.93) (-0.62) (-0.95) (-0.44) (-1.53) (-1.36) (-0.89) (0.55) (3.91) (3.64) (0.87) (0.16) Europe . 0.06 . 0.02 . -0.11 . -0.03 . 0.06 . 0.00 . (1.04) . (0.70) . (-1.46) . (-1.71) . (1.29) . (-0.07) Developed Asia . 0.09 . 0.04 . -0.13 . -0.02 . -0.02 . 0.05 . (1.12) . (1.12) . (-1.29) . (-0.75) . (-0.27) . (1.24) Latin America . 0.00 . 0.00 . -0.01 . -0.01 . 0.00 . 0.07 . (-0.02) . (-0.02) . (-0.11) . (-0.57) . (-0.07) . (1.56) Emerging Asia . -0.06 . -0.03 . 0.05 . -0.05 . -0.02 . 0.15 . (-0.85) . (-0.91) . (0.53) . (-2.25) . (-0.41) . (3.65) Emerging Other . -0.09 . -0.03 . -0.01 . -0.01 . 0.11 . 0.08 . (-1.16) . (-0.84) . (-0.14) . (-0.51) . (1.74) . (1.71) Economic Development 1.20 1.06 0.62 0.43 2.34 2.57 0.30 -0.23 -3.33 -3.71 -0.78 -0.38 (0.98) (0.73) (1.09) (0.62) (1.64) (1.39) (0.85) (-0.52) (-3.61) (-3.33) (-1.01) (-0.49) Economic Development -0.15 -0.14 -0.08 -0.06 -0.28 -0.29 -0.04 0.03 0.38 0.42 0.11 0.07

(Squared) (-0.97) (-0.79) (-1.13) (-0.72) (-1.60) (-1.29) (-0.83) (0.50) (3.46) (3.14) (1.16) (0.79) Sector Size -0.03 0.04 -0.08 -0.06 -0.95 -0.02 0.29 0.32 -0.19 -0.02 0.78 0.62 (-0.16) (0.19) (-0.89) (-0.66) (-0.80) (-1.49) (0.97) (1.06) (-0.59) (-0.06) (2.81) (2.62) Efficiency 1.12 1.23 -0.05 -0.01 -0.66 -0.76 0.81 0.75 0.02 -0.53 -1.17 -0.94 (0.96) (1.06) (-0.09) (-0.02) (-0.47) (-0.53) (2.35) (2.14) (0.03) (-0.63) (-1.63) (-1.58) R2 0.07 0.33 0.08 0.29 0.13 0.3 0.19 0.37 0.52 0.57 0.52 0.57 s 2 0.010 0.008 0.002 0.002 0.015 0.014 0.001 0.001 0.006 0.005 0.004 0.003 Nobs 35 35 35 35 35 35 35 35 35 35 35 35

Notes: The estimated regression, equation (2) in the text, is estimtaed using 2SLS using 2007 annual data from 35 different countries and is given by s + b sSIZE

+ b sEFFICIENCY

+ b sRGDP + b sRGDP

+ b sREGION + e where e ~ N(0,s )

IEU = b0 1 n,s 2 n,s 3

2 n 4 n 5

2 n n n n

580 LA

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Table 9a. Cross-country differences in fuel intensity profiles and the BRIC economies (AFI), with electricity Combustables, Renewables and

Waste

Coal and Peat

Oil and Petroleum Products

Natural Gas

Electricity and Heat Generation (f1 = 1) (f1 = 2) (f1 = 3) (f1 = 4) (f1 = 5)

Constant 0.90 1.09 0.26 0.19 0.32 0.19 -0.17 -0.004 -0.43 -0.55 (5.62) (5.10) (2.91) (1.85) (1.26) (0.54) (-0.64) (-0.01) (-2.30) (-2.02) Europe . 0.04 . 0.01 . -0.06 . 0.04 . 0.05 . (0.96) . (0.51) . (-0.91) . (0.63) . (1.06) Developed Asia . -0.01 . 0.05 . -0.002 . -0.02 . 0.05 . (-0.29) . (2.05) . (-0.03) . (-0.29) . (0.87) Latin America . -0.04 . -0.003 . -0.02 . 0.06 . 0.03 . (-0.75) . (-0.13) . (0.23) . (0.81) . (0.54) Emerging Asia . -0.01 . 0.05 . 0.003 . -0.07 . 0.08 . (-0.10) . (2.02) . (0.04) . (-0.89) . (1.42) Emerging Other . -0.07 . -0.02 . 0.12 . -0.13 . 0.05 . (-1.33) . (-0.67) . (1.23) . (-1.52) . (0.74) Brazil 0.13 0.16 -0.02 0.004 -0.05 -0.03 -0.06 -0.13 0.01 0.03 (2.05) (2.35) (-0.60) (0.13) (-0.44) (0.27) (-0.58) (-1.26) (0.13) (0.39) Russia 0.16 0.12 0.03 0.01 -0.16 -0.15 -0.05 -0.01 0.04 0.02 (2.17) (1.74) (0.83) (0.38) (-1.37) (-1.26) (-0.39) (-0.12) (0.44) (0.23) India -0.11 -0.04 -0.01 0.03 -0.35 -0.43 -0.46 -0.69 0.22 0.22 (-1.66) (-0.52) (-0.21) (0.67) (-3.10) (-3.41) (-1.11) (-1.59) (2.94) (2.35) China -0.04 -0.06 0.26 0.23 -0.24 -0.23 -0.1 -0.06 0.09 0.07 (0.58) (-0.88) (6.35) (6.48) (-2.18) (-2.07) (-0.86) (-0.57) (1.18) (0.84) Economic Development -0.19 -0.23 -0.05 -0.04 0.04 0.07 0.07 0.03 0.15 0.17 (5.17) (-4.93) (-2.50) (-1.70) (0.64) (0.93) (1.18) (0.42) (3.53) (2.76) Resource Endowment . . 0.02 0.03 1.66 0.71 2.61 4.10 . . . . (0.15) (0.24) (1.80) (0.63) (1.54) (2.19) . . R2 0.70 0.77 0.75 0.86 0.41 0.51 0.24 0.47 0.43 0.48 s 2 0.005 0.005 0.001 0.001 0.012 0.010 0.011 0.011 0.007 0.008 Nobs 35 35 35 35 35 35 35 35 35 35

Notes: The estimated regression, equation (1) in the text, is estimtaed using OLS using 2007 annual data from 35 different countries and is given by f + b fENDOW

+ b fRGDP + b fREGION + b fBRIC + e where e ~ N(0,s )

AFI = b0 1 n,f 2 n 3

2 n 4 n n n n

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T? 581

Table 9b. Cross-country differences in fuel intensity profiles and the BRIC economies (AFI), without electricity Combustables,

Renewables and Waste Coal and Peat

Oil and Petroleum Products

Natural Gas

Nuclear Power Hydroelectric Power

Geothermal Power (f2 = 1) (f2 = 2) (f2 = 3) (f2 = 4) (f2 = 5) (f2 = 6) (f2 = 7)

Constant 0.83 1.08 0.09 -0.21 0.35 0.21 -0.21 -0.27 -0.21 -0.01 0.05 0.07 0.02 0.06 (4.10) (3.99) (0.36) (-0.68) (1.22) (0.53) (-0.73) (0.66) (-1.82) (-0.03) (0.41) (0.45) (0.50) (1.42) Europe . -0.08 . 0.07 . 0.16 . -0.11 . -0.03 . -0.05 . 0.02 . (-1.09) . (0.82) . (1.53) . (-1.01) . (-0.62) . (-1.28) . (2.46) Developed Asia . 0.13 . 0.02 . -0.06 . -0.08 . -0.02 . 0.10 . -0.01 . (1.37) . (0.18) . (-0.42) . (-0.57) . (-0.33) . (1.87) . (-0.61) Latin America . 0.12 . 0.20 . -0.15 . -0.05 . -0.02 . -0.04 . -0.01 . (1.37) . (1.66) . (-1.00) . (-0.29) . (-0.26) . (-0.58) . (-0.86) Emerging Asia . -0.11 . 0.04 . -0.31 . -0.49 . -0.001 . -0.03 . -0.01 . (-1.21) . (0.37) . (-2.27) . (-0.92) . (-0.02) . (-0.53) . (-0.53) Emerging Other . -0.06 . 0.48 . -0.24 . -0.12 . -0.02 . -0.03 . -0.01 . (-0.65) . (4.27) . (-1.69) . (-0.83) . (-0.30) . (-0.47) . (-0.57) Brazil 0.14 0.06 -0.06 0.02 -0.06 -0.06 -0.11 0.05 -0.01 0.03 0.11 -0.01 -0.01 -0.01 (1.66) (1.17) (-0.59) (0.35) (-0.51) (-0.82) (-0.96) (0.61) (-0.10) (1.04) (2.28) (-0.25) (-0.58) (1.01) Russia 0.16 -0.01 0.10 0.13 -0.17 0.01 -0.08 -0.03 0.02 0.02 -0.02 -0.04 -0.01 0.00 (1.79) (-0.22) (0.86) (1.74) (-1.34) (0.12) (-0.59) (-0.26) (0.45) (0.54) (-0.37) (-1.11) (-0.51) (-0.03) India -0.11 -0.04 -0.02 0.02 -0.36 -0.01 -0.14 0.08 0.003 -0.03 -0.01 0.04 -0.01 -0.01 (-1.33) (-0.56) (-0.16) (0.24) (2.93) (-0.14) (-0.31) (0.81) (0.07) (1.04) (-0.27) (1.00) (-0.63) (-0.88) China -0.04 -0.01 0.39 0.14 -0.25 0.01 -0.14 0.01 0.01 -0.02 -0.01 -0.04 -0.01 0.00 (-0.45) (-0.09) (3.55) (1.94) (-2.11) (0.09) (-1.13) (0.08) (0.15) (-0.68) (-0.22) (-1.29) (-0.37) (-0.26) Economic Development -0.17 -0.23 0.002 0.06 0.04 0.07 0.10 0.10 0.05 0.01 -0.003 -0.004 -0.002 -0.01 (-3.69) (-3.85) (0.03) (0.82) (0.54) (0.85) (1.47) (1.14) (2.10) (0.20) (-0.11) (-0.13) (-0.26) (-1.35) Resource Endowment . . 0.22 0.27 2.01 0.87 2.08 3.62 . . . . . . . . (0.69) (0.78) (1.97) (0.71) (1.12) (1.61) . . . . . . R2 0.56 0.67 0.44 0.62 0.39 0.52 0.40 0.50 0.16 0.32 0.17 0.43 0.03 0.37 s 2 0.006 0.006 0.009 0.007 0.01 x.xxx 0.013 0.013 0.002 0.002 0.002 0.002 0.0001 0.0001 Nobs 35 35 35 35 35 35 35 35 35 35 35 35 35 35

Notes: The estimated regression, equation (1) in the text, is estimtaed using OLS using 2007 annual data from 35 different countries and is given by

f + b fENDOW

+ b fRGDP + b fREGION + b fBRIC + e where e ~ N(0,s )

AFI = b0 1 n,f 2 n 3 2

n 4 n n n n


Table 10. Cross-country differences in end-use energy consumption and the BRIC economies, by sector (SEU)

Sector

Residential and

Industrial (S = 1)

Transportation (S = 2)

Commercial (S = 3)

Agriculture (S = 4)

Constant -4.92 -7.63 0.03 1.11 6.48 7.83 -0.59 -0.32 (-1.79) (-2.75) (0.01) (0.37) (3.03) (3.52) (-1.12) (-0.47) Europe . 0.03 . -0.10 . 0.06 . 0.01 . (0.65) . (-1.90) . (1.63) . (0.54) Developed Asia . 0.09 . -0.14 . 0.04 . 0.01 . (1.45) . (-1.94) . (0.76) . (0.32) Latin America . -0.01 . -0.09 . 0.09 . 0.01 . (-0.20) . (-1.12) . (1.67) . (0.36) Emerging Asia . 0.04 . -0.10 . 0.07 . -0.01 . (0.63) . (-1.51) . (1.43) . (-0.14) Emerging Other . -0.19 . -0.02 . 0.22 . -0.01 . (-2.58) . (-0.24) . (3.72) . (0.29) Brazil 0.07 0.07 0.04 -0.04 -0.12 -0.05 0.02 0.02 (0.69) (0.74) (0.39) (-0.41) (-1.56) (-0.60) (0.83) (0.76) Russia 0.11 0.19 -0.14 -0.25 0.01 0.05 0.02 0.01 (0.94) (1.56) (-1.28) (-1.85) (0.09) (0.47) (0.90) (0.39) India -0.02 -0.04 -0.10 -0.17 0.13 0.21 -0.01 -0.003 (-0.23) (-0.43) (-1.07) (-1.65) (1.64) (2.84) (-0.30) (-0.14) China 0.15 0.15 -0.21 -0.29 0.05 0.14 0.01 0.01 (1.50) (1.55) (-2.30) (-2.74) (0.66) (1.74) (0.55) (0.29) Economic Development 2.58 3.86 0.03 -0.45 -2.92 -3.60 0.32 0.19 (1.93) (2.88) (0.03) (-0.31) (-2.81) (-3.35) (1.22) (0.57) Economic Development (Squared) -0.31 -0.47 0.00 0.06 0.35 0.43 -0.04 -0.02 (-1.95) (-2.90) (0.01) (0.34) (2.80) (3.35) (-1.26) (-0.62) Sector Size 0.09 0.18 0.33 0.36 -0.37 -0.50 -0.05 -0.04 (0.45) (1.02) (1.81) (1.85) (-2.39) (-3.52) (-1.32) (-0.97) Efficiency 0.48 0.65 0.10 -0.31 -0.76 -0.53 2.16 2.11 (0.42) (0.66) (0.09) (-0.28) (-0.86) (-0.66) (0.83) (0.72) R2 0.33 0.63 0.38 0.52 0.59 0.76 0.22 0.31 s2 0.008 0.006 0.008 0.008 0.006 0.005 0.001 0.001 Nobs 35 35 35 35 35 35 35 35

Notes: The estimated regression, equation (2) in the text, is estimtaed using 2SLS using 2007 annual data from 35 different countries and is given by

s + b sSIZE

+ b EFFICIENCY

+ b sRGDP + b sRGDP 2 + b REGION + b sBRIC + e

SEU = b0 1 s

n,s 2 n,s 3 s

n 4 n 5 2

n 6 n n

where en ~ N(0,sn )

2012] A

RE

TH

E B

RIC

S DIF

FE

RE

NT

? 583

Table 11. Cross-country differences in end-use energy consumption and the BRIC economies, by industry within sector (IEU)

Industrial Sector Transportation Sector Residential and Commercial Sector

Energy Intensive Industries

(S = 1; I = 1) Non-energy Intensive

Industries (S = 1; I = 2)

Road Industries

(S = 2; I = 1)

Non-road Industries (S = 2; I = 2)

Residential

(S = 3; I = 1)

Commercial (S = 3; I = 2)

Constant -2.21 -0.48 -0.22 0.56 -3.10 -5.70 -0.04 1.16 5.05 6.68 2.34 -0.68 (-0.76) (-0.17) (-0.15) (0.34) (-1.01) (-1.75) (-0.04) (1.30) (2.22) (2.49) (1.02) (-0.35) Europe . 0.05 . 0.02 . -0.10 . -0.04 . 0.06 . -0.01 . (1.04) . (0.65) . (-1.69) . (-2.39) . (1.37) . (-0.32) Developed Asia . 0.08 . 0.04 . -0.16 . -0.02 . -0.01 . 0.06 . (1.13) . (1.08) . (-2.08) . (-0.98) . (-0.09) . (1.31) Latin America . 0.00 . -0.01 . -0.11 . 0.00 . 0.03 . 0.08 . (-0.001) . (-0.18) . (-1.39) . (-0.12) . (0.48) . (1.73) Emerging Asia . -0.09 . -0.04 . 0.02 . -0.05 . -0.01 . 0.18 . (-1.45) . (-1.13) . (0.27) . (-2.62) . (-0.17) . (4.37) Emerging Other . -0.14 . -0.04 . 0.05 . -0.05 . 0.12 . 0.07 . (-1.83) . (-0.90) . (0.59) . (-2.00) . (1.62) . (1.44) Brazil 0.10 0.08 0.06 0.05 -0.02 -0.07 0.00 -0.02 -0.13 -0.10 -0.03 0.05 (0.97) (0.83) (1.13) (0.83) (-0.14) (-0.63) (0.15) (-0.62) (-1.60) (-1.13) (-0.38) (0.71) Russia 0.05 -0.06 -0.05 -0.10 -0.09 -0.04 -0.01 -0.07 0.12 0.09 -0.05 0.16 (0.40) (-0.44) (-0.81) (-1.43) (-0.67) (-0.29) (-0.24) (-1.69) (1.21) (0.73) (-0.53) (1.89) India 0.06 0.05 0.00 0.00 -0.27 -0.33 0.09 0.07 0.08 0.12 0.05 0.09 (0.56) (0.56) (0.04) (-0.01) (-2.38) (-3.03) (3.04) (2.42) (0.93) (1.37) (0.55) (1.37) China 0.25 0.18 0.03 0.00 -0.29 -0.30 0.01 -0.02 -0.02 -0.01 0.01 0.15 (2.36) (1.72) (0.58) (-0.02) (-2.59) (-2.65) (0.33) (-0.76) (-0.21) (-0.07) (0.12) (2.25) Economic Development 1.09 0.34 0.19 -0.14 1.57 2.79 0.02 -0.55 -2.17 -2.92 -1.13 0.17 (0.77) (0.24) (0.27) (-0.17) (1.05) (1.77) (0.04) (-1.27) (-1.96) (-2.25) (-1.01) (0.18) Economic Development (Squared) -0.13 -0.05 -0.03 0.01 -0.19 -0.32 0.00 0.07 0.24 0.33 0.15 0.01 (-0.74) (-0.28) (-0.32) (0.08) (-1.02) (-1.72) (-0.02) (1.28) (1.84) (2.11) (1.10) (0.06) Sector Size 0.00 0.12 -0.07 -0.04 0.47 0.00 0.00 0.00 -0.13 -0.14 -0.20 -0.36 (0.01) (0.63) (-0.72) (-0.40) (2.12) (2.28) (-0.05) (0.03) (-0.83) (-0.80) (-1.20) (-2.93) Efficiency 0.63 0.40 -0.07 -0.18 -0.40 -0.73 0.49 0.50 0.59 -2.16 -11.25 -0.69 (0.53) (0.39) (-0.12) (-0.31) (-0.31) (-0.61) (1.35) (1.52) (0.05) (-0.19) (-0.99) (-0.08) R2 0.25 0.59 0.16 0.39 0.47 0.69 0.39 0.64 0.57 0.68 0.44 0.79 s2 0.010 0.007 0.002 0.002 0.012 0.011 0.001 0.001 0.006 0.006 0.005 0.003 Nobs 35 35 35 35 35 35 35 35 35 35 35 35

Notes: The estimated regression, equation (2) in the text, is estimtaed using 2SLS using 2007 annual data from 35 different countries and is given by s + b sSIZE

+ b sEFFICIENCY

+ b sRGDP + b sRGDP

+ b sREGION + b sBRIC + e where e ~ N(0,s )

IEU = b0 1 n,s 2 n,s 3

2 n 4 n 5

2 n 6 n n n n

I

THE ENERGY OF BRAZIL: TUDO ACABA EM SAMBA

Carlos Rufın1

T is fair to claim that, among all the BRICS (South Africa included), Brazil is the energy giant. The relative scarcity of energy resources in China, India, and South Africa is uncontroversial. But what about

Russia? It is one of the world’s major oil and gas producers; it has abundant hydroelectric resources (and potential), and plentiful coal as well. I will argue, however, that Brazil represents the future of the world’s energy supply to a much greater extent than Russia. Brazil has a diverse and largely renewable energy base; has pioneered the development of biofuels; and is now at the technological frontier of oil production. Con- trast these elements with the situation in Russia, where most of the oil and gas is pumped from areas like the Caspian that have been under exploitation for more than a century.

To understand Brazil’s energy industry, it is necessary to analyze the three great transformations that have shaped the development of the industry in Brazil. The shift towards the use of modern energy supply in Brazil began with the effort to harness the country’s huge waterways as sources of electricity; an effort that continues to this day, although with increasing acrimony and difficulty. The second great transformation was Brazil’s success in working its vast landmass to turn it into the world’s most advanced biofuel supply complex. The third and final transformation has stemmed from the development of world-class capabilities to dig at unprecedented depths below the sea and the discovery of major oil deposits off Brazil’s shores. I will discuss each transformation in turn.

I. BRAZIL, THAT DAM COUNTRY

Brazil is one of the world’s largest holders of freshwater. But unlike Canada, its waters are not closeted by a relative lack of major rivers, or by a long frozen season. Brazil’s waters flow along three major basins—

1. Carlos Rufın is the Director of Undergraduate International Programs and Associ-

ate Professor of Strategy and International Business at the Sawyer Business School of Suffolk University. Trained in international development issues, he is a consult- ant to the World Bank and the author of numerous scholarly publications, including a book on the reform of the electric power industry around the world and especially in Brazil and other Latin American countries. His areas of expertise include the political economy of privatization and organization, management of political and regulatory risk, business influence on public policy, regulation of private business activity, and international business.

585


the Amazon, Parana , and Sa o Francisco basins—that feed large rivers and tributaries. These enormous masses of water often flow slowly but with massive mechanical energy that stands ready to be turned into electricity.

In fact, the electrification of Brazil began towards the end of the 19th century with the realization that the country’s geography and rivers contained excellent potential to bring electricity to the emerging metropolises of Sa o Paulo and Rio de Janeiro. Drawing on previous experiences elsewhere, Canadian investors brought American engineer Pearson to reverse or alter the flow of several rivers near the Atlantic coast and send their waters down the steep escarpment that separates much of Brazil’s coast from the interior plateau, the planalto. With these hydroelectric plants in place, the Brazilian Light & Traction Co.—still known simply as “Light”—provided Rio and Sa o Paulo with sources of electricity that remain in operation to this day.

Nevertheless, by contemporary standards, the dams built by Light were small affairs. Large-scale dam construction began after the Second World War with the establishment of plans for Brazil’s industrialization based on hydroelectric energy. The first public sector electricity company, Com- panhia Hidro-Ele trica do Sa o Francisco (CHESF), was established in 1945 to build and manage the Paulo Afonso Dam in the Sa o Francisco river. The dam was constructed in order to foster the development of the Northeast, the poorest part of Brazil, along the lines of the Tennessee Valley Authority. In 1952 the National Development Bank (now BNDES, Banco Nacional de Desenvolvimento Econo mico e Social) was created with the responsibility, among other things, of managing a Fed- eral Electrification Fund that would channel resources to public sector utilities. In the same year, the State of Minas Gerais established the Cen- trais Ele tricas de Minas Gerais (CEMIG) to spur industrial development around the state capital of Belo Horizonte. The 1954 National Electrifi- cation Plan identified hydro-generation as a key resource and called for the formation of a federal holding company, Eletrobra s, to coordinate the electricity sector. With these new instruments in place, the construction of large dams by the public sector began in earnest with the Furnas Hy- droelectric Project in 1957, which would ultimately reach a capacity of more than 1,200 MW. The dam was built by CEMIG and the federal government, which created a special-purpose company also called Furnas (Tendler, 1968). In 1961, Eletrobra s was finally incorporated and became the parent company of CHESF and Furnas.

The culmination of large-scale public sector hydroelectric projects was reached with the Itaipu Dam. Itaipu , commenced in 1973, was jointly developed by Paraguay and Brazil on a 50-50 basis to attain, at 12,600 MW, the largest capacity of any dam in the world. Itaipu remained the largest capacity dam up until the opening of China’s Three Gorges complex in 2006. But Itaipu was not the last project of its kind. After a long hiatus caused by Brazil’s economic troubles during the 1980s and reform

2012] ENERGY OF BRAZIL 587

of the electricity industry in the 1990s, the government has, in the last five years, once again taken a leading role with the development of the Rio Madeira Complex and the Belo Monte Dam, both in the Amazon basin.

Just as important as the construction of large dams was the development of a national electricity grid by Eletrobra s and its subsidiaries. As available sites for the construction of new large-scale hydroelectric facilities became increasingly distant from the major urban areas they had to be linked by massive transmission lines to the consumption centers. The next step was to interconnect the various basins of the country to allow for more efficient management of available generation resources relative to electricity demand throughout the country. Interconnection between the basins was finally achieved in 1998, when the North-South Intercon- nection joined the northern and south-central grids through a 1,300-km line between the substations of Imperatriz, in Maranha o State, and Samambaia, in the Federal District of Brasılia (Eletrobra s, 2012) (see Fig- ure 1).

Because of the continental size of Brazil and the cascading structure of many of the dams (i.e., many dams are situated linearly along a certain river basin so that upstream dam operations affect all the downstream dams), operation of the country’s interconnected grid is a very complex undertaking and must be counted as another major achievement in the harnessing of Brazil’s waters.

II. A SWEET LAND

The sugarcane industry has a long history in Brazil—nearly as long as

the country itself. Although the first commodity boom in Brazil’s history came with the tree that gave its name to the country, Brazilwood, the systematic colonization of Brazil began with the establishment of sugarcane plantations in the Northeast region of the country, from Bahia to Rio Grande do Norte. It was in Brazil that the Portuguese perfected what we now call the sugarcane “business model”: the use of African slave labor to grow and process sugarcane to meet Europe’s insatiable demand for the commodity, which dominated Atlantic trade for the next three centuries. The Northeast’s sugar industry went into a secular decline in the 17th century after its Dutch occupiers moved to the Carib- bean and outcompeted the Portuguese at their own game. The legacy of this first sugar boom in Brazil is a bitter one: a vast, impoverished former slave population and a feudalistic social structure that is still very much a part of Northeastern Brazil.

After many other commodity booms, the real renaissance of Brazil’s sugar industry came in the 1970s with the first oil shock of 1973. The Brazilian government’s response to this shock, which profoundly affected Brazil’s then oil-dependent economy, would be the origin of the world’s most successful biofuels complex. To reduce dependence on imported oil and cultivate support from the sugar growers along the way, the Brazilian government launched the Proa lcool program in 1975. The program man-


Figure 1. Brazil’s Electricity Transmission Grid, 2011 Source: Eletrobra s, 2011

dated the blending of ethanol distilled from sugarcane juice with gasoline for motor vehicles and encouraged conversion of vehicles from gasoline to ethanol.

Although the program successfully encouraged the expansion of the ethanol-based automobile fleet in the country, it ran into severe problems during the 1980s when oil prices plunged, international sugar prices rose, and the country’s economic difficulties made it increasingly hard for the


government to provide subsidies to stabilize ethanol prices. The program was only saved by a major technological breakthrough in the late 1990s: the development of flex-fuel engines capable of operating on any blend of gasoline and ethanol. By allowing car buyers to arbitrage between the price of gasoline and the price of sugar (via ethanol), flex-fuel technology eliminated the dilemma of having to choose one type of fuel on a permanent basis, and with oil prices rising once more, this made ethanol a very attractive fuel for Brazilian drivers. Flex-fuel vehicles now dominate car sales in Brazil (see Figure 2).

Figure 2. Vehicle sales in Brazil

Source: Mario Roberto Duran Ortiz / ANFAVEA, 2008

The success of Brazil’s ethanol industry cannot be attributed to technology alone, however. In fact, to accomplish the replacement of the dominant technology for motor vehicle fueling on a massive, commer- cially viable scale, other elements of the “ecosystem” had to be in place: a wide distribution network to make ethanol reasonably available to most or all Brazilian drivers and an ethanol production complex capable of keeping up with demand at a reasonable cost. One of the remarkable features about the use of biofuel in Brazil is the widespread availability of ethanol in gas stations throughout Brazil; more than 35,000 stations in total (Projeto Agora, 2011). Without this distribution network (conspicu- ously absent, for instance, for ethanol in the United States), flex-fuel vehicles would be less attractive to Brazilians. But the most extraordinary aspect of the development of the ethanol sector in Brazil is the transformation of the sugarcane/ethanol production complex, which has made the Brazilian sugarcane industry the most advanced in the world. To begin with, most Brazilian sugarcane is no longer grown in the Northeast, but


around Brazil’s industrial heartland, the state of Sa o Paulo, and, to a much lesser extent, the neighboring states of Parana and Mato Grosso do Sul, which account for 85 percent of sugarcane growing in the country (see Figure 3). Sa o Paulo alone contains more than 60 percent of all land under sugarcane cultivation. About one-half of the sugar crop is devoted to ethanol production, via 230 combined milling and distilling plants, plus another 100 ethanol-only plants.

Figure 3. Areas of sugarcane cultivation in Brazil

Source: Goldemberg, J. 2008.

In addition, the Brazilian sugarcane industry makes intensive use of technology to lower production costs and increase ethanol production without concomitant increases in area under cultivation, which presently covers 2 to 3 percent of Brazil’s arable land. Through improvements in cultivation practices, plant varieties, and irrigation, the industry can har- vest two crops of sugarcane every year. Every element of the plant is given a productive use: the leaves and roots are left on the ground as fertilizer; the bagasse is burnt to generate electricity to move the mill’s


machinery and distill the sugarcane juice into ethanol, and any excess electricity production is sold to other electricity users. Another residue from the juice extraction process, called vinasse, is also reused as fertilizer. Increasingly, the fibrous elements of the sugarcane can be used to produce paper and certain types of plastics instead of being burnt. The combination of these technological and agricultural advances makes Bra- zilian sugar and ethanol highly competitive internationally, with Brazil’s sugarcane production constituting about 30 percent of world production, and 20 percent of its ethanol production being exported (see Figure 4).

Figure 4. International Sugar Production Costs, ca.2009 Source: Sylvia Larrea, Inter-American Development Bank

III. THE TREASURE AT THE BOTTOM OF THE OCEAN

The most recent and most surprising of Brazil’s energy transformations

is the shift from massive oil importer to massive oil producer, and even exporter. The transformation is both recent and surprising because it only took place with the discovery of the huge offshore “pre-salt” oil deposits in the last decade. The deposits were discovered through the use of exploration and production technologies that were simply unavailable fifteen or twenty years ago. The challenges involved in accessing the oil are indeed formidable: the largest fields lie more than 200km offshore in the Atlantic Ocean, at total extraction depths of 2km to 7km below sea level and another 5km beneath the ocean floor. To put this in context, the infamous Macondo well in the Gulf of Mexico, operating at what was for a long time the technological frontier in offshore drilling, was pumping oil at a total depth of slightly more than 5km, with a water depth of 1.5km.

Even more surprising, the development and mastery of the technology needed to operate at these extraordinary conditions did not belong to one


of the major oil companies, but to Petrobra s, Brazil’s state-owned oil company (and near-monopoly within Brazil). The breakthrough is a story of patient and lengthy investment that made Petrobra s the world leader in offshore oil extraction, in a sector and a country that have been characterized by enormous corruption and rent-seeking. Indeed, it is impossible to find a comparable example in the world, with the possible exception of Norway’s Statoil. Even PDVSA, the Venezuelan equivalent of Petrobra s long known for its technical excellence, was swiftly consumed by the policies and conflicts coming out of Hugo Cha vez’s rise to power, and is now a shadow of its former self. The ability of successive Brazilian governments to keep Petrobra s under professional management criteria paid off with the discovery of the world’s largest oil deposits of the last two decades.

But there is more to this transformation. Just as the Proa lcool initiative eventually led to the formation of a world-class sugarcane/ethanol complex, the Brazilian government does not want Brazil to be simply an oil producer, but is determined to make this an opportunity to build an entire oil cluster that can not only pump oil, but produce all the equipment needed to make the oil flow: giant oil platforms, sophisticated ducts and valves that can withstand the critical operating conditions in the pre-salt fields, and even the highly sophisticated electronics and data management required for the control of the equipment under these conditions. If successful, this policy stands to transform entire industries in Brazil, from shipbuilding to software. Major multinational companies have already taken note and, as happened during the “Brazilian miracle” of the 1970s in steel, chemicals, cars, and other sectors, are already setting up shop in Brazil. General Electric, for instance, is building its fifth global R&D center in Rio de Janeiro in order to be closely involved in the development of this new energy complex.

IV. AND NOW THE BAD NEWS

A Brazilian joke tells that the non-Brazilian peoples of the Earth were

upset when they saw that God had endowed Brazil with abundant resources, a wondrous nature, delightful fruits, and plenty of sun to enjoy its thousands of miles of sandy beaches. God had a simple but consoling answer: “Wait until you see the kind of people I put there. You won’t feel it’s so unfair then.”

There are indeed a lot of challenges ahead for Brazil’s energy transformations to fully bear fruit, and although Brazil’s politics are probably the biggest challenge, they are not the only one. To begin with, the energy flowing from any of the major sources discussed above will not come cheap. Take hydroelectric energy: although most of the existing dams are entirely or substantially amortized, and can thus generate electricity at a very low monetary cost, the expansion of hydroelectric generation will be much more expensive than in the past. Because the Parana and Sa o Francisco basins have been largely exploited with regard to large dams,


new sites are available only in the Amazon basin. At the outset, this means that they will be increasingly far away from the major centers of electricity demand, requiring large investments in the construction of transmission lines in addition to the cost of the facilities. For example, the Rio Madeira complex is located near the Peruvian border, requiring the construction of a 2,500km transmission “highway” from Porto Velho in Rondo nia State to Araraquara in Sa o Paulo—the longest transmission line in the world (ABB, 2012) (see Figure 1).

To make matters worse, Brazil and the world have changed a lot since the heyday of dam building under the military regime (1964-1985). Not only is there a great deal of opposition to construction of large dams any- where in the world, but the importance of the Amazon as the world’s largest rainforest attracts attention and pressure from all around the globe when it comes to flooding large tracts of the forest and building large construction sites, transmission lines, and the related roads that become conduits for deforestation. In addition, the displacement of local residents, especially indigenous peoples, is not easily accomplished in a democratic setting. These factors are already forcing a redesign of dam structures and construction plans in order to flood a smaller area and to create non-permanent construction staging areas. The upshot is a higher cost per MW of generation capacity added.

Next, consider the expansion of ethanol production. Inevitably, improvements in productivity will be insufficient to avoid bringing more land under sugarcane cultivation. This will run into important constraints. First, because the areas north, east, and south of the current sugar-lands are heavily populated and industrialized, expansion will have to proceed in a westward direction, towards Mato Grosso, Mato Grosso do Sul, and Goia s. Unfortunately, the further expansion moves away from Sa o Paulo, the more limited the transport infrastructure is, raising the cost of shipping the ethanol from production sites to the centers of consumption and export markets. Brazil’s railroad network, for instance, barely reaches Campo Grande, the capital of Mato Grosso do Sul (see Figure 5).

For example, in 2008, shipping one metric ton of soy produced in Lucas do Rio Verde (Mato Grosso) to Shanghai cost $202 on average, while shipping a ton from Iowa cost $77 (Hecht & Mann, 2008). In addition, although the sugar-lands are far away from the Amazon rainforests and the Pantanal wetlands (see Figure 3), the claim by the sugar growers’ association, Unica, that expansion of production would have no impact on either area is simply disingenuous. Unica’s claim ignores the fact that even if expansion does not directly affect either area, it is quite certain to have an indirect effect. As more land is turned into more valuable crops in South-Central Brazil, less valuable uses—particularly cattle ranching— will migrate northward and westward, further eating into the margins of the rainforest and the wetlands. In fact, this migration of ranching is already happening as the agricultural frontier has progressively conquered


Figure 5. Brazil’s Railroad Network, 2007

Source: http://www.brazilmapxl.com/rail-map.html

the vast savannahs of the cerrado that extend from the limits of the Ama- zon rainforest to the pampas and deserts of Southern Brazil, Paraguay, and Argentina. Additionally, there is growing concern about the destruction of the cerrado itself—an area that, while much less biodiverse and less populated by indigenous peoples than the Amazon, is nonetheless a valuable biome in itself.

The most expensive challenge is the “pre-salt” oil. Lying several kilometers offshore in the middle of the Atlantic Ocean, and at hitherto un- tapped depths, fully exploiting it will require an enormous investment; and by requiring local production of much of the equipment to be used, the Brazilian government is certain to increase the cost even further, regardless of other advantages that it may bring to Brazil. The Macondo well disaster in the Gulf of Mexico in 2010 should serve as a warning


about the risk of controlling oil spills at the depths of the pre-salt fields; especially when considering that any coastal oil contamination would hit Brazil’s main tourist beaches in Rio de Janeiro and Sa o Paulo. Just how much uncertainty surrounds the exploitation of the pre-salt fields was un- derlined in June 2012, when Petrobra s and the main private Brazilian oil exploration company, OGX, announced significant cuts in their estimates of pre-salt oil production.

There is still one more challenge to Brazil’s energy transformation, possibly the biggest one. Can the Brazilian state keep all these plates spin- ning? Of particular concern is the willingness of Brazilian politicians to make good use of the oil bonanza. There are good reasons to worry. Brazil has a highly fragmented parliament, where European-style parties pursuing coherent ideological programs contend with many other ones, topped by the Partido do Movimento Democra tico Brasileiro (PMDB). These parties are pure patronage machines, bargaining their parliamen- tary votes for targeted benefits for their members and narrow constituencies. The entrepreneurial attitude of these politicians encourages them to change parties as soon as they spot a better opportunity for rent-seeking. The result is a high level of grand corruption and a state that often works as a predatory patronage mechanism, absorbing close to one-half of Bra- zilian GDP in exchange for fairly poor services. In 2011, Brazil ranked 73 out of 177 countries (from least to most corrupt) in the well-known Cor- ruption Perceptions Index of Transparency International (Transparency International, 2012). In this fraudulent context, Brazilian politicians are already scrambling for a piece of the oil pie. In fact, Petrobra s may have been left alone up to this point simply because Brazil did not have large oil reserves and rents to seek until the recent discoveries, in contrast to the well-known reserves in Mexico or Venezuela, for instance. As an example of the feeding frenzy in the Brazilian parliament, a fierce conflict has been going on for several years about the allocation of oil-related tax revenues. Current Brazilian law allocates most of these revenues to the states where the oil is produced as compensation for the actual and potential environmental damage. But politicians from non-oil producing states want a piece of the pie and have introduced legislative proposals to modify the current allocation formula. This conflict only exacerbates the already problematic division between north and south Brazil: Brazil’s economy and programmatic parties have their center of gravity in the southern half, while the northern half, home to the greatest poverty and clientelism, is overrepresented in parliament.

In sum, if Brazil is to fully realize the potential created by its three energy transformations, it needs to accomplish a number of things. First, it needs to find a consensus about its additional sources of electricity— whether this electricity comes from a fuller exploitation of the Amazon basin or from other sources, such as natural gas-fueled cogeneration, wind and solar, biofuels, nuclear, or even oil and (imported) coal. This is not an easy task. Every alternative has significant environmental impacts


or risks, with the possible exception of wind and solar—and it is difficult to envisage wind and solar attaining the scale needed to meet Brazil’s future needs (more on this below).

Second, Brazil needs to increase its investment in the infrastructure needed to make these transformations possible, especially in the transport infrastructure needed to connect the agricultural lands of the central part of the country with the major urban centers and export facilities on the eastern seaboard. Like other Latin American countries, Brazil allocates too much of its tax revenue to consumption expenditure—salaries, pensions, and consumables—and too little to investment.

Third, Brazil needs to develop a new energy cluster that is internationally competitive and not an over-protected monopoly. The latter would increase the cost of exploiting the pre-salt fields, drain resources that could otherwise be employed more efficiently in other sectors, and add another drag to the rest of the Brazilian economy. Importantly, as we are already seeing, creating this cluster is not only about building factories and physical facilities, but also improving the educational system to produce the workforce and managers required to operate such facilities efficiently.

The key to these accomplishments will be keeping the sharks at bay. The most destructive sharks are the old-school politicians, who will do their utmost to siphon funds to line their own pockets and “splash” their supporters with some largesse. Pure rent-seeking of this kind will take resources away and allocate it to uses of very little economic value. Lum- bering more than predatorial, technocrats and high-level bureaucrats in the public sector will seek to control the greatest amount of resources in order to maintain or enhance their power and support their ideological goals. The danger of such vast bureaucratic control is that these officials and technocrats do not have a monopoly on the efficient implementation and operation of major investment projects. While they can point with pride to accomplishments like Itaipu , there are also significant failures, like the management of Brazil’s airports. Lastly, we should not forget that many private-sector managers, both domestic and foreign, would be delighted to consolidate or obtain monopolistic positions that would ensure them a comfortable life. All too often, the desire to build national champions and new clusters in Brazil has resulted in the creation of protected, market-dominant positions for privileged companies at the expense of Brazilian consumers and other sectors of the economy, as the banking and electronics industries show.

V. DON’T DESPAIR (YET)

The recent history of Brazil shows that moving forward is far from im-

possible. Before we take an excessively negative view of the future, we need to consider the favorable elements of the situation. The most important element is the fact that the massive investment effort needed to expand Brazil’s energy sources can only be accomplished in partnership


with the private sector, including foreign companies. Despite the huge size and capacity of the Brazilian state, it lacks the technology, organizational capacity, and capital to simultaneously accomplish all that is needed. This will limit the temptation of the senior civil servants to try to maintain exclusive control. An instructive recent example is the investments in transport infrastructure related to the celebration of the FIFA World Cup in Brazil in 2014. The inability of the government-owned air- port operator, Infraero, to make essential improvements in Brazil’s airports in time for the Cup compelled the current government—a strong proponent of public-sector leadership in the economy—to bring in the private sector in order to avoid major embarrassments two years from now.

While private-sector involvement alone is no guarantee against corruption (and can often make things worse), the opportunity to create competitive processes for the award of contracts to the private sector can act as an instrument to limit corruption, because contending companies have an interest in monitoring the award process. Moreover, the participation of multinational companies can promote the absence of corruption to the extent that these companies have a global reputation to protect. The key will be to award contracts on a transparent, competitive basis open to foreign as well as domestic bidders. Fortunately, President Dilma has shown a determined will to stamp corruption out, and has already sacked several of her ministers in connection with corruption allegations.

But perhaps it is time to think about a new energy transformation for Brazil; one that is less dependent on large infrastructure investments and the rent-seeking that has sometimes come with past transformations. As the country debates how to meet its future energy needs without further damaging its unique ecosystems, it might be worth considering that large hydro (and nuclear) facilities are yesterday’s solutions, not tomorrow’s. Thanks to the widespread construction of large dams across the world in the second half of the 20th century, there is increasingly strong evidence about the negative impacts of large dams: displaced peoples who seldom obtain the compensation that they were promised; massive, if temporary, carbon emissions from the vegetation that is flooded by the reservoir; permanent changes in local climate due to the creation of large bodies of water; and massive alteration of riverine ecosystems. In Brazil’s case, to this list we need to add the impact of the construction of transmission lines across thousands of miles of rainforest.

What are the alternatives to building more large dams, expanding culti- vated areas, or extracting more hydrocarbons? Brazil has vast potential for solar, wind, and small hydro generation of electricity. Many parts of Brazil have a large proportion of sunny days, because the rains tend to be concentrated in a relatively short season. The vast, east-facing coastline and the orography of the escarpment that separates much of the coast from the inland plateau result in excellent wind conditions throughout a good portion of Brazil’s eastern seaboard (see Figure 6).


Figure 6. Brazil Wind Map Source: http://www.electronica-pt.com/index.php/content/view/199/37/

The deployment of smart-grid technology, together with the steep drop

in the cost of solar panels in recent years, creates the opportunity to de- ploy solar panels throughout the country, and especially in Brazil’s com- pact cities, where the energy generated by these panels during the daytime—when people are at work—can be aggregated and directed towards other users. Another major opportunity lies in solar water heating. A Brazilian quirk from the days of cheap hydroelectricity is the widespread use of the chuveiro, an electric water heater installed at the showerhead. The chuveiro increases the risk of electrocution—it is said to have been one of the secrets behind the success of havaianas sandals, because their rubber prevents ground contact when taking a shower— and, because the chuveiro relies on simple resistance heating, it is tremen- dously inefficient. In fact, the use of the chuveiro in the mornings and early evenings is a major contributor to peak electricity demand in Brazil during the daily cycle, and accounts for one-fourth of household use of electricity in Brazil (Arau jo & Belchior, 2011). Chuveiros could be easily replaced by low-cost solar water heating kits that require no external energy input, only enough water pressure to fill the tank associated with the kit. In fact, replacement is not even necessary—existing chuveiros can


just be left in place and turned on during rainy days. A Brazilian design for a low-cost solar water heating kit, called ABSC (Aquecedor Solar de Baixo Custo, or Low-Cost Solar Water Heater), is available in the public domain and could be industrially produced at a low cost, because it in- volves little more than a few plastic parts.

VI. A MODEST PROPOSAL: FOCUS ON THE POOR

A new energy transformation that pays particular attention to offering

affordable energy to the poor would help meet Brazil’s social needs in addition to helping address its dilemma of energy and environmental sustainability. Although poverty is still extensive in Brazil, the poor account for a relatively small proportion of energy consumption, simply because they cannot afford it. But, with the rapid incorporation of large segments of the poor into the working and middle classes, thanks to the favorable economic conditions and the expansion of social programs, a good part of the growth in demand for energy in Brazil will surely come from this economically rising part of the population. As the new working class purchases cars and appliances, their energy needs will grow significantly. It is here that a fourth transformation could make a difference by helping meet these needs at a lower economic and environmental cost.

Many of the elements to make this happen are already available. Rooftop solar panels and solar water heaters will work particularly well, for instance, in many favelas (informal settlements) precisely because they are often located on steep hillsides where formal housing was not allowed. Building on such sites has many disadvantages, but one sure advantage is a much greater exposure to the sun and thus increased potential for the use of solar technologies. By selling electricity during the day, when the price of electricity is at its highest, and buying electricity after dark, when its price is dropping, favela households will be able to lower their electricity bills, while solar water heaters will save them up to 25 percent of their electricity consumption.

Opportunities are not confined to exploiting alternative sources of energy, but should include opportunities to save or make more efficient use of energy as well. Here also, the low-hanging fruit may be found in the favelas. Poor construction techniques, materials, and knowledge result in self-built housing that requires a lot of cooling at the end of the day, a situation only exacerbated in hillside locations. A simple, low-cost solution already successfully implemented in South Africa, is the deployment of cellulosic roof insulation—which can be easily made from recycled paper, for instance—that drastically decreases the heating of interior spaces covered by tin roofs. Several companies in Brazil, such as COELBA in Bahia, AES Eletropaulo in Sa o Paulo, and Light in Rio, are already expanding programs to replace old refrigerators and dangerous, inefficient electrical circuits inside the houses of low-income families (Ma rquez and Rufın, 2011). These programs could easily be expanded or supplemented by others offering construction advice to help improve ventilation and


natural lighting in self-built housing, following the lead of cement giant Cemex with their Patrimonio Hoy program in Mexico.

Brazil’s tremendous accomplishments in the development of hydroelectric generation, the production and use of biofuels, and offshore oil drilling may or may not bring new successes in regard to energy. When looking at the future of energy in Brazil, the expression “tudo acaba em samba” (it all ends with a samba) comes to mind. Anyone who has been to a samba school rehearsal will understand this expression without difficulty: confusion, even chaos; nothing starts when it is supposed to, and ends much later than scheduled; it’s crowded and unbearably hot, and very noisy. And yet, “tudo acaba em samba” is not an expression of despair, but of joy; because amid all the craziness, the music emerges and everyone is happy while they dance and sing to the samba. Brazil’s energy industry is certain to experience important setbacks as well as advances over the next decade. Brazil is not a country for those who abhor strong emotions. But the past record and the present striving augur well for the future. Don’t be surprised if it turns out to be a happy one, after all.

REFERENCES

ABB, 2012. Rio Madeira: The longest transmission link in the world - 2,500 kilometers. http://www.abb.com/industries/ap/db0003db004333/1371 55e51dd72f1ec125774b004608ca.aspx.

Arau jo, Jose Eurıpedes de, and Belchior, Fernando Nunes, 2011. Cus- tos associados a substituic a o de chuveiros ele tricos por aquecedores solares. O setor eletrico, 62. http://www.osetoreletrico.com.br/web/colunis tas/jose-starosta/570-custos-associados-a-substituicao-de-chuveiros-ele- tricos-por-aquecedores-solares.html.

Baer, W., 1995. The Brazilian Economy: Growth and Development, 4th edition (Westport, CT: Praeger).

Barzelay, M., 1986. The Politicized Market Economy Alcohol in Bra- zil’s Energy Strategy (Berkeley, CA: University of California Press).

Eletrobra s, 2011. Mapa LTs Sistema Eletrobra s – Dez 2011. http:// www.eletrobras.com/elb/services/DocumentManagement/FileDownload. EZTSvc.asp?DocumentID{39F86A33-ED4D-4CB1-863B-AB3510A17F 81}&ServiceInstUID={E10AC30C-C496-4C15-BFC2-1C1C408B879D}.

Eletrobra s, 2012. Histo ria da Eletrobra s. http://www.eletrobras.com.br/ Em_Biblioteca_40anos/interno_96-02.asp?id=5&descricao=O%20mapa %20do%20Brasil,%20que%20saiu%20na%2055%AA%20edi%E7%E3 o%20da%20Carta%20Quinzenal%20(publica%E7%E3o%20da%20 Eletrobr%E1s),%20em%201997,%20mostra%20o%20tra%E7ado%20 do%20sistema%20interligado%20do%20pa%EDs,%20com%20 destaque%20para%20a%20linha%20Norte-Sul/%20Acervo%20Ele- trobr%E1s%20-%20abril%20de%201997.

Hecht, Susanna B., and Mann, Charles C., 2008. How Brazil outfarmed the American farmer: After a half-century of dominance, the U.S. is los-


ing its edge in agriculture to a booming, high-tech Latin American power- house. Its secret weapon? Soybeans. Fortune Magazine, January 19.

Patricia Ma rquez and Carlos Rufın (eds.), Private Utilities and Poverty Alleviation: Market Initiatives at the Base of the Pyramid (Cheltenham and Northampton: Edward Elgar Publishing, 2011).

Memo ria da Eletricidade, 1988. Panorama do setor de energia ele trica no Brasil (Rio: Centro da Memo ria da Electricidade no Brasil).

Projeto Agora, 2011. Estudo Municıpios Canavieiros. http://www.muni cipios-canavieiros.com.br/download/09_CAP_07.pdf.

Tendler, J., 1968. Electric Power in Brazil: Entrepreneurship in the Public Sector (Cambridge, MA: Harvard University Press).

Goldemberg, J., 2008. Review: The Brazilian biofuels industry. http:// www.biotechnologyforbiofuels.com/content/pdf/1754-6834-1-6.pdf.

Transparency International, 2011. Corruption Perceptions Index 2011. http://files.transparency.org/content/download/101/407/file/2011_CPI_EN. pdf.

Trebat, Thomas J., 1983. Brazil’s State-Owned Enterprises: A Case Study of the State as Entrepreneur (Cambridge, England: Cambridge Uni- versity Press).

Updates

T

FCPA RISKS FOR U.S. COMPANIES IN

LATIN AMERICA, RENEWABLE ENERGY

THRIVES IN BRAZIL, AND MEXICO AND

THE NEW PRI: ENRIQUE PEN A NIETO

Fernando Avelar*

I. FCPA RISKS FOR U.S. COMPANIES IN LATIN AMERICA

HE Foreign Corrupt Practices Act (FCPA) has been a point of increased worry for U.S. companies doing business abroad. React- ing to FCPA enforcement actions, U.S. companies have imple-

mented advanced compliance programs when dealing with international subsidiaries and partners.1 The recent increase in FCPA enforcement by the federal government and the multimillion-dollar penalties that have been levied on U.S. companies for violations of the FCPA2 are the predominant reasons companies are in a rush to get their compliance programs up to par. Latin America is one of the primary areas where U.S. companies are most at risk for FCPA violations because of the corrupt culture of business and politics present in many Latin America countries.3

This article is intended to be an overview of anti-corruption law in the United States and Latin America and to examine why compliance with the FCPA is more important now than ever.

A. FCPA OVERVIEW

The FCPA was enacted in 1977 with the intended purpose of making it

illegal for certain persons and entities to make payments to foreign government officials in order to obtain new business or retain current busi-

* Fernando Avelar is a third-year law student at SMU Dedman School of Law. He

is currently serving as the Latin America Reporter for the International Law Re- view Association. He would like to thank his family and friends for the support they have given him during his time in law school.

1. Matt Ellis, Is the FCPA working? Three dispatches from Latin America, FCPA COMPLIANCE & ETHICS BLOG (Oct. 4, 2011, 7:01 AM), http://tfoxlaw.wordpress. com/2011/10/04/is-the-fcpa-working-three-dispatches-from-latin-america/.

2. PricewaterhouseCoopers, L.L.P., What You Should Know about the Foreign Cor- rupt Practices Act, DOING BUSINESS IN LATIN AMERICA 3 (May 2011), http://www. pwc.com/en_US/us/transaction-services/publications/assets/pwc-doing-business-in- latin-america-foreign-corrupt-practices-act.pdf.

3. See Corruption Perceptions Index 2011, TRANSPARENCY INT’L (Nov. 2011), http:// cpi.transparency.org/cpi2011/results/ (click “Download Report”).

605


ness.4 The FCPA was the response from the U.S. Congress after “more than 400 US companies admitt[ed] to making questionable or illegal payments to foreign government officials, politicians, and political parties.”5

The U.S. Congress wanted to stop the bribery of foreign officials and “restore the integrity of American businesses” abroad.6 Essentially, the FCPA requires that no officer, director, employee, or agent of a company shall corruptly offer to pay something of value or give something of value to any foreign official for the purpose of “(i) influencing any act or decision of such foreign official in his official capacity, (ii) inducing such foreign official to do or omit to do any act in violation of the lawful duty of such official, or (iii) securing any improper advantage.”7

B. U.S. GOVERNMENT’S FOCUS ON FCPA VIOLATIONS

One of the main reasons U.S. companies should be worried about po-

tential FCPA violations is the U.S. government’s recent focus on ensuring that U.S. companies are acting as if they were in the United States when abroad. Since 2005, the agencies responsible for enforcing the FCPA, the Department of Justice (DOJ) and the Securities and Exchange Commis- sion (SEC), have ramped up their efforts to prosecute companies in violation of the FCPA.8 The U.S. government decided to substantially increase the amount of resources dedicated to FCPA enforcement9 leading to a record high number of companies being prosecuted for FCPA violations in 2010.10

In 2004, there were only five enforcement actions conducted by the SEC and DOJ, while in 2010 their enforcement actions rose to a total of seventy-four.11 A reason that may have contributed to the increase in the number of enforcement actions is the Sarbanes-Oxley Act, which requires companies to review and report failures in books and records testing, resulting in the detection of more violations.12

The increased focus on FCPA enforcement can be seen in the opening of new SEC offices focused on enforcement, an increase in FBI agents focused on enforcement, and financial incentives being offered through

4. Foreign Corrupt Practices Act, U.S. DEP’T OF JUSTICE, http://www.justice.gov/crim-

inal/fraud/fcpa/ (last visited Aug. 14, 2012). 5. Doing Business in Latin America, supra note 2, at 2. 6. Id. 7. 15 U.S.C. § 78dd-1(a)(1)(A) (2006). 8. Bethany Hengsbach, Aggressive FCPA Enforcement Persists: Increased Activity,

Along With Recent Legal Developments, Mandate that Companies Remain Vigilant, JDSUPRA (Feb. 2, 2012), http://www.jdsupra.com/legalnews/aggressive-fcpa-enforcement-persists-in-80168/.

9. Id. 10. Thomas R. Fox, FCPA Enforcement: Why the Increase Between the First 25 Years

and the Last 5?, FCPA COMPLIANCE & ETHICS BLOG (Mar. 11, 2011, 6:48 AM), http://tfoxlaw.wordpress.com/2011/03/11/fcpa-enforcement-why-the-increase-between-the-first-25-years-and-the-last-5/.

11. Id. 12. Id.

ENRIQUE PEN A NIETO 2012] 607

legislation to whistleblowers.13 With all of the resources and focus being directed towards enforcement of the FCPA, companies doing business in Latin America have good reason to be careful.

C. LATIN AMERICA’S RISK OF CORRUPTION

Latin America is of special importance to U.S. companies conducting business abroad because of its proximity to the United States and its potential for more than 500 million new consumers.14 In addition to this, the amount of Free Trade Agreements (FTAs) with Latin American countries is increasing. The United States now has signed a FTA with the following Latin American countries: Chile, Colombia, Costa Rica, Do- minican Republic, El Salvador, Guatemala, Honduras, Mexico, Nicara- gua, Peru, and Panama.15 Significantly, the United States only has nineteen FTAs and, out of those, ten are with countries from Latin America.16 The barriers to entry in Latin America for U.S. businesses are becoming less and less difficult to overcome, creating attractive business opportunities for U.S. companies.

Of the FCPA actions brought by the SEC in the past two years, over half have involved bribery in Latin America.17 As mentioned previously, most Latin American countries have been identified by the Corruption Perceptions Index as being highly vulnerable to corruption.18 Only two Latin American countries are considered to be on the same level with the United States, perceived as “very clean.”19

In addition, recent cases indicate that U.S. companies most at risk for FCPA violations conduct business in regions where state-owned companies dominate the market.20 As mentioned previously, “the FCPA prohibits any domestic individual or business entity from making payments to a ‘foreign official’ for the purpose of obtaining or retaining business.”21

The FCPA defines “foreign official” as “any officer or employee of a foreign government or any department, agency, or instrumentality thereof.”22 Thus, “whether an employee of a state-owned company is a

13. Hengsbach, supra note 8. 14. What You Should Know about the Foreign Corrupt Practices Act, supra note 2, at

1. 15. Free Trade Agreements, OFFICE OF U.S. TRADE REPRESENTATIVE, http://www.

ustr.gov/trade-agreements/free-trade-agreements/ (last visited Aug. 14, 2012). 16. Id. 17. Rose Romero et al., Energy Companies Find Profits, Peril in Latin America, NAT’L

L.J., Apr. 9, 2012, available at http://www.tklaw.com/files/Publication/fd01cdc5-37 b0-4d12-8c7c-a284024e8114/Presentation/PublicationAttachment/dac6af25-07b0- 4cf3-b0d9-6cddbf17453d/NLJ%20FCPA%20Article_Romero%2c%20Roper%2c %20Stockham.pdf.

18. See Corruption Perceptions Index 2011, supra note 3. 19. See id. 20. Romero et al., supra note 17. 21. Alison N. Kleaver & Joseph Barton, Meaning Of FCPA’s “Foreign Official”

Causes Uncertainty For Companies Doing Business Abroad, LATIN AM. BLOG

(May 24, 2012), http://www.latinolawblog.com/2012/05/articles/fcpa/meaning-of- fcpas-foreign-official-causes-uncertainty-for-companies-doing-business-abroad/.

22. 15 U.S.C. § 78dd-1(f)(1)(A) (2006).


foreign official depends . . . upon whether state-owned companies are ‘instrumentalities,’ ” but the case law on “instrumentalities” is convoluted.23

Many of the Latin American countries have large business structures that are state-owned. “For example, the governments of Brazil, Colom- bia, Mexico and Venezuela wholly own the oil companies in their respec- tive countries,” thus making it difficult to know when a U.S. company is more at risk for FCPA violations.24

The lack of anti-bribery and anti-corruption laws in Latin American countries does not help the situation. Brazil, one of the most robust economies in Latin America, currently only has anti-bribery laws that hold individual persons liable for bribery acts, but has no equivalent provisions that apply to corporate liability.25

Recently, two U.S. law firms and twelve Latin American law firms jointly surveyed 439 respondents across fourteen Latin American countries to try and gauge the amount of corruption that exists in those countries.26 Two key highlights from the survey are (1) that only 28 percent of the respondents believe that anti-corruption laws are effective in the country they work in, and (2) that “[h]alf of all respondents believe that their company has lost business to competitors making illicit payments in the region.”27

This information points to the fact that some Latin American countries still have some ground to cover in order to bring their anti-bribery and anti-corruption laws up to U.S. standards. In addition, a lack of anti-bribery and anti-corruption laws cultivates an environment in which officials at the local level expect illicit payments from international companies doing business in their town.28 This correlates with one of the key highlights from the survey mentioned above: companies that do not partake in the bribery tactics lose a competitive edge to companies who are willing to play the game.29

D. A CHANGING LANDSCAPE

As mentioned above, many of the Latin American countries where American companies do business do not have adequate laws in place to battle corruption and bribery schemes. Since the increased enforcement of the FCPA, American businesses are taking matters into their own hands by making sure their compliance programs are advanced enough to

23. Kleaver & Barton, supra note 21. 24. Romero et al., supra note 17. 25. Matteson Ellis, Lessons from the Mensala o: Brazil’s Largest-Ever Corruption Trial,

CORP. COMPLIANCE INSIGHTS (Aug. 22, 2012), http://www.corporatecompliancein- sights.com/lessons-from-the-mensalao-brazils-largest-ever-corruption-trial/.

26. Thomas R. Fox, Latin American Anti-Bribery Survey, FCPA COMPLIANCE & ETH-

ICS BLOG (July 5, 2012, 1:51 AM), http://tfoxlaw.wordpress.com/2012/07/05/latin- american-anti-bribery-survey/.

27. Id. 28. Ellis, supra note 1. 29. Fox, supra note 26.


detect and handle any corruption that might occur within the corporation while operating abroad.30

For example, in Mexico, United States-based energy companies have implemented stable compliance programs that have communicated to foreign officials that bribes are no longer tolerated; rather, they are to be frowned upon.31 In a coastal town where many of these companies do business, local officials know not to expect any extra payment or benefit because of the repetitive FCPA training by the U.S. energy companies.32

It seems that the uniform action taken by these companies has created an environment where bribes are not the norm.33

An ever-increasing number of corporations have been upgrading and implementing advanced compliance programs to deal with the corruption issues they face in Latin America.34 In the joint survey mentioned above, 93 percent of the 439 respondents from multinational companies said their company had taken steps to protect the company from corruption risk.35 In addition, the survey stated that 75 percent of the respondents said their company had anti-corruption training.36 The numbers for local and regional companies were not as good as for multinational companies — only 75 percent said their company had taken steps to protect the company from corruption risk, and only 35 percent had anti-corruption training available for their employees.37

For U.S. companies doing business in Latin America, it is of high importance they understand the risks posed by the region. Latin America is a growing region full of business opportunities, but the compliance industry in Latin America lags behind. Because of this, U.S. companies must implement their own compliance programs in order to guard themselves from the broad provisions of the FCPA.

II. RENEWABLE ENERGY THRIVES IN BRAZIL

In recent times, countries all over the world are beginning to place

great emphasis on using clean energy. Whether it is because of global warming or to import less energy, clean energy seems to be the wave of the future, and while some countries have turned away from this trend, Brazil has welcomed it with open arms.

Brazil has been recognized as a growing leader in the use of renewable energy. Brazil’s Energy Research Company recently released the 2011

30. See Ellis, supra note 1. 31. See id. 32. Id. 33. Id. 34. See Samuel Rubenfield, Latin America Surveys Find Gaps in Corporate Anti-Cor-

ruption Measures, WALL ST. J. (June 14, 2012, 10:13 AM), http://blogs.wsj.com/ corruption-currents/2012/06/14/latin-america-survey-finds-gaps-in-corporate-anti- corruption-measures/.

35. Id. 36. Id. 37. Id.


National Energy Balance Report, which provides a detailed analysis of energy usage in Brazil.38 The most staggering fact from this report is that nearly 86 percent of Brazil’s electricity in 2010 originated from renewable energy sources.39 This number is quite impressive compared to other economic superpowers of the world; for example, the United States was only at 13 percent.40

Brazil has used a multi-step approach in order to nurture a strong and efficient renewable energy market. It began with Brazil’s implementation of Law 10.438, also known as the Programme of Incentives for Alter- native Electricity Sources (PROINFA).41 Brazil instituted policies that coordinated with PROINFA to allow renewable energy businesses better access to funds via their state bank, Brazilian Development Bank (BNDES).42 Brazil also uses an auction-based system to award long-term contracts for energy business.43 All of these decisions have helped Brazil build a successful renewable energy sector, a sector that Brazil hopes to become a world leader in.

A. PROINFA

In 2002, Brazil enacted its flagship act, PROINFA, to cultivate the re-

newable energy sector.44 PROINFA was created by Brazil in response to the energy crisis of 2001 that plagued the nation and stunted its productive capacity and growth.45 PROINFA’s main goal is to have 10 percent of all electricity produced in the country come from renewable energy sources.46 The program is split into two phases: (1) promoting the use of

38. Charles Kennedy, Renewable Energy Supplied 88.8% of Brazil’s Electricity in

2011, OILPRICE.COM (June 19, 2012, 10:01 PM), http://oilprice.com/Latest-En- ergy-News/World-News/Renewable-Energy-Supplied-88.8-of-Brazils-Electricity- in-2011.html.

39. Balanco Energetico Nacional Ano Base 2010, MINISTE RIO DE MINAS E ENERGIA

16 (2011), http://www.forumdeenergia.com.br/nukleo/pub/resultados_pre_ben_ 2010.pdf.

40. How Much of Our Electricity Is Generated from Renewable Energy?, U.S. ENERGY

INFO. ADMIN., http://www.eia.gov/energy_in_brief/article/renewable_electricity. cfm (last updated June 27, 2012).

41. See Lei No. 10.438, DIA RIO OFICIAL DA UNIA O [D.O.U.], 29.4.2002 (Braz.), available at http://www.planalto.gov.br/ccivil_03/Leis/2002/L10438compilada.htm.

42. See Stephan Nielsen, Local Content Rule Thwarts Solar Development in Brazil, RENEWABLE ENERGY WORLD (Aug. 9, 2012), http://www.renewableenergyworld. com/rea/news/article/2012/08/local-content-rule-thwarts-solar-development-in- brazil.

43. Jared Anderson, Data Show Brazil’s Wind Energy Market Is Wide Open for Busi- ness, AOL ENERGY (Aug. 27, 2012), http://energy.aol.com/2012/08/27/data-show- brazil-s-wind-energy-market-is-wide-open-for-business/.

44. Programme of Incentives for Alternative Electricity Sources (PROINFA), WORLD

RESOURCES INST., http://projects.wri.org/sd-pams-database/brazil/programme-incentives-alternative-electricity-sources-proinfa (last visited Aug. 28, 2012) [hereinafter PROINFA].

45. Marcos Chaves Ladeira & Andre Vertullo Bernini, Brazil Encourages Alternative Electric Energy Development: Taking a Closer Look at Brazil’s PROINFA Pro- gram, BRAZILIAN-AMERICAN CHAMBER COM. (May 20, 2012), http://brazilcham. com/print/65568.

46. Id.


renewable energy (i.e., wind, biomass, and small hydro) via various incentives and subsidies, and (2) converting those renewable energies from the first phase into a 10 percent renewable energy share of total annual energy consumption for Brazil.47

B. BNDES FINANCING

One of the key benefits for businesses looking to undertake renewable

energy projects in Brazil is the generous financing through Brazil’s state bank.48 The projects are financed via the state-bank, BNDES, which is the chief federal agency for long-term funding of Brazil’s development.49

The BNDES offers long-term financing with low interest rates for renewable energy projects—such as wind—if a certain percentage of the parts for the project are made in Brazil.50 For example, the current requirement is 60 percent for wind projects.51

C. AUCTION-BASED SYSTEM

Another successful contributor to Brazil’s renewable energy growth is

the regulated auction system used to award contracts.52 These contracts have been handed out since 200953—using the auction system—and have been consistently given to several companies since then.54 The wind project auctions have attracted several investors because the price of wind power in the latter half of 2011 fell below the price of electricity generated by natural gas.55 These auctions have created an environment of competition across the Brazilian energy sector, forcing many companies to be more competitive with their pricing.56

Brazil’s continued success in the renewable energy sector is a culmination of several different policies synthesizing to create a thriving renewable energy sector. Brazil’s emergence into renewable energy was a fairly recent and rapid ascension, and it will be interesting to see if Brazil can sustain that community in the long-term.

47. PROINFA, supra note 44. 48. See Ladeira & Bernini, supra note 45. 49. Id. 50. See Christiana Sciaudone, Bank Set to Further Tighten Brazil’s Wind Turbine Con-

tent Rules, RECHARGE (Aug. 24, 2012), http://www.rechargenews.com/energy/ wind/article320778.ece.

51. See id. 52. See Analysis of the Regulatory Framework in Brazil 2011, GWEC, http://www.

gwec.net/publications/country-reports/analysis-regulatory-framework-brazil/# (last visited Dec. 13, 2012).

53. Id. 54. See Luiz Claudio S. Campo & Lucio Teixeira, Renewable Energy Recap: Brazil,

RENEWABLEENERGYWORLD.COM (Jan. 2, 2012), http://www.renewableenergyworld.com/rea/news/article/2012/01/renewable-energy-recap-brazil.

55. Id. 56. Id.


III. MEXICO AND THE NEW PRI: ENRIQUE PEN A NIETO

In early July, Enrique Pen a Nieto was chosen by the citizens of Mexico to be the country’s new leader.57 President Pen a Nieto’s win over his counterparts in rival parties was not a big surprise, but the fact that he belonged to the Institutional Revolutionary Party (PRI) was.58 The PRI dominated the political realm in Mexico for seventy-one years until 2000 when Vicente Fox of the National Action Party (PAN) beat out the PRI.59 Looking back on the seventy-one year reign by the PRI, the party’s control in Mexico is remembered for its “corruption, electoral fraud and occasional bouts of brutal authoritarianism,” which is why many in Mexico are not fully convinced that President Pen a Nieto was the right answer.60 But President Pen a Nieto recognized this and recently stated, “[t]he Mexican people have given our party a second opportunity. We will honor it with results.”61 President Pen a Nieto hopes to reaffirm the people of Mexico’s confidence in the PRI by following through with his campaign promises, which were primarily to stir economic growth via tax reform and oil privatization and to reduce the vast amount of drug- related violence that has plagued Mexico for years.62

A. ECONOMIC DEVELOPMENT

One of the foundations for Mr. Pen a Nieto’s presidential campaign was

his pledge to improve economic development in Mexico and create more jobs for the Mexican people.63 According to Luis Videgaray, Mr. Pen a Nieto’s campaign manager, the first priority after the July 1 victory was to pass corporation-aimed tax reform.64 Mexico currently has one of the “lowest tax takes in the western hemisphere,” and the tax reform that is envisioned by President Pen a Nieto is one that will help the Mexican government raise more revenue and come more in line with the international

57. Ruben Navarrette Jr., Is Pen a Nieto good news for Mexico?, CNN (July 3, 2012,

2:24 PM), http://edition.cnn.com/2012/07/03/opinion/navarrette-mexico-election/index.html.

58. See Pamela K. Starr, Enrique Pen a Nieto: Mexico’s new face, L.A. TIMES (July 6, 2012), http://articles.latimes.com/2012/jul/06/opinion/la-oe-starr-mexico-president- 20120706.

59. Navarrette, supra note 57. 60. See Daniel Trotta, Mexican Election Could Return Old Rulers to Power, CHI. TRIB.

(July 1, 2012), http://articles.chicagotribune.com/2012-07-01/news/sns-rt-us-mexico- electionbre85s1g3-20120629_1_enrique-pena-nieto-pri-mexican-election.

61. Nacha Cattan, Pena Nieto Prosperity Vow for Mexico Means Mastering the PRI, BLOOMBERG (July 2, 2012, 12:10 PM), http://www.bloomberg.com/news/2012-07- 02/pena-nieto-prosperity-vow-for-mexico-means-mastering-his-party.html.

62. See Adam Thomson, Pen a Nieto vows to push on with reforms, FIN. TIMES (July 3, 2012, 2:07 AM), http://www.ft.com/intl/cms/s/0/8b96dd16-c4a1-11e1-a98c-00144fea bdc0.html#axzz26UebjMeG (requires registration).

63. Rory Carroll, Enrique Pen a Nieto: hopes, fears and swoons for Mexico’s would-be president, GUARDIAN (June 29, 2012, 9:40 AM), http://www.guardian.co.uk/world/ 2012/jun/29/enrique-pena-nieto-mexico-elections.

64. Adam Thomson, Pen a Nieto pledges business tax reform, FIN. TIMES (June 21, 2012, 9:59 AM), http://www.ft.com/intl/cms/s/0/d6df6b08-baec-11e1-81e0-00144fea bdc0.html#axzz24uIfcevk (requires registration).


standards.65 The plan for President Pen a Nieto is to close some of Mex- ico’s tax loopholes that allow Mexico’s biggest companies to not pay their fair share.66

In addition to tax reform, President Pen a Nieto hopes to improve the Mexican economy by adding an element of privatization to Mexico’s state-owned oil industry, currently dominated by Pemex.67 The plan is to open up the oil sector and provide private capital in order for it to become more efficient and effective.68 President Pen a Nieto has been in close talks with the United States about his energy and infrastructure plans in Mexico, which would include private sector investments in Mex- ico’s oil monopoly and shale gas industry.69

In order to achieve these reforms, President Pen a Nieto will have to negotiate and compromise across party lines because the PRI failed to achieve a majority in Congress.70 This will be key if President Pen a Nieto wants to achieve his oil privatization reform pledge, because a constitutional amendment will likely be required.71 The Mexican Constitution states, “[i]n the Nation is vested the direct ownership of all natural resources of the continental shelf and the submarine shelf of the islands . . . .”72 In order for a constitutional amendment to be passed, a two- thirds majority will be necessary, which the PRI does not currently hold.73 One of the primary reasons for a shift from PAN back to the PRI is the immense drug-violence in Mexico, which has resulted in more than 55,000 deaths since 2007.74 President Pen a Nieto pledged during his campaign to create an elite federal security force that will coordinate with local police to track down drug traffickers.75 In order to do this, Presi- dent Pen a Nieto needs to acquire the cooperation of the state governors and convince them to adjust their security institutions to combat drug violence.76

It seems that President Pen a Nieto’s campaign pledges of drug and economy policy reform are all contingent on reaching out to other party leaders for cooperation. President Pen a Nieto will need to come through on at least some of his campaign pledges if the PRI is to reassure its new image of modern democracy with Mexican doubters.

65. Id. 66. Id. 67. See Andres Oppenheimer, Mexico will not return to third world foreign policy,

MIAMI HERALD (July 4, 2012), http://www.miamiherald.com/2012/07/04/2880840/ mexico-will-not-return-to-3rd.html.

68. See Thomson, supra note 64. 69. See Oppenheimer, supra note 67. 70. Cattan, supra note 61. 71. Id. 72. Constitucio n Polıtica de los Estados Unidos Mexicanos [C.P.], as amended, art. 27,

Diario Oficial de la Federacio n [DO], 5 de Febrero de 1917 (Mex.) (emphasis supplied).

73. Cattan, supra note 61. 74. Trotta, supra note 60. 75. Cattan, supra note 61. 76. Id.

T

CANADA UPDATE: A REVIEW OF

CANADA’S RECENT HOLDING

REGARDING THE PROPOSED SECURITIES

ACT, CANADA’S ANTI-SPAM LAW THAT

MAY SOON TAKE EFFECT, AND THE

DISCIPLINARY HEARING OF JOE GROIA

David Paulson*

HIS update includes three parts. Part I is a review of a recent decision by the Supreme Court of Canada that held the proposed Canadian Securities Act unconstitutional. Part II is a brief sum-

mary of Canada’s anti-spam legislation, which is planned to take effect early next year. Part III is an analysis of a recent decision by the Law Society of Upper Canada disciplinary board, which found that Mr. Joe Groia fell below the professional standard of civility.

I. CANADA’S PROPOSED NATIONAL SECURITIES REGIME IS

HELD UNCONSTITUTIONAL

On December 22, 2011, the Supreme Court of Canada (the Court) held that the proposed Canadian Securities Act (Securities Act) was unconstitutional.1 The Securities Act, if validly adopted, would have created a single regulatory scheme to govern the trade of securities throughout Ca- nada.2 A single national regulator has been suggested as the best remedy to the barriers that an interprovincial system places on market participants.3 While creating a single national regulator seems like a noble goal, this is difficult to accomplish without the complete cooperation of each province; Parliament’s general commerce power is limited by “the organizing principle that the orders of government are coordinate and not

* David Paulson is a third-year law student at SMU Dedman School of Law. He is

currently serving as the student reporter on Canada for the International Law Re- view Association. He would like to thank Virginia Torrie for her insight on the Supreme Court of Canada’s recent decision regarding the proposed Canadian Se- curities Act, as well as his family and friends for the support they have given him during his time in law school.

1. Reference Re Sec. Act, [2011] 3 S.C.R. 837 (Can.). 2. Id. at para. 2. 3. See Peer Review of Canada, FIN. STABILITY BOARD 30 (Jan. 30, 2012), http://www.

financialstabilityboard.org/publications/r_120130.pdf.

615


subordinate one to the other.”4

The Court analyzed the Securities Act under five factors: (1) whether the impugned law is part of a general regulatory scheme; (2) whether the scheme is under the oversight of a regulatory agency; (3) whether the legislation is concerned with trade as a whole rather than with a particular industry; (4) whether it is of such a nature that provinces, acting alone or in concert, would be constitutionally incapable of enacting it; and (5) whether the legislative scheme is such that the failure to include one or more provinces or localities in the scheme would jeopardize its successful operation in other parts of the country.5

Against the backdrop of these factors, the Court found the Securities Act would have the effect of displacing provincial legislation—after a certain number of provinces opted in, provinces who chose not to opt-in would constructively have their provincial legislation displaced.6 Further, the Securities Act regulates matters that clearly fall within the provincial powers—and, if adopted, the effect “would be to duplicate and displace the existing provincial . . . securities regimes.”7

Focusing on the last three factors, the Court found the Securities Act unconstitutional.8 The trading of securities relates to a specific industry.9

Under the fourth factor, the Court found the provinces were capable of passing uniform legislation for most of the matters under the Securities Act and could delegate responsibility to a single regulator to accomplish the remaining parts of the Securities Act.10 The Court does recognize certain limitations of the provinces’ ability to accomplish this.11 The fifth factor appears to be of significance; while the provinces have the choice of opting in to the Securities Act, the Court notes that the national goals of the Securities Act would not be met without participation from all of the provinces.12

While recognizing the importance of a single regulatory scheme, the Court held the Securities Act as a whole was unconstitutional under Par- liament’s general commerce power.13 But the Court holds open the possibility that a similar scheme might succeed under Parliament’s power to regulate interprovincial or international trade.14 The Court also suggests a cooperative approach would be more appropriate.15 The Court pointed

4. See Reference Re Sec. Act, 3 S.C.R. 837 at paras. 47, 61-62, 71. 5. Id. at para. 80 (citing General Motors of Canada Ltd. v. City National Leasing,

[1989] 1 S.C.R. 641, 661-662 (Can.)). 6. Id. at para. 99. 7. Id. at paras. 100, 106. 8. Id. at paras.111, 134. 9. Id. at paras.112, 117.

10. Id. at para. 118. 11. See id. at para. 121. 12. Id. at para. 123. 13. See id. at para. 129. 14. Id. 15. See id. at para. 130.

2012] CANADA UPDATE 617

to the approaches taken by Germany, Australia, and the United States— a national securities regime similar to these models remains a possibility, and this decision is likely a step in that direction.16

II. CANADA’S ANTI-SPAM LAW

On December 15, 2010, Bill C-28 was passed by the Government of

Canada.17 The purpose of the law is to deter spamming and other decep- tive and damaging online threats.18 On April 24, 2012, the Ministry of Industry stated the law is expected to take effect in 2013.19 Part of the delay may be attributed to the recent ruling that held the Securities Act unconstitutional and the possibility that Bill C-28 may also raise similar constitutional concerns.20 The law has been categorized by a number of articles as the toughest anti-spam law in the world.21 Aside from the rigid requirements and stiff fines, the private right of action and the damages a plaintiff may receive are significant.22

The thrust of the anti-spam provisions centers on an opt-in requirement. The law prohibits commercial electronic messages to be sent to a person, unless that person has previously consented to receiving the message.23 There are several exceptions to this general rule, such as product recall information or information related to confirming a transaction that was previously entered into—arguably these would be examples of implied consent, which is permitted.24 There is also a transitional provision, which appears to provide a small measure of grace for the first three years after the law takes effect.25

Additionally, the consent requirement is not limited to e-mail; the Bill defines “electronic message” as “a message sent by any means of tele-

16. Id. at paras. 48-52. 17. Bill C-28: Canada’s Anti-Spam Legislation, INDUS. CANADA, http://www.ic.gc.ca/

eic/site/ecic-ceac.nsf/eng/h_gv00567.html (last modified Nov. 11, 2011). 18. Id. 19. Bernice Karn, Canada’s Anti-Spam Legislation – Potential Delay?, CASSELS

BROCK LAW. (Apr. 26, 2012), http://www.casselsbrock.com/CBNewsletter/The_ Cassels_Brock_Report April_2012#art39908.

20. For a comprehensive discussion analyzing Bill C-28 in light of the Court’s recent ruling, see Ravi Shukla, Constitutionality of Anti-Spam Legislation, LEXOLOGY

(July 10, 2012), http://www.lexology.com/library/detail.aspx?g=e94047f7-68b8-4e 43-951b-67139447c010.

21. See, e.g., Susanna Sharpe, Implications of Canada’s CASL - Toughest Anti-Spam Law the World Has Ever Seen, CIRCLEID (Jan. 18, 2012, 12:17 PM), http://www. circleid.com/posts/how_canadas_new_anti_spam_act_could_affect_your_email_ marketing/.

22. An Act to promote the efficiency and adaptability of the Canadian economy by regulating certain activities that discourage reliance on electronic means of carrying out commercial activities, and to amend the Canadian Radio-television and Telecommunications Commission Act, the Competition Act, the Personal Infor- mation Protection and Electronic Documents Act and the Telecommunications Act, S.C. 2010, c. 23, § 51 (Can.) [hereinafter Canada’s Anti-Spam Legislation].

23. Id. § 6(1). 24. See id. § 6(6)(a)-(g). 25. Id. § 66.


communication, including a text, sound, voice or image message.”26 A “commercial electronic message” is an “electronic message” whose purpose is “to encourage participation in a commercial activity.”27

There is also a requirement that even if the “commercial electronic message” was consented to, it must contain means by which the receiver can opt-out of future messages.28 Once a party indicates a preference to no longer receive any messages from the sender, the sender must give effect to this preference within ten business days.29

The law also provides a broad scope of jurisdiction; if the message is sent or accessed by a computer system in Canada, then the law applies to the sender.30 The word “accessed” suggests that if the e-mail or other form of “electronic communication” was routed through some type of computer system in Canada, then a Canadian court would have jurisdiction.31 There are similar express consent requirements to deter against spyware, malware, and other online threats.32

The Bill provides for both administrative monetary penalties and damages in a private right of action. Only one action may be made, either the administrative or the private right of action.33 It also appears that who- ever brings the case first has a right to proceed.34 In the case of a company or any person not considered to be an individual, the administrative monetary penalties are capped at $10,000,000.35 While this is no small sum, the private right of action may be even more damaging. In addition to compensatory damages, an individual may also receive a maximum of $200 for each violation of sending an electronic message without consent, not to exceed $1,000,000 for each day of occurrence.36 In a case violating the provisions targeted at spyware and other online threats, the maximum fine is $1,000,000 for each day the violation occurred.37 In the case of a single plaintiff this may not seem daunting. But in the context of a class- action suit, this could easily bankrupt a small business and cause a serious problem for most mid-size businesses. The impact increases in scope when considered along with the three-year limitation period.38

26. Id. § 1(1). 27. Id. § 1(2). 28. Id. §§ 6(2)(c), 11(1). 29. Id. § 11(3). 30. John Beardwood & Gabriel M. A. Stern, Complying with Anti-Spam Legislation:

A Cross-Jurisdictional View, FASKEN MARTINEAU 4 (May 20, 2011), http://www. fasken.com/files/Publication/3a4ad896-e799-4c5e-b4bf-031c49865b1b/Presentation/ PublicationAttachment/bb9deb86-0bb8-40e2-a7b5-a009b124484b/IP%20Bulletin_ John%20Beardwood_May%202011.pdf.

31. Id. 32. See Canada’s Anti-Spam Legislation §§ 7-8. 33. Id. § 48(1)-(3). 34. See id. 35. Id. § 20(4). 36. Id. § 51(1)(b)(i). 37. See id. § 51(1)(b)(ii). 38. See id. § 47(2).


If a company sent one e-mail a week to 500 people over the course of two years, and these e-mails were not consented to in accordance with this law, the maximum fine would be $10,400,000, and this is a very small number of recipients. Thankfully, the law provides that a court must consider a number of factors to determine the amount payable under this law, including the sender’s ability to pay.39

While the law appears rather harsh, it contains a number of exceptions and demands the trial court exercise discretion in determining the fine or penalty.40 The approach taken by the drafters of the Bill, to make the law broadly inclusive and then carve out some exclusions, appears to be an extremely effective way to combat unsolicited messages. In the end, the law will likely have a strong impact on reducing unwanted e-mails and phone calls, while at the same time have a limited adverse effect on small businesses and other individuals whose conduct may not necessarily be the specific target of this law.

III. THE DISCIPLINARY HEARING OF MR. JOE GROIA AND

THE QUESTIONS THAT REMAIN

The Law Society of Upper Canada (Law Society) is Ontario’s self-regulating body responsible for regulating, licensing, and disciplining lawyers.41 On June 28, 2012, a Law Society Hearing Panel (Tribunal) found Mr. Joe Groia guilty of professional misconduct.42 The charge was incivility, or in the words of the Tribunal, “not incivility per se, but rather the effect of a licensee’s alleged uncivil conduct on the administration of justice.”43 This is a contentious topic and it should be noted that this article is not proposing that civility is unimportant, but merely suggesting—with the upmost respect for the Law Society of Upper Canada—that the Tri- bunal may have, in this case, expanded the definition of civility so dramatically as to cause confusion and injury to the public.

A. INTRODUCTION

This article cannot, in this limited space, undertake a detailed examina-

tion of the trial court transcript and evaluate the Law Society’s ruling— nor is this necessary to point out some of the questionable aspects of the ruling. Rather, this article will focus on three primary aspects of the ruling that are especially troubling. First, the Law Society failed to clearly define civility; it appears to have held that context has no bearing on whether one’s conduct is civil. Second, there were issues surrounding the evidence. The Tribunal failed to distinguish between the standard of

39. See id. § 51(3)(a)-(i). 40. See id. § 6(1), 6(6)(a)-(g). 41. About the Law Society, LAW SOC’Y UPPER CANADA, http://www.lsuc.on.ca/with.

aspx?id=905 (last visited Jan. 3, 2013). 42. Law Soc’y of Upper Can. v. Joseph Peter Paul Groia, [2012] ONLSHP 0094

(Can.). 43. Id. at para. 21.


proof and the evidentiary burden; but more importantly, a conflict of interest was created when it chose to consider the appellate court transcripts. Third, no one recommended the Law Society look into this matter—this was a unilateral action by the Law Society that appears to have been spurred on by the news media.

B. BACKGROUND

A brief background of the events leading up to this ruling is necessary to understand the impact and the unanswered questions left in its wake. In 1997, Mr. Groia was retained as counsel by Mr. John Felderhof who was charged with eight securities violations by the Ontario Securities Commission (the Commission or OSC).44 During the first seventy days of the trial there was evidence of several disputes between the prosecution and defense involving “the admissibility of evidence and by countless accusations of prosecutorial misconduct made by Mr. Groia.”45 This constant back and forth between the prosecution and defense culminated in an application by the prosecution, made on April 17, 2001, to have the judge presiding over the trial removed.46 Both the Superior Court of On- tario and the Court of Appeal for Ontario dismissed the application, finding that Justice Peter Hryn did not lose jurisdiction and should continue to hear the case.47 But in making this determination, both courts made extensive comments on Mr. Groia’s inappropriate conduct.48 These comments were admitted into evidence and served as a basis for the Law Society’s finding that Mr. Groia was guilty of professional misconduct.49

The Tribunal held that to permit Mr. Groia to re-litigate these comments would amount to “an abuse of process.”50 After the application for Jus- tice Hryn’s removal was denied and the case was remanded, the Commis- sion retained new counsel, and the case proceeded without any further incident.51 Mr. Groia’s client was acquitted of all charges in 2007.52 And in 2009, the Law Society issued Mr. Groia notice of this disciplinary pro- ceeding.53 The disciplinary hearing of Mr. Groia appears to be entirely based on the conduct occurring during the first seventy days of the trial, just prior to the application from the prosecution to have the trial judge removed.54

C. CIVILITY

The Tribunal openly acknowledges there is no single definition of civil-

44. Id. at paras. 4, 7. 45. Id. at para. 9. 46. Id. at para. 10. 47. Id. at paras. 12-13. 48. Id. 49. Id. at paras. 110-11, 156, 178-80, 184-87, 189. 50. Id. at para. 96. 51. Id. at para. 14. 52. Id. 53. Id. at para. 16. 54. See id. at paras. 14, 97.


ity.55 Several sources are listed, and perhaps by cobbling together the various excerpts one could come up with some basis against which the Tribunal is measuring Mr. Groia’s conduct. The Tribunal quotes the Su- preme Court of Canada (the Court) in the context of a lawyer who has written a private letter to a judge criticizing his ruling; the pertinent part defines incivility as “potent displays of disrespect for the participants in the justice system, beyond mere rudeness or discourtesy.”56 In the same decision the Court stated, “[o]n the other hand, lawyers should not be expected to behave like verbal eunuchs. They not only have a right to speak their minds freely, they arguably have a duty to do so. But they are constrained by their profession to do so with dignified restraint.”57 The Court of Appeal for Ontario described incivility as “[u]nfair and demean- ing comments.”58

The Tribunal made several other references to what civility may or may not look like, but settled on a rather vague definition, stating that incivility does not necessarily require “the use of a profane language, extreme rudeness, violence, harassment or racial epithets[;]” rather, “[a] pattern of conduct that includes persistent attacks and sarcasm directed at opposing counsel can form the basis of incivility.”59

As noted by the Tribunal, Mr. Groia’s controversial comments were made in the first phase of the trial and centered primarily on the prosecutor’s failure to comply with the court’s rulings regarding document production, and the position taken by the Commission that arguably continued throughout the first phase of this trial—specifically, that the Commission’s “goal [was] simply to seek a conviction.”60

There is ample evidence the Commission had serious shortcomings in their disclosures. The lead investigator stated these shortcomings were due to “budgetary considerations.”61 There was evidence to suggest the prosecutor agreed that a number of documents were authentic and relevant and then subsequently took the contrary position.62 There was evidence that after failing to disclose all documents, the prosecution’s solution was to produce 197 more boxes, which they alleged would, finally, comply with the judge’s order.63

Indeed, it was not Mr. Groia, but rather the prosecutor, who was cen- sured for challenging the court’s rulings “in a context strongly suggesting that they were presumptively wrong and unfair.”64 Yet, the Tribunal found there was no evidence of prosecutorial misconduct because Mr. Groia’s client was not acquitted on the basis of prosecutorial misconduct

55. Id. at para. 56. 56. Id. at para. 59. 57. Id. 58. Id. at para. 66. 59. Id. at para. 62. 60. Id. at para. 116. 61. Id. at para. 115. 62. See, e.g., id. at para. 142. 63. Id. at para. 118. 64. Id. at para. 173.


and “[i]ncidents such as the OSC’s refusal to produce the relevant documents and the manner in which the prosecution tendered them did not amount to prosecutorial misconduct.”65

This is slightly concerning, but what is more concerning is the Tribu- nal’s finding that because Mr. Groia did not seek a stay and pursue a motion based on prosecutorial misconduct, his only motivation must have been to disrupt the proceedings by provoking the prosecution.66 And perhaps most concerning of all, the Tribunal found Mr. Groia fell short of his “overriding duty to ensure that the trial was conducted fairly and efficiently, and in an atmosphere of calm.”67 The Tribunal found that the duties Mr. Groia owed to his client were second to ensuring an efficient trial and an “atmosphere of calm.”68 So, where is this coming from? The Tribunal quotes the Court:

But, as an officer of the court concerned in the administration of justice, he has an overriding duty to the court, to the standards of his profession, and to the public, which may and often does lead to a conflict with his client’s wishes or with what the client thinks are his personal interests. Counsel must not mislead the court, he must not lend himself to casting aspersions on the other party or witnesses for which there is no sufficient basis in the information in his possession, he must not withhold authorities or documents which may tell against his clients but which the law or the standards of his profession require him to produce.69

The Court is stating that counsel should not mislead the court, make baseless accusations, or withhold documents. This is commonly understood and accepted, but it lends nothing to the Tribunal’s statement that Mr. Groia should have been more concerned with the trial being conducted efficiently and in an “atmosphere of calm” than he should have been with defending his client. Ironically, the last portion of this quote explicitly states that one must not withhold documents they are required to produce, yet according to the Tribunal, “the OSC’s refusal to produce the relevant documents . . . did not amount to prosecutorial misconduct.”70

Additionally, the Tribunal states that the conduct of the opposing counsel cannot serve as justification for one’s own conduct.71 Perhaps this is true in some instances, but where the basis of the charge is incivility rooted in false accusations that were allegedly unjustified, common sense would dictate that if the accusations had some basis—and were grounded in the misconduct of opposing counsel—then the Tribunal must address

65. Id. at para. 177. 66. Id. at para. 135. 67. Id. at para. 137. 68. Id. 69. Id. (quoting R. v. Lyttle, [2004] 1 S.C.R. 193, para. 66 (Can.)). 70. Id. at para. 177. 71. Id. at para. 182.


this fact.72 There was clearly some basis for all of the accusations Mr. Groia laid against the prosecution.

While finding that Mr. Groia failed to conduct the trial in an efficient and calm manner, the Tribunal concluded Mr. Groia did not have a basis to make these allegations, and because they were unjustified, they constituted conduct that fell below the standards of professional conduct.73 But this, the heart of the ruling by the Tribunal, highlights the confusion and the lack of clarity caused by this decision.

The Tribunal would not recognize any evidence Mr. Groia put on regarding the conduct of the prosecution because it claimed this evidence had no bearing on Mr. Groia’s conduct and was not a valid defense, nor did the Tribunal even call any members of the prosecution as witnesses.74

The Tribunal would not let Mr. Groia relitigate the issues raised by the Superior Court of Ontario and the Court of Appeal for Ontario, despite the fact that these statements were made in the context of the prosecution’s application to have the trial judge removed.75 The Tribunal focused the discussion on Mr. Groia’s failure of his overriding duty to ensure the trial was conducted efficiently and in an “atmosphere of calm,”76 and then found that the “attacks on the prosecution were unjustified and therefore constituted conduct that fell below the standards of principles of civility, courtesy and good faith required by the Rules of Professional Conduct.”77 The end of the Tribunal’s reasoning appears to rest solidly on the grounds that Mr. Groia was intentionally misleading the court.78 This appears to be illogical. If the misconduct was based on unjustified attacks and misleading the court, then why was the conduct of the opposing counsel irrelevant? Why would the Tribunal not allow Mr. Groia to defend against the statements found in the rulings by the Supe- rior Court of Ontario and the Court of Appeal for Ontario?

D. THE BURDEN OF PROOF AND THE CREATION OF A CONFLICT

OF INTEREST

The burden of proof in a disciplinary hearing before the Law Society is the civil standard, which is proof on a balance of probabilities; otherwise put—more likely than not.79 While the Tribunal appears to have grasped this point well, it appears to have failed to understand that regardless of the standard of proof, the evidence must always be “clear, convincing and

72. Id. at para. 190. 73. Id. 74. Id. at paras. 26, 182. 75. Id. at para. 96. 76. Id. at para. 137. 77. Id. at para. 190. 78. Id. at para. 189. 79. How to Prepare for an Ontario Tribunal Hearing, LAW SOC’Y UPPER CANADA,

http://rc.lsuc.on.ca/jsp/ht/prepareForTribunalHearing.jsp (last updated June 2012); see also F.H. v. McDougall, [2008] 3 S.C.R. 41, paras. 40-44 (Can.).


cogent.”80 The Law Society mistakes the burden of proof for the evidentiary burden when it rejects a high evidentiary standard.81

While the standard of proof states that the evidence must establish that Mr. Groia is more likely than not guilty of misconduct — the evidence to support this conclusion must still be “clear, convincing and cogent.”82

The Court explicitly stated this when the Court held, “evidence must always be sufficiently clear, convincing and cogent to satisfy the balance of probabilities test.”83 The effect of neglecting this distinction can lead to a critical error, specifically in this case where the Law Society relied heavily on the admonishments of the Superior Court of Ontario and the Court of Appeal for Ontario to support a finding that Mr. Groia was guilty of incivility.84

The purpose of these hearings before the Superior Court of Ontario and the Court of Appeal for Ontario was not to determine whether or not Mr. Groia’s conduct was acceptable; the purpose was to determine whether the trial judge should be removed.85 Mr. Groia was not a party to these proceedings; he was not even the lawyer who represented the defense in these proceedings.86

The Tribunal openly acknowledges this and proceeds to suggest, “as a matter of substance,” that he was a party to these proceedings.87 The Tribunal’s ruling does not address the fact that the defense was concerned with the case against its client, not the critiques of Mr. Groia’s conduct. By holding that the statements made by the Superior Court of Ontario and the Court of Appeal for Ontario constituted evidence, the Tribunal appears to suggest that the defense should have focused their appeal on Mr. Groia’s comments.

The appellate transcripts do not have any inherent probative value nor are they relevant. Unless the Tribunal cannot independently define civility and must rely on the appellate courts to tell them what it is, there is no reason why Mr. Groia’s conduct should be analyzed in any other context than that of a complete trial transcript. This would not be such an issue except for the fact that by considering the transcripts of these appellate courts the Tribunal is creating a conflict of interest. Instead of advocating for his client, the lawyer must now advocate for himself or suffer the consequences of having this admitted in a disciplinary hearing. This is fur-

80. Compare Law Soc’y of Upper Can., [2012] ONLSHP 0094, para. 25 (erroneously

conflating the evidentiary burden and the civil standard of proof), with McDougall, 3 S.C.R. 41, paras. 45-46 (“[t]here is only one legal rule and that is that in all cases, evidence must be scrutinized with care by the trial judge . . . [s]imilarly, evidence must always be sufficiently clear, convincing and cogent to satisfy the balance of probabilities test”).

81. Law Soc’y of Upper Can., [2012] ONLSHP 0094, para. 25. 82. McDougall, 3 S.C.R. 41, para. 46. 83. Id. 84. See, e.g., id. at para. 97. 85. See id. at paras. 10-13. 86. Id. at paras. 39, 91. 87. Id. at para. 92.


ther highlighted by the fact that the Tribunal would not permit Mr. Groia to relitigate these issues during the disciplinary hearing.88

E. THE “INVESTIGATION”

The Tribunal goes to great lengths to express the importance of self- regulation.89 This slowly evolves into the statement that, “[t]he self-governing aspect of law societies in the public interest, as well as the unique position of their disciplinary panels to determine when incivility crosses the line, is well-recognized.”90 But the Law Society should be a self-regulating body, not an organization prone to be swayed by the latest head- lines. Not a single individual appears to have lodged any complaint against Mr. Groia. The Law Society appears to have first learned about Mr. Groia’s conduct from a news report, and it remains unclear whether the Law Society even read the transcript of the trial court prior to filing a notice of the hearing against Mr. Groia.91

These facts suggest the possibility that the Law Society had an agenda prior to bringing trial against Mr. Groia; this is further supported by the Tribunal’s statements regarding a recent decline in civility that raises some concerns.92

F. CONCLUSION

There is no doubt that during a trial a lawyer can cross the line and say something that is quite uncalled for, but this recent finding of misconduct does little to suggest where the line is actually crossed, or to what extent a lawyer’s inappropriate response may be tempered by the circumstances. Additionally, this ruling creates a conflict of interest by finding Mr. Groia should have refuted or appealed the comments made by the Superior Court of Ontario and the Court of Appeal for Ontario. This conflict is further amplified by the Tribunal’s holding that the comments are irrefu- table persuasive evidence of Mr. Groia’s misconduct. Most significantly, the Tribunal suggests that a lawyer’s duties to his client are second to the duties of ensuring the trial is conducted in an efficient and calm manner.

Civility is important, an interest that has long been recognized, but the Tribunal’s concept of civility is over-aggressive. Civility in the context of refraining from misleading the court, refraining from making racial epithets, or cursing, is one thing—these likely take precedence over a lawyer’s duty to fiercely advocate for his client. But efficiency and calm should not be wrapped into the same category as misleading a tribunal, nor should efficiency and calm take precedence over the duty to zealously advocate.

88. Id. at para. 96. 89. Id. at paras. 74-80. 90. Id. at para. 79. 91. Id. at paras. 18, 20. 92. Id. at para. 72.

U.S. 1

NAFTA UPDATES AND AMERICAN

TRADE NEWS HIGHLIGHTS FOR

SUMMER 2012

Sarah Bridges*

I. NAFTA UPDATES

A. DECISION RENDERED – MOBIL INVESTMENTS CANADA INC. V. CANADA

oil companies Mobil Investment and Murphy Oil Corporation (Mobil and Murphy respectively) beat Canada in a two-to-one NAFTA panel decision is-

sued on May 22, 2012. The panel’s holding that obligations imposed on the companies by a Canadian province for spending on research and development breached Article 1106 of the North American Free Trade Agreement (NAFTA or the Agreement) ended a five-year suit surrounding offshore operations in Newfoundland.2 The companies do not see the victory as “unqualified,” however, as the panel rejected the companies’ claims that the Canadian government violated Article 1105, which man- dates that investors be treated with “fair and equitable treatment and full protection” by member countries.3

Mobil and Murphy initiated suit based on breaches by Canada of specific commitments it made when it entered NAFTA in 1994 regarding the Canada-Newfoundland Accord Implementation Act (the Act) and offshore oil and gas operations.4 At the time the Agreement was made, certain laws and regulations then in place in the member countries violated provisions of the Agreement. As such, Article 1108 provided certain “exceptions” to allow such laws to continue, subject to some

* Sarah is a third-year student at SMU Dedman School of Law. Prior to beginning

law school, Sarah received a Bachelor of Arts from Midwestern State University. She would like to thank her parents for their love and support throughout her law school journey.

1. ExxonMobil, Murphy Oil Beat Canada in NAFTA Case, HUFFINGTON POST (June 1, 2012, 3:31 PM), http://www.huffingtonpost.ca/2012/06/01/canada-nafta-ex- xon_n_1562996.html.

2. Id.; Request for Arbitration, Mobil Inv. Can. Inc. v. Can., ICSID Case No. ARB(AF)/07/4, ¶ 49 (Nov. 1, 2007).

3. Laura Payton, Oil Companies Win NAFTA Fight Over Local Investment, CBC (June 1, 2012, 4:56 PM), http://www.cbc.ca/news/politics/story/2012/06/01/pol-nafta- ruling-offshore-oil.html; North American Free Trade Agreement, U.S.-Can.-Mex., art. 1105, Dec. 17, 1992, 32 I.L.M. 289 [hereinafter NAFTA].

4. Request for Arbitration, supra note 2, ¶ 49.

627


limitations.5 Article 1108 allowed the member states to list out any nonconforming measures maintained at a federal, state, or local level that they wished to remain in effect. It further provided that certain NAFTA provisions, including Article 1106, did not apply to those measures or to continuations or amendments thereof, provided, however, the amendments did not “decrease the conformity of the measure, as it existed immediately before the amendment.”6

In turn, Canada listed the Act in Annex I, partially excluding it from the control of the Agreement.7 The Act provides that in order to begin an oil and gas development project, an operator must submit a “benefits plan” to the Minister of Mines, Energy, and Resources, detailing that preference will be given to Canadian goods and services during the project.8 The plan must also provide for the operator to make expenditures “for research and development to be carried out in the province.”9 The Act survived the Agreement under Article 1108 and continued without remarkable issue until 2004.

Mobil asserted that in November of 2004, new guidelines for these research and development expenditures were adopted that forced operators to spend an assessed amount—sometimes millions of dollars—on research and development.10 Even if funds were not spent on research, the new guidelines required the companies to pay their assessed fees into a fund. This was a significant alteration to the previous version of the Act, which did not specify amounts to be spent and allowed the operators to determine the amount based on current needs, what was already available in Canada, and the circumstances.11 Mobil asserted this amendment increased the Act’s nonconformity with Article 1106 of the Agreement, in violation of Article 1108. Specifically, Mobil asserted that the amendment made the Act in greater violation of the subsection of that article forbidding any demand by a member country that an investor give preferential treatment to its goods or services.12 In addition, Mobil claimed the amendment was in violation of Article 1105(1) of the Agreement, which provides that investments made by investors should be afforded “fair and equitable treatment and full protection and security” by the member countries.13

Mobil filed its required notice of intent to file suit on August 2, 2007, seeking rescission of the nonconforming amendment and estimated dam-

5. NAFTA, supra note 3, art. 1108. 6. Id. 7. NAFTA, supra note 3, Annex 1, at I-C-26. 8. Id. 9. Id.

10. Notice of Intent to Submit a Claim to Arbitration Under NAFTA Chapter 11 by Mobil Inv. Can. Inc., Mobil Inv. Can. Inc. v. Can., ICSID Case No. ARB(AF)/07/4, ¶¶ 2-3 (Aug. 2, 2007) [hereinafter Notice of Intent to Submit a Claim by Mobil].

11. Id. ¶ 4. 12. NAFTA, supra note 3, art. 1106. 13. Id. art. 1105(1).

2012] NAFTA UPDATES 629

ages of $40 million.14 Murphy followed suit the next day, estimating its damages at $10 million.15 The suits were consolidated and heard before a three-member panel in the International Centre for Settlement of Invest- ment Disputes. Canada argued the guidelines should be permitted because they were within industry norms; they were flexible, based on rollover provisions and an operator’s ability to pay the required fees through subcontractors and during both exploration and production; they resulted in payments that were conservative and common in other countries; and they required payments that were a fair estimate of what oil and gas companies operating in Canada would typically spend.16

Reports of the ruling stemmed first from the U.S. Investment Arbitra- tion Reporter website, but the official ruling has not yet been released, as final publication of the award must await approval of redactions of confi- dential business information on both sides.17 The panel ruled the Act was indeed in violation of Article 1106 of the Agreement, but that it did not violate fair treatment under Article 1105.18 The dissenting panelist was Canada’s one nominee, who dissented in the portion of the judgment against the Act’s amendments, but not against the portion of the judgment that was in Canada’s favor.19 While damages have still not been awarded, there is speculation the 2-1 split and the panel’s determination that the amendments did not violate Article 1105 will result in an amount lower than the $50 million requested.20

B. NEW FILING: PANEL REVIEW REQUESTED – U.S. DEPARTMENT OF

COMMERCE’S FINAL DETERMINATION REGARDING BOTTOM- MOUNT

REFRIGERATOR/FREEZERS FROM MEXICO

Samsung Electronics Mexico and LG Electronics Monterrey Mexico filed requests for panel review with the U.S. Section of the NAFTA Sec- retariat in late April 2012, pursuant to Article 1904 of the Agreement.21

The companies seek review of the International Trade Administration’s determination that imports of bottom-mount combination refrigerators from Mexico were being sold in the United States at less than fair value.22

Review of antidumping and countervailing duty determinations are addressed in chapter 19 of the Agreement, which “established a mechanism to replace domestic judicial review of final determinations in antidumping

14. Notice of Intent to Submit a Claim by Mobil, supra note 10, ¶ 4, 39. 15. Notice of Intent to Submit a Claim to Arbitration Under NAFTA Chapter 11 by

Murphy Oil Co., Mobil Inv. Can. Inc. v. Can., ICSID Case No. ARB(AF)/07/4, ¶ 4, 39 (Aug. 3, 2007).

16. Counter Memorial of the Gov’t of Can., Mobil Inv. Can. Inc. v. Can., ICSID Case No. ARB(AF)/07/4, ¶¶ 104-24 (Dec. 1, 2009).

17. Payton, supra note 3; Jarrod Hepburn, Canada Loses NAFTA Claim, IA REP. (June 1, 2012), http://www.iareporter.com/articles/20120601.

18. Payton, supra note 3; Hepburn, supra note 17. 19. Payton, supra note 3. 20. Id. 21. Notice of Request for Panel Review, 77 Fed. Reg. 26252 (May 3, 2012). 22. Notice of Final Determination, 77 Fed. Reg. 17422 (Mar. 26, 2012).


and countervailing duty cases involving imports from a NAFTA country with review by independent binational panels.”23 In the United States, final determinations such as these are made by the International Trade Administration of the Department of Commerce (ITA).24 Pursuant to NAFTA procedure, a panel will be formed to review the ITA’s final determination to ensure that it is within antidumping or countervailing duty laws of the United States.25 A panel formed in such situations may do one of two things: uphold the final determination, or remand it to the investigating authority.

In this case, the ITA investigated sales during all of 2010 and issued its Preliminary Determination on November 2, 2011.26 The investigation was conducted to determine whether bottom-mount combination refrigerators from Mexico were being sold in the United States at less than fair value, as provided in section 735 of the Tariff Act of 1930.27 The ITA’s final report determined the companies concerned were indeed selling at less than fair value. In addition, with respect to the merchandise exported from Mexico by Samsung Electronics Mexico, the ITA determined there were “critical circumstances,” meaning that importers in the United States likely had knowledge of the dumping and the substantial injury that could be done by it; nevertheless, there were massive imports of the concerned product within a short period of time.28

The panel review, which the NAFTA Secretariat lists in “active” status,29 and associated proceedings will be governed by the Rules of Proce- dure for Article 1904 Binational Panel Review as published in the Federal Register.30 The panel review will be limited to questions of fact or law, including whether the ITA had jurisdiction to make its final determination, which the complainants allege in their panel filings.31 In an interest-

23. Notice of Request for Panel Review, 77 Fed. Reg. 26252. 24. Overview of the Dispute Settlement Provisions, NAFTA SECRETARIAT, http://www.

nafta-sec-alena.org/en/view.aspx?conID=615 (last updated May 30, 2011). 25. Notice of Request for Panel Review, 77 Fed. Reg. 26252. 26. See Notice of Preliminary Determination of Sales at Less Than Fair Value, Post-

ponement of Final Determination, and Affirmative Critical Circumstances Deter- mination: Bottom Mount Combination Refrigerator-Freezers From Mexico, 76 Fed. Reg. 67688, 67690 (Nov. 2, 2011).

27. Notice of Final Determination of Sales at Less Than Fair Value and Affirmative Critical Circumstances Determination: Bottom Mount Combination Refrigerator- Freezers From Mexico, 77 Fed. Reg. 17422, 17422 (Mar. 26, 2012).

28. Id. Section 735(a)(3) of the Tariff Act provides that “critical circumstances” exist if there is a reasonable basis to suspect the following: (1) there is a history of dumping and resulting material harm caused by the subject merchandise, or the person importing the product knew or should have known that the exporter was selling it at less than its fair value and that injury was likely to result; and (2) there have been massive imports of the concerned goods over a relatively short time period. Tariff Act of 1930 § 735(a)(3), 19 U.S.C. § 1673d (West 2012).

29. Status Report of Dispute Settlements, NAFTA SECRETARIAT, http://www.nafta-sec- alena.org/en/StatusReportResults.aspx (last updated Dec. 15, 2012) (set “Panel Status” to “Active” and “Filing Year” to 2012 to generate the report).

30. North American Free Trade Agreement: Rules of Procedure for Article 1904 Binational Panel Reviews, 59 Fed. Reg. 8686, 8686 (Feb. 23, 1994).

31. 59 Fed. Reg. at 8689.


ing twist in this case, the International Trade Commission (ITC) recently published an independent determination regarding bottom-mount combination refrigerators.32 That investigation, triggered by a petition filed with the ITC by Whirlpool Corporation, found the below-value sale imports from Mexico did not materially injure, threaten, or retard an industry in the United States.33 While the ITC is an independent source that uses its investigations to combat unfair trade practices, it takes its authority from the same Tariff Act that concerned exporters are allegedly violating,34 and its report will likely aid the exporters in their upcoming NAFTA panel review.

II. AMERICAN TRADE NEWS HIGHLIGHT – SOFTWOOD

LUMBER DISPUTES

In a rare defeat in one of many disputes regarding exports of softwood lumber from Canada, the United States lost against Canada in arbitration surrounding the Softwood Lumber Act (SLA).35 Despite this holding, the Deputy Assistant U.S. Trade Representative asserts that not only is the fair pricing of timber in the strong interest of the Unites States, but that Canada “provided publicly-owned timber harvested in its interior to softwood lumber producers for prices far below market value.”36

The decades-old dispute over Canadian exports of softwood lumber has been evaluated as akin to a sibling rivalry, resulting in review over the years by the U.S. Department of Commerce, the World Trade Organiza- tion, and NAFTA.37 The dispute revolves around Canadian subsidies of softwood lumber, which is categorized as its name would indicate—easy- to-saw lumber, such as pine.38 The historical disputes are lengthy, involved, and illustrate frustration on many levels on both the U.S. and Canadian sides. For example, three NAFTA cases filed by Canadian exporters, originating as early as July of 2002, lasted until mid-2007. Even then, these cases were only resolved due to jurisdictional issues—and the NAFTA panel’s decision still spanned 174 pages.39

32. Bottom Mount Combination Refrigerator-Freezers from Korea and Mexico, 77

Fed. Reg. 28623, 28623 (May 15, 2012). 33. Id. 34. Peter S. Menell, The International Trade Commission’s Section 337 Authority, 2010

PATENTLY-O PAT. L.J. 79, 79-80 (2010), available at http://www.patentlyo.com/ files/menell.itc.pdf.

35. Press Release, Office of the U.S. Trade Representative, Statement by the Office of the U.S. Trade Representative in Response to Decision in Third Softwood Lumber Arbitration (July 18, 2012), available at http://www.ustr.gov/about-us/press-office/ press-releases/2012/july/ustr-statement-response-softwood-lumber-arbitration.

36. Id. 37. Indepth: Softwood Lumber Dispute, CBC (Aug. 23, 2006), http://www.cbc.ca/news/

background/softwood_lumber. 38. Id.; Office of the U.S. Trade Representative, supra note 35. 39. Canfor v. United States, Secretariat File No. USA-CDA-2002-1904-03, Notice of

Arbitration by Canfor (July 9, 2002); Canfor v. United States, Secretariat File No. USA-CDA-2006-1904-05, Decision on the Preliminary Question by the Arbitral Tribunal (June 6, 2006) (a consolidated arbitration).


As a result of these disputes, Canada and the United States entered into the SLA in 2006.40 In exchange for the U.S. agreement to lift duties so long as lumber prices stayed above a certain range, Canada pledged to impose export measures on softwood lumber when its price fell below a certain level.41 Canada may not circumvent those export measures by giving grants or other subsidy-type assistance to the exporters.42 In its request for arbitration, the United States alleged Canada improperly graded public timber as “grade 4,” the grade at which timber is mostly unusable, allowing it to sell the timber to Canadian lumber producers at a very low price of twenty-five cents a unit.43 Further, the United States assert that the amount of timber from public lands that Canada assessed at “grade 4,” and thus sold to its producers below premium, has increased dramatically since the enactment of the SLA.44

A two-week trial ensued wherein a panel reviewed the four claims of the United States: (1) Canada advised local log graders to rely on their own “local knowledge” to conduct tests, using a system of untested practices to result in lumber being improperly graded;45 (2) Canada sanc- tioned the use of “kiln warming” on the timber, which makes inconsistencies easier to detect, resulting in lower grades;46 (3) Canada encouraged new formulas and methods for log scaling, namely “bucking” and “sweeping,” that resulted in lower grades;47 and (4) Canada made revisions to its scaling manuals, removing a provision that previously excluded imperfections below a certain size from consideration when grading.48 In holding for Canada, the panel noted that it believed Canada’s actions, including its new techniques and policies, were actually to improve accuracy of grading, that even if the new methods did not accomplish that task they were not sufficient to be said to “circumvent” the agreement, and there was not a sufficient causal connection between the country’s actions and the increase in “grade 4” timber to hold Canada liable.49

Despite its disappointment in the ruling, the Office of the U.S. Trade Representative vowed to “continue vigorously enforcing the SLA and other U.S. trade agreements,” also pledging continued review of Cana-

40. Office of the U.S. Trade Representative, supra note 35. 41. Softwood Lumber Act of 2008, 19 U.S.C.A. §§ 1683-1683g (2008) (see U.S.C.A.

Popular Name Table for acts of Congress for U.S.C.A. codification). 42. Office of the U.S. Trade Representative, supra note 35; United States v. Canada,

LCIA Case No. 111790, Request for Arbitration by the United States, ¶ 20 (Jan. 18, 2011).

43. United States v. Canada, LCIA Case No. 111790, Request for Arbitration by the United States, ¶¶ 25-28 (Jan. 18, 2011) (note the price for lumber-quality timber in Canada at the time ranged from two to ten Canadian dollars).

44. Id. ¶¶ 29-30. 45. United States v. Canada, LCIA Case No. 111790, Final Award, ¶ 281 (July 26,

2012). 46. Id. ¶¶ 309-11. 47. Id. ¶¶ 342-43. 48. Id. ¶¶ 375-76. 49. Id. ¶¶ 370, 381, 429.


dian pricing practices under the SLA.50 The SLA was expanded for an additional period in 2012, making its terms effective through 2015.

50. Office of the U.S. Trade Representative, supra note 35.

Document

T

REPORT OF THE OAS ELECTORAL

OBSERVATION MISSION IN ECUADOR1

HE Organization of American States (OAS) deployed an Electo- ral Observation Mission (EOM/OAS) for the general elections in the Republic of Ecuador, in response to an invitation from the

National Electoral Council (CNE). The Secretary General of the OAS, Jose Miguel Insulza, appointed Dr. Rafael Alburquerque to lead the mission, which consisted of 68 international observers from 20 OAS member and observer countries. The Mission was present in 17 provinces, in the Metropolitan District of Quito, and in Spain and the United States.

The EOM/OAS would like to highlight the important participation of the citizens of Ecuador, who exercised their franchise peacefully and with great civic spirit. At the same time, the Mission would like to recognize in particular the work of the CNE, which made an important effort to ensure that the electoral process was carried out in conditions of normality. The observers of the Mission were able to witness that the citizens expressed their will at the polls in a free and unhindered manner.

I. ELECTORAL ORGANIZATION AND INFORMATION

TECHNOLOGY

The OAS Mission held several meetings with electoral authorities to gather information about the organization of the electoral process and would like to emphasize the willingness of the CNE to work with the Mission.

Regarding the selection process for the members of polling stations, the Mission observed that selections were made according to the criteria of fairness and level of education. In this sense, it took note of the high participation of young people and citizens trained in both the polling stations and the Intermediate tabulation centers. However, the Mission was informed that one day before Election Day, some members of polling stations were still awaiting training.

Regarding the electoral roll, the Mission heard concerns from some political actors who demanded access to it in order to carry out campaign activities.

In order to carry out a transparent and technically sound process, the CNE engaged the services of renowned companies and experts to provide services related to various aspects of electoral mechanics, including secur-

1. Press Release, Report of the OAS Electoral Observation Mission in Ecuador,

Organization of American States (Feb. 19, 2013), available at http://www.oas.org/ en/media_center/press_release.asp?sCodigo=E-052/13.

637


ity, the official count and the quick count. However, the Mission noted significant delays in implementing processes as established in the electoral calendar, in the scheduling of computing operations, and in the analysis of security conditions. Important tools for the security of the electoral process such as incident reports from simulations, documented contin- gency plans and efficacy trials were not available before the election.

II. VOTING PROCESS

The Mission would like to highlight the important efforts of the Ecua-

dorian authorities to ensure greater inclusiveness in this election by incor- porating voters with disabilities, prisoners awaiting sentencing, and Ecuadorians abroad.

In terms of the accessibility of the vote, the Mission highlights the incorporation of preferential voting (voting without waiting in line) for senior citizens, women who are pregnant or people holding children in their arms. For voters with disabilities, assisted voting was implemented, whereby a trusted person helped the voter to mark or cast a ballot. In the city of Ambato a new pilot project called “Vote at Home” began, in which ballots were taken to the homes of 18 people with disabilities to enable them to cast their votes. In our view, this is a practice that other countries in the hemisphere would do well to emulate. The Mission acknowledges the search for alternatives to facilitate access to the vote for all citizens of Ecuador, regardless of their condition, in compliance with the Organic Law on Elections and Political Organizations, also known as the Code of Democracy, of Ecuador.

The OAS witnessed the election at the Garcıa Moreno men’s prison. It should be noted that the voting process was held on Friday, February 15, in an orderly manner, with the inmates themselves serving as members of polling stations, and in the presence of representatives from the Ministry of Justice, Human Rights and Worship, delegates of the CNE and international observers.

The vote abroad is an important measure that allows citizens residing outside the country to elect their representatives. 93 polling stations were observed, which covered a total of 45,020 voters. While in Washington, DC, the elections were carried out in conditions of normality, in the case of voting in Madrid, a lack of organization was observed. Significantly, this was the first time the OAS observed the vote abroad, and the organization appreciates the willingness of the CNE to accredit observers for this purpose.

The Mission noted that disclosure of the quick count by the CNE generated confidence in the results.

III. MEDIA OBSERVATION

The reforms contained in the Code of Democracy, namely a ban on

advertising by state institutions, the establishment of electoral advertising

2012] OAS ELECTORAL OBSERVATION MISSION 639

spaces for campaigns of political subjects and the proscription of con- tracting and campaign advertising by private actors, created certain conditions of fairness among candidates when compared to past elections.

However, the new rules apply only during the campaign period (from January 4 to February 14), which resulted in the displacement of competition to the pre-campaign period (from October 18 to January 3). Accord- ing to data collected by the EOM/OAS, the lack of regulation during the pre-campaign period resulted in differential access and exposure of the contenders in the media at this stage of the electoral process. The new rules govern publicity or advertising guidelines during the campaign, but not news coverage. The EOM noted that during the campaign period there was an unequal coverage between political parties or movements with presidential candidates depending on the type of ownership of the media.

Finally, the Mission observed that media presence in terms of both time and space is markedly favorable to male candidates running for the National Assembly. This data reveals fewer opportunities for women to make their proposals heard which negatively impacts their real possibilities of reaching office. It is also worth noting that the presence of the candidates, in general, is slightly higher in the public media than in private.

IV. WOMEN’S POLITICAL PARTICIPATION

Ecuador has one of the most advanced legal frameworks in the region in terms of gender equality, derived mainly from the constitutional guarantee of equality in the exercise of public functions. The Code of Democ- racy establishes parity in the composition of multi-person candidatures and important measures to strengthen its effectiveness, such as gender alternation and non-registration of lists that do not comply with the regulation.

The Mission notes the commitment of the CNE to the inclusion of both women and other underrepresented groups in the electoral process.

It has been established that the parties complied with parity in their lists of nominees for the National Assembly and the Andean Parliament. However it was also found that 82% of the lists were headed by men, which - combined with the reduction in the size of constituencies – im- pedes the opportunities of women to be elected and to occupy a seat.

V. POLITICAL FINANCING

In terms of equity, the system of rules governing campaign financing is intended to enable political subjects to compete fairly, as it limits total campaign expenses, finances electoral campaigns from government resources and restricts private contributions. Similarly, although the Code of Democracy establishes explicit prohibitions on the use of public re-


sources, there is no regulation that defines clearly and sufficiently the scope and limitations of this practice.

On transparency, the existing regulations on accountability, government control and the sanctions regime are comprehensive, detailed and specific. Having established civil, criminal and personal accountability contributes to the rigorous nature of registration and financial reporting. Despite this, access to information on the flow of resources is partial or limited, as evidenced by the lack of access to timely information on the pre-campaign expenses of political subjects.

VI. RECOMMENDATIONS

One objective of the Electoral Observation Missions of the OAS is to make recommendations to authorities in order to improve the organization and administration of elections. To this end, the Mission proposes the following:

• It is recommended that the CNE continue its efforts to strengthen institutions and staff training in order to reinforce its direct control over the various stages of the electoral process.

• In terms of electoral organization and information, it is recommended that the planning and organization of the processes begin much earlier to provide enough time to carry out tests and simulations, and to implement the necessary adjustments in the organization of the process and comply with the electoral timetable. Additionally, it is recommended that the CNE develop policies, standards and procedures relating to information security.

• With regard to the training of the members of the polling stations and tabulation centers, it is recommended that such training should be concluded at least one week before Election Day.

• Regarding the electoral roll, it is recommended to allow political parties timely access to said instrument, keeping in mind the limits to the information set out in the existing regulatory framework.

• In terms of gender, it is important to mention that the National Electoral Council has created a Committee on Inclusion and Re- search that will evaluate the results of the elections from a gender perspective. This represents a great opportunity to consider certain reforms that would better ensure effective parity in decision- making positions and competition on equal terms as well as the institutionalization of gender equality in the internal structures of political organizations that generate candidate lists, the establishment of a rule of alternation for the heads of lists, and the allocation of public and media space to support female candidates.

• In terms of political finance, the EOM/OAS recommends reducing the risks associated with the use of public resources for electoral purposes by taking the measures needed to clarify actions and behaviors that undermine fairness in competition, and establishing a suitable sanctions regime. The media monitoring and expenditure control functions carried out by the CNE are key sources of information that would enable it to properly exercise

2012] OAS ELECTORAL OBSERVATION MISSION 641

this control. The EOM recommends improving the quality and quantity of information by automating the presentation systems of financial accountability by political subjects to streamline ver- ification and audit processes, as well as reporting to the public on the management of income and expenses of the election campaign.

The OAS has been observing elections for 50 years. The objective of these missions is to cooperate with member countries to strengthen their democratic systems. In this regard, now concluded the electoral process in Ecuador, the Mission reiterates its commitment to hold a post-electoral visit, in order to follow up on the recommendations with the relevant authorities, and offer the support of the OAS in the entire electoral cycle.

In the coming weeks, the Chief of Mission, Rafael Alburquerque, will be presenting a report to the OAS Permanent Council on the activities of the EOM/OAS in Ecuador.

Finally, it is necessary to acknowledge the generous financial contributions from the governments of Bolivia, Canada, Chile, Spain, France and the United States, which made possible the work of this Mission.

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