Domestic Industry Development in the Context of the International Crisis: Evaluating Strategies

8/13/2019 Domestic Industry Development in the Context of the International Crisis: Evaluating Strategies

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INTRODUCTION 3

PROTECIONISM & THE CRISIS OF 2008 5

1. An overview of protectionism prior to the crisis of 2008 5

2. Was there an increase in protectionism as a response to the crisis? 6

3. Brazil in the context of the Global Crisis 11

INDUSTRIAL POLICY AND PROTECTIONISM 14

1. Why Industrial Policy? 14

2. Responding To Market Failures 15

2.1. Learning Externalities 15

2.2. Externalities Among Sectors and Problems of Coordination 15

2.3. Informational Externalities and Diversification 16

2.4. Barriers to Entry and Externalities Associated with Exports 17

2.5. Externalities of Foreign Direct Investment 17

3. Conclusions 18

CASE STUDY: GOODS AND SERVICES IN 19

THE OIL AND GAS (O&G) SECTOR

1. Introduction 19

2. Industrial Policy In The Oil And Gas (O&G) Sector 19

2.1. Survey of Industrial Policy Actions 19

(A) Local Content Requirement Policy in Exploitation and Production (E&P)

(B) PROMEF and Congeners

(C) Other Measures

2.2. Policy Evaluation 21

(A) What are the Goals? What is the Best Way to Achieve them?

(B) Which Sectors?

(C) Sunset Clauses

(D) Competition and Innovation

(E) The Optimum Local Content Rule

(F) Foreign Direct Investment

3. Conclusions 25

Table of co ntents


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CASE STUDY: MEDICAL, HOSPITAL, AND 27

ODONTOLOGICAL EQUIPMENT (MHOE)

1. Introduction 27

2. Industrial Policy For Medical, Hospital, And Odontological Equipment (Mhoe) 27

2.1. Survey of Industrial Policy Actions 27

(A) Preference Margin in Public Procurement

(B) Other Measures

2.2. Policy Evaluation 27

(A) What are the Goals? What is the Best Way to Achieve them?

(B) Which Sectors?

(C) Sunset Clauses

(D) Competition and Innovation

(E) The Preference Margin in Public Procurement

(F) Foreign Direct Investment

3. Conclusions 32

ANNEXES 33

Industrial Policy In South Korea 33

Industrial Policy In Norway 34

FINAL CONSIDERATIONS 36

NOTES 38

BIBLIOGRAPHY 41

TABLES, FIGURES & GRAPHS (order of appearance)

Graph 1: Percentage (%) of G-20 trade protection measures by large groups 9

Graph 2: Index of coverage of G-20 trade measures 9

Graph 3: The share (%) of main product groups in Brazilian exports 11

Graph 4: The appreciation of the real and commodity prices 12

Figure 1: Classification of Public Policy 14

Figure 2: The Fleet Modernization and Expansion 20

Program (PROMEF) Schematic Summary

Figure 3: The Exploitation and Production (E&P) Supply Chain 23

Table 1: Preference Margins in Medical, Hospital, and Odontological Equipment (MHOE) 29

Figure 4: Determinants of Technological Improvement for Developing Countries 31


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3

I

n Brazil, the discussion about the guidelines of industrial policy again

moved to the fore when the Industrial, Technological and Foreign Trade

Policy (PITCE) was introduced in 2003. The appreciation of Brazilian real

that began in 2008 (and interrupted briefly between September, 2008

and April, 2009) combined with the worldwide economic crisis, raised

the discussion to a position of prominence on the public policy agenda.

Exchange-rate appreciation can lead to the de-industrialization of the economy (the

Dutch disease), but this is not the only cause. Increasingly intense competition from the

Chinese in the domestic market and in third-party markets served to underscore issuesalready emphasized in government policies. The issue of technological innovation raised

by PITCE and reinforced with the Poltica de Desenvolvimento Produtivo (PDP) [Productive

Development Policy] was seen as one of the main challenges facing public policy and the

private sector in its goal of making Brazilian industry more competitive. The increase in

Brazils share of worldwide exports is directly dependent on raising productivity where

technological innovation plays a crucial role.

In September 2008, the world economic and financial crisis became the center of attention.

As a member of the G-20 and an active participant, Brazil argued in favor of monitoring and

that the recession should not lead to protectionism, a position that is discussed in meetings

of this group to this day.

In April 2011, the government introduced a new set of measures, later expanded in 2012,

called the Plano Brasil Maior [Greater Brazil Plan]. At the core of the plan were the same

guidelines as in previous plans - innovation as a key factor in increasing productivity which

consolidated the aim to increase productivity and improve technology in the production

chains. One of the instruments selected to increase the density of the production chains

was a local content policy.

However local content policies establish performance requirements for the foreign

investor, and are therefore contrary to the rules of the World Trade Organization (WTO). The

justification for this interpretation is that local content rules distort the flows of trade by

reducing the potential market for imports and therefore could be considered a protectionist

measure. Nevertheless, this study is based on the following premise: before rejecting any

consideration of the issue of local content, in the light of WTO rules (always subject to

interpretation), the principal question to ask is whether the policy tool fulfill the functions

that governments want.

Guimares (2012) identifies two justifications for local content policies. One is

macroeconomic in nature and short-term, designed to assure domestic demand. The second

has specific long-term goals associated with industrial development.

In Brazil exchange rate controls, a macroeconomic issue in nature, were used along with

the import substitution industrialization model. This was a long-term perspective extending

Introduction


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from the 1950s until the end of the decade of the 1980s. Local content requirements were

designed to minimize the use of foreign exchange reserves and the same time, encouragedomestic production. As Tavares Jr. (2012) argues, this policy had positive effects in terms of

the creation and consolidation of a diversified industrial base, but its long-term use was one

of the factors contributing to low investment in technological innovation in Brazil.

A return to local content requirements cannot be justified as a means of economizing

the use of international reserves in the Brazilian economy at this moment. However, when

the matter of strengthening the local productive chains is raised in the context of industrial

policy, local content appears to be understood as one of the instruments that could contribute

to this goal in a framework in which the question of technological innovation continues to

be the principal focus of industrial policy. In this case, the problem is to understand how

local content policy meets the proposed objectives. Further, the analysis must be done ona sector basis since the potential domestic supply response to restrictions on imports will

vary. Another perspective on local content requirements (LCR) policy is whether its use was

a response to the worldwide economic crisis. Although the local content issue had previously

been raised in some sectors in Brazil (petroleum and gas), the worldwide crisis created a

scenario in which the issue of protectionism gained force. In this case, the discussion turned

to the issue of the crisis and protectionism.

The overall objective of the study is, therefore, to offer a reflection on the issue of

industrial policy in terms of its goals and instruments that contribute to the discussion of

Brazilian policy, keeping in mind the considerations raised above. Thus, the first chapter

offers a brief analysis of the post 2008 world economic context. Were there signs of a newwave of protectionism? How did Brazil react to this new situation? The purpose of this section

is to try and understand the extent to which the effects of the crisis contributed to industrial

policy guidelines post-crisis. Once again, this chapter does not intend a detailed analysis of

the issue. The idea is to make some general observations that permeate reflections about

industrial policy and protectionism in Brazil. The second chapter offers a theoretical analysis

of the guidelines of industrial policy where the issues of market failures and externalities

are highlighted as markers for government interventions. The third chapter starts from the

assumption that the heterogeneity of the features that characterize different production

chains requires the use of case study analysis. Furthermore, the impact of each policy tool

must be analyzed separately. Therefore local content requirement policies were selected for

analysis in the oil and gas sector and in the medical, hospital and odontological equipment

sector1. These sectors were chosen for the following reasons: they are technologically

intensive; they have been given a high priority on the government agenda (exploration of

petroleum reserves and improvement in health services); and for both the share of foreign

investment is a factor which influences the question of access to new technology and the

supply of inputs. The fourth chapter offers some results and conclusions.


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At the G-20 meeting in April 2009, the appropriate

international agencies were asked to monitor the dataon trade and investment of member countries of the

group. The fear that the economic crisis would lead to a

repetition of the protectionist wave of the 1930s was a

recurrent theme in the discussions about the effects of

the worldwide recession.

This section offers a general view of protectionism.

Next the issue of the guidelines for Brazils industrial

policy in the post-2008 context is examined.

1.AN OVERVIEW OF PROTECTIONISM PRIOR

TO THE CRISIS OF 2008

The issue of protectionism can be analyzed from two

perspectives. In the first protectionism is understood to

be an answer to international and/or domestic crises. In

this case, protection is justified as a form of mitigating

the decline in employment and income as a result of the

crisis. Here the crisis of the 1930s is an example of the

generalized use of instruments of trade protection. In

the second perspective, protectionism is viewed as an

integral part of industrial development policy. The import

substitution model adopted in Latin America through the

middle of the decade of the 1980s is an example.

The two perspectives are not mutual ly exclusive.

One of the assumptions that served as a guideline for

the import substitution model was the shortage of

foreign reserves (a macroeconomic question). The lack of

reserves was understood to be one of the roadblocks

to development of Latin American countries in the

decade of the 1950s. By the first half of the 1980s,

the proliferation of non-tariff barriers, the increase in

the number of investigations into unfair trade practices

and voluntary agreements to restrict exports led to

the concept of a new protectionism that was applied,

particularly in the foreign trade policy of the United

States. The strong appreciation in the dollar brought into

sharp and made it clearer the changes in the patterns of

comparative advantages that were taking place in world

trade. The proliferation of investigations into unfair tradepractices and voluntary agreements for the restriction of

exports, that make up non-multilateral protectionist trade

barriers were characteristic of this period (Pereira, 1998).

In the 1990s, a new consensus on the benefits of the

liberalization of trade and financial investment became

standard. In Latin America, the discussion of the exhaustion

of the import substitution model marked the end of the

decade (Pereira, 1998). The creation of the World Trade

Organization (WTO), that marked the end of the Uruguay

Round of discussions, consolidated the commitment to amultilateral discipline in the direction of a liberal order in

the trade of goods and services. Even the increase of the

preferential trade agreements was considered a positive

step towards liberalization. One example was Mercosul,

characterized as open regionalism. A common external

tariff barrier was adopted to create a Customs Union that

included Argentina, Brazil, Uruguay, and Paraguay and

promoted tariff reduction on the domestic agendas of the

member countries.

The consensus view was that the benefits ofliberalization of trade and finance began to diminish

toward the end of the 1990s. The Asian Crisis, the low

rate of growth in a large number of the Latin American

countries, and the Argentine crisis, among other

problems, were given as examples that liberalization by

itself would not assure the hoped economic growth. Note

that the crisis that occurred in the Latin American and

Asian countries during this period cannot be attributed

solely to trade and financial liberalization. In Brazil,

exchange rate appreciation (one of the principal factors

of the anti-inflationary program of 1994) together

with trade liberalization, coexisted with a scenario of

low rates of economic growth and a reduction in the

number of jobs in various sectors. As Cordoba and Laird

(2006) point out, trade liberalization is an instrument

that requires an institutional and economic structural

environment for its benefits to be assured. In the

absence of these conditions, the costs of liberalization

lead to protectionist pressure.2

Protectionis m and

the cr is is of 2008


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The Doha Round began in 2001 as the Development

Round and reflected the concerns of the developingcountries that the gains promised with the commitments

of the Uruguay Round had not materialized in a

satisfactory fashion. There was no demand for greater

trade protection but rather for a greater degree of

autonomy in local policies. A review of foreign investment,

countervailing duties, and intellectual property agreements

became part of the agenda for countries like India and

Brazil (one example is the issue of intellectual property).

The agricultural impasse that began in 2003 led to

the relative stagnation of the Doha Round. On the otherhand, however, the growth in the worldwide economy up

to 2008 was a factor that ameliorated the demands for

protectionism but not the discussion about the guidelines

for industrial development policies.

In the Brazilian case, as mentioned above, the

appreciation of the foreign exchange rate led to growing

deficits in the current account balance of the balance of

payments. The contagious effect of the Asian crises, the

Russian moratorium and macroeconomic issues led to

the abandonment of exchange rate policy as an anchor ofthe anti-inflation stabilization program in January 1999.

However, the debate about external vulnerability in

Brazil revived the question of the role of industrial policy

and foreign trade (Pinheiro, et.al. 2002).

In 2003, the issue of industrial policy gained strength

with the introduction of Industrial, Technological and

Foreign Trade Policy (PITCE). Earlier policies had stressed

the creation of production capacity (the import substitution

model) or efficiency in production processes (in the 1990s),

but not the issue of competitiveness in international trade

(Salerno and Daher, 2006). What was new in the PITCE was

the emphasis on the issue of technological innovation.

In 2008 the Productive Development Policy (PDP) was

published providing broader coverage and proposals

for linking production chains.3 None of these programs

are identified with the issue of protectionism. They

emphasize, however, the role of the State in the promotion

of industrial development, in particular and those sectors

associated with new technologies.

2.WAS THERE AN INCREASE

IN PROTECTIONISM AS A

RESPONSE TO THE CRISIS?

Reports prepared by the WTO for joint publication with

the OECD and UNCTAD about trade measures introduced

by the G-20 countries after the crisis do not suggest

the emergence of a new wave of protectionism, as can

be seen in the Box on G-20 Trade Measures. However,

some points should be noted:

i) All of the reports expressed concern with the low

rate of removal of the protectionist measures

adopted;

ii) The high incidence of sector-based measures

for sectors that were already considered to be

sensitive in some countries even before the cris is is

stressed. Thus, the crisis, by enacting measures for

protection for temporary/permanent relief, delayed

the implementation of the necessary structural

changes in the face of changes in the patterns of

comparative advantages;

iii) The clear indication of concern that the increase

in protectionism did not occur immediately after

the onset of the crisis, but rather beginning in the

middle of 2011, where uncertainties regarding the

direction of economic recovery began to dominate

the international scenario;

iv) Added to the issue of sensitive sectors, currency

misalignments begin to be included in the list of

justifications for protectionist measures; and

v) The three most recent reports highlight the

increase in non-tariff measures associated with

the guidelines of industrial policy.


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G-20 Trade Measures

1st Report: September, 2009

Covers the period from April to August 2009. The

forecast for declining volumes of trade and investment

for 2009 shaped and deepened the worldwide recession.

But there was no indication of the establishment of

trade protection measures. However, an increase in

tariffs, non-tariff barriers (especially in the steel and

automotive sectors); and new subsidies for agricultural

exports were observed. The fiscal and financial packages

were considered positive for the recovery of the world

economy. However, some of the points contained in

these packages included trade restrictions such as

performance clauses that favored local industry at

the expense of imports. Therefore, the incidence of

protectionist measures was consistent with episodes

prior to the recession.4The risk that was stressed was

that new measures continued to be introduced and that

measures for temporary relief became permanent.

2nd Report: March, 2010

Covers the period from September 2009 to February 2010.

No increase in the number of trade restriction measures

was observed in comparison with the first report.However,

the new trade measures introduced were concentrated in

labor-intensive sectors. The concern with the performance

clauses associated with financing packages continued. In

addition, the stimulus package for the economic recovery

via increases in government procurement accentuated the

preference for local companies and products. The report

called attention to the slow recovery of the world economy

and the unemployment generated that led to continued

demands for protectionist measures.

3rd Report: June, 2010

Covers the period from November 2009 to the middle of May

2010. There are no substantial differences in comparison

with the previous report, because they cover almost the

same period. It points out, however, that the principal

trade measures referring to dumping investigations and

subsidies and safeguards, are legal instruments for trade

protection. Is also identifies the issue of sectoral policiesfor those sectors considered sensitive by governments,

(automotive, steel, textiles and clothing). These are sectors

that presented problems prior to the crisis in some

countries, but which are targeted for support measures

with potentially restrictive effects on trade flows.

4th Report: November 2010

Covers the period from May to October 2010. The report

coincides with a period in which the economy and world

trade began to recover. Restrictive measures on tradecontinued to be introduced but at a slower pace. The same

thing occurred, however, with the pace of withdrawal of

measures implemented after 2008. Therefore, monitoring

of protectionism should continue. Two issues were

contributing to the demand for protection even in a more

favorable international environment: high unemployment

rates in some of the G-20 countries, and exchange rate

appreciations perceived to be the fruit of deliberate

policies by trading partnersdesiring to obtain additional

competitive advantages, sometimes known as beggarthy neighbor policies.

5th Report: May 2011

Covers the period from the middle of October 2010 to April

2011. Number of trade restrictions increased. The report

points to restrictions on exports of food and minerals, an

increase in tariffs for imports and non-automatic licenses.

It is the first time that the report clearly expresses

concerns about possible increases in protectionism.

6th Report: October 2011

Covers the period from May to October 2011. The report

highlights the signs of an increase in protectionism

as a response to currency issues and macroeconomic

disequilibrium in some countries, already anticipated in the

report for November 2010. In addition, industrial policies that

involve import substitution measures return to use once

again. The commitment to withdraw protectionist measures

as a response to the crisis continues at a slow pace.


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7th Report: May 2012

Covers the period from the middle of October 2011

to the middle of May 2012. The report begins with the

following statement: The last seven months did not

show any slowdown in the imposition of new restrictive

measures on trade by the economies of the G-20. At

the same time it stresses the issue of a protectionist

bias in the guidelines of industrial policies of some

countries in the G-20. Government procurement as

an instrument to encourage domestic industries andsectoral policies devoted to the increase of local content

are examples cited as forms of protectionism although

they are difficult to monitor (evaluate). In the general

list of protectionist measures, the most used over these

periods are dumping investigations.

8th Report: October 2012

Covers the period from the middle of May 2012 to

the middle of October 2012. It does not point out any

change in the trade policies of the G-20. It warns ofthe persistence of policies designed to be temporary.

Only 21% of the trade-related measures that had been

introduced since October 2008 have been removed.

SOURCE: WTO/OECD/UNCTAD (2012) REPORT ON G20 TRADE AND INVESTMENT

MEASURES, VARIOUSISSUES.

Therefore, although the reports of the G-20 do

not suggest an intensification of protectionism thatreminds the 1930s, they do call attention to the use of

measures that have the potential to distort the flow

of trade. That raises the next question: How can this

protectionism be measured?

According to Cadot and Malouche (2012), tariffs on

imports have declined in last two decades in the developing

and developed countries and the number of countries that

have consolidated their tariffs under the most-favored-

nation clause of the WTO has increased.5 In addition,

the use of a number of non-tariff measures (NTM) hasincreased in the developed countries as well as in the large

emerging economies. Here the analysis enters a grey area.

Some NTMs such as phyto-sanitary barriers and technical

standards are designed to assure norms and standards

of safety and quality that are considered important

for the well-being of society. Trade measures, such as

investigations of dumping and subsidies, although they

restrict the flow of trade, are legal instruments recognized

by the WTO and could be discussed in mediation panels if

their use is considered unfair.

Graph 1 shows the percentage of restrictive measures

by principal groups collected by the WTO for the G-20

countries. Since the start of the publication of these

reports in 2009, 710 trade restriction measures have

been identified. It is clear, therefore, that there has

been a concentration of trade remedies, which would be

expected in times of crisis associated with exchange rate

disequilibrium.

In the second place, border measures, such as

changes in tariffs, import licenses, technical barriers and

phytosanitary requirements were computed.

Finally, there are export measures that relate to the

limits on exports of agricultural and mineral products,

and/or subsidies for agricultural exports.

Although it would be desirable to estimate a qualitative

index of protectionism, here it encounters the problem

of how to measure the restrictive effect of NTMs in the

aggregate. It would be necessary to calculate the tariff

equivalents of all the NTMs, a task that is not always

G-20 Trade Measures


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possible.6A first approach therefore can be the use of an

index of incidence to give an overall view of the use of traderelated measures. The report of the G-20, for example,

shows the index of coverage7, shown on Graph 2.

There is no per iod in which the coverage index

approaches 1.5%. In cumulative terms, 3.5% of world

imports and 4.4% of the imports by the G-20 were targeted

by trade measures.8Note that the results confirm reduction

in the use protectionist measures after 2009 and their

more frequent use beginning in the middle of 2011.

Using the same methodology, a report published by

the WTO (2012) which takes a total of measures of all

its members, shows that the difference between trade

remedies and border measures diminished becausemany developing countries have neither the qualified

human resources nor the institutional structure to

permit them to initiate investigations on unfair trading

practices.9 The data permit a comparison of the period

from the middle of October 2010 to the middle of May

2012. For the total accumulated measures the percentage

attributable to the G-20 countries was 47%. Even if trade

remedies are excluded, the percentage is still 40%. Thus,

the G-20 countries are responsible for a large share

of the introduction of protectionist measures. It should

Trade remedy

Border

Exports

Others

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Graph 1: Percentage (%) of G-20 trade protection measures by large groups*

SOURCE: WTO/OECD/UNCTAD (2012)

*THENUMBEROFMEASURES IN EACHOFTHE

PERIODS, ACCORDING TO THE ORDER SHOWN

ONGRAPH1 IS: 80; 95; 56; 54; 122; 108;

124; AND71.

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Part. % in world imports

Part % in Imports of G-20

SOURCE: WTO/OECDE/UNCTAD (2012)

Graph 2: Index of coverage of G-20 trade measures


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not be surprising that these conclusions are similar to

those in the reports about the G-20. The most recentglobal report of the G-20 (middle of October 2011 to the

middle of 2012), shows that some countries are returning

to import substitution policies. Furthermore, the number

of restrictions associated with government procurement

policies has increased.

Another source following protectionist measures is

the Global Trade Alert (GTA) coordinated and prepared by

Evenett (2012). In the latest report published in 2012, the

share of the G-20 in the increase in protectionism was

noted. According to the report, in 2009, the group wasresponsible for 60% of all protectionist measures. This

percentage increased to 75% in 2011, and in the first half

of 2012 rose to 79%. Just like the reports from the WTO, the

GTA is subject to criticism because it includes measures

that need to be analyzed to see if there is a restrictive

effect on trade, besides the fact that measures need to

be verified if they strictly adhere to the rigor of the WTO

which must respond to its members.10Nevertheless, just

as with the reports from the WTO, the main message is

that there is an increase in protectionism in comparison

to the immediate post-crisis moment. This added to the

uncertainties with regard to the global economic recovery

beginning in 2011.

According to Henn and Mc Donald (2011), analysis

of the data of discriminatory trade policies, and

implemented between July 2008 and April 2010, shows

that in aggregate terms there was a decline of only

0.2% in international trade due to the increased use

of discriminatory measures. On the other hand, at

the product level, they conclude that the reduction

varied between 5% (border measures) and 7% (behind

the border measures). In this article, the authors infer

that measures like the application of antidumping

measures and other less conventional protectionist

measures such as NTMs, discriminatory procurement

policies, domestic subsidies and remedial policies

contributed more strongly to the recent decline in

international trade flows.

In another article in 2010, Kee, Neagu and Nicita attempt

to answer the following question: Has protectionism beenrising since fall 2008?. To do so, the authors compare the

Overall Trade Restrictiveness Indices (OTRI) for various

countries between 2008 and 2009. The results of the

calculations which took into account only tariff policies and

the antidumping measures of the countries show that there

were no generalized increases in protectionism resulting

from the global financial crisis. The increase in tariffs and

antidumping measures in the countries studied explained a

total of less than 2% of the collapse in world trade.

Although many nations have increased their tariffson selected products, only a few countries, like Malawi,

Russia, Argentina, Turkey and China showed a significant

decline and impact on their trade flows. The United

States and the European Union on the other hand, use

one of the principal tools of trade policy: antidumping

measures to protect their domestic industry. But even

after taking into account antidumping measures, the

evidence supplied in the article suggests that the impact

on trade as a result of changes in trade policy during the

period analyzed was minimal.

Datt and others (2011) examine the reports of the

WTO and the GTA. They call attention to the fact that

the response to the crisis in 2008 included measures for

trade liberalization, promotion of trade and restrictions

on trade in the form of NTM, all giving the advantage to

sectoral analysis. They found the growth in global supply

chains (the verticalization of production chains) as one of

the reasons for the nonproliferation of protectionism as

a response to the crisis.They agree with the observation

of the WTO and the GTA that the extension of the crisis

and the macroeconomic disequilibrium expressed in the

foreign exchange issue could be leading to a change in

the global context and that the risk of an increase in

protectionism could not be discarded.

In short, the studies cited above do not show a significant

impact on world trade as a result from protectionist

measures. This result, however, could be related to the

selective sectoral nature in the use of various instruments.11


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3.BRAZIL IN THE CONTEXT OF THE GLOBAL CRISIS12

Brazil was also affected by the crisis. In 2009, gross domestic

product fell by 0.3%, recovering in 2010 and increasing by

7.5%, and then slowing down again, 2.7% in 2011 with the

worsening of international conditions in the middle of 2011.

According to Irwin (2012), the crisis of 2008 did not

bring about a repetition of the protectionist movements

of the 1930s due to the fact that different exchange rate

regimes were in effect. During the crisis of the 1930s,

many countries were operating under the gold standard,

but during the current crisis the majority of countries

were operating under flexible exchange rates. Flexible

exchange rates give greater autonomy to governments

in the management of their monetary policies as well

as functioning to attenuate the impact of external

shocks.13In summary, governments have a larger number

of instruments to deal with external disturbances. In the

case of Brazil, however, other factors must be taken into

account in the analysis of the foreign exchange effect.

The first is the strength shown in the behavior of

commodity prices, which began to recover in the middleof 2010. On the one hand it contributed to minimizing

the effect of the crisis by improving the terms of trade

and increasing foreign reserves. On the other hand it

intensified the appreciation of the domestic currency,

which again placed the issue of deindustrialization and

primarization of Brazilian exports on the agenda (Pereira,

2011 and Pereira and Souza, 2011). Graph 3 illustrates the

issue of primarization of exports and graph 4 shows

the rapid appreciation of the effective exchange rate

associated with the rise in commodity prices.14The second refers to the issue of the competitiveness

of Brazils industrial products. In world trade, the share of

Brazil in exports increased from 0.9% to 1.4% between 2000

and 2011. This increase can be explained by the performance

of agriculture exports, as Brazilian manufacturing continued

to have a share of less than 1% during this period.15

The third highlights the increase in the coefficients

of imports in the industry as an indicator of the lack of

competitiveness of the Brazilian products, accentuated

Graph 3: The share (%) of principal product groups in Brazilian exports

SOURCE: SECEX/MDIC


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12

by the exchange rate issue. According to calculations byFIESP (2012), the import coefficient for total industry in

Brazil increased from 16.2% to 23.1% between 2006 and

2011 and for the transformation industry the coefficient

increased from 14.4% to 21.9%. The results vary from

sector to sector, but the sharp increase in the coefficients

has come to be a part of the agenda among government

and segments of the private sector.16

The fourth factor to be highlighted refers to the results

of the trade balance, which continued to be in surplus, even

with the appreciation in the exchange rate. In 2008, the tradebalance was US$24 billion, followed by a balance of US$25

billion (2009), US$20 billion (2010) and US$29 billion (2011).

What do these observations indicate?

The appreciation of the exchange rate and the primarization

of exports on the post-crisis raised in its strongest form

the question that has permeated the discussions of

industrial policy and foreign trade in Brazil. It is not a merely

situational question or one that relates only to the currency

issue. Improving the competitiveness of Brazilian productsis an issue that has been part of the discussion in Brazil since

the 1990s. The competitiveness agenda includes questions

about infrastructure, the tax system, and education,

among others (Bonelli, 2011). Nevertheless although there

is a consensus about the agenda of horizontal policies to

improve the competitiveness of Brazilian products there is

no consensus regarding the guidelines of industrial policy

and foreign trade when discussing selective measures. The

correction of market failures as an argument for the use

of industrial policy should be analyzed with great care asshown in the following chapter. Indeed, when protectionist

measures are used there is always the risk that new

distortions will be created.

The introduction of the Plano Brasi l Maior [Greater

Brazil Plan] occurred in the context of international

uncertainties about the recovery of the international

economy and the increased intensity of the debate in

Brazil about the risks of de-industrialization associated

with the appreciation of exchange rate.17 The issue of

Commodities Prices Index

Real Effective Exchange Rate Index

01_

08

03_

08

05_

08

07_

08

09_

08

11_

08

01_

09

03_

09

05_

09

07_

09

09_

09

11_

09

01_

10

03_

10

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07_

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09_

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11_

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180

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140

120

100

80

60

Graph 4: The appreciation of the real and commodity prices*

* INDICES ARE BASED ON JANUARY 2008. THE PRICE INDEX IS COMPOSED OF

THE23 PRINCIPALCOMMODITIESSELECTEDBYSECEX. THEINDEXOFTHEREAL

EXCHANGERATEISCOMPOSEDOFTHEEURO, THEDOLLAR, THEARGENTINEPESO,

THEJAPANESEYEN, THECHINESEYUANANDTHEPOUNDSTERLING .

PREPARATION: IBRE/FGV (2012)


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13

strengthening the productive chains gained even more

strength when the government identified the growthin demand as an opportunity to stimulate domestic

supply in the productive chains with new investments

(petroleum, shipbuilding, energy and health).

The strategic guidelines in the Plano Brasil Maior

(2011)18are:

To promote innovation and technological development;

To create and strengthen critical skills in the domestic

economy;

To increase the technological and productive density

of value chains; To expand the internal and external markets for

Brazilian companies;

To assure inclusive and environmentally sustainable

growth;

To increase the levels of productivity and competitiveness

of Brazilian industry.

The core continues to be consistent with the

plans announced over the last 10 years. The issue of

technological innovation however was given greater

emphasis in the issue of local production chains. Thusthere were five Productive Systems Blocks identified:

Block 1: Electro-electronic, mechanical and health

systems19

Block 2: Scale intensive production systems

Block 3: Labor intensive productive systems in

Block 4: Agribusiness production systems

Block 5: Commerce, logistics and services

As already mentioned, the share in the global production

chains was one of the attenuating forces in the demand for

protection. In the case of Brazil, however, the same reasoning

increased the demands for protection. Greater emphasis

was given to the issue of local added-value, which had been

the focus of discussion and controversy. The issue is not,

however, whether Brazil is, or is not, more protectionist,

but rather if these measures, such as local content

requirements (LCR), help to achieve the objective of creating

a technologically efficient and advanced industrial base

that can be inserted into the global supply chains. Several

observations maybe helpful in clarifying this conclusion.

In the most recent report of the WTO on the

G-20 the temporary increase in import tariffs on 100products (8 digit classification code) announced by the

present government in September 2012 was mentioned.

The average tariffs for these products increased from

13.6% to 23.4%. In this group intermediate goods figure

predominantly, which will increase the costs of final

products. The share of these products on the list of

imports is small (3.1%), but they accumulated a deficit

of US$1.5 billion in the January-July period in 2012. The

same report, however, notes that there was a temporary

tariff reduction of around 800 products in the capitalgoods, IT and telecommunications sectors.20

If we believe that understanding the use of these

instruments and the goals of industrial policy is a way to

contribute to the discussion instead of asking whether or

not there is a protectionist bias in the policy inaugurated

in 2011, it is then important to ask whether the increase

observed in tariff rates did not follow a logic dictated by the

guidelines of industrial policy. Or if the reduction in tariffs

signifies a concern with the competitiveness of products.

A second clarification refers to the issue of productionchains. In the past, local content requirements (LCR)

associated with government procurement policies

performed an important role in the creation of

domestic demand for the supply chains. In the current

scenario, where the pace of technological innovation

has accelerated, local content requirements (LCR) could

consolidate domestic supply in a continued lag behind

international competitors. The China effect must also

be considered. If it was possible in the past to guarantee

comparative advantages in labor-intensive goods,

meeting the demands of countries at a lower level of

development, today this is much more difficult because

of the competition from China.

Finally, it is worth considering whether or not the

strategy of an industrial policy that gives priority to

issues of local content might create barriers to free trade

agreements, those that have been precisely the channels

for the construction of global and regional supply chains,

as observed in the Asian region (Baumann, 2010).


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14

1.WHY INDUSTRIAL POLICY?21Ideally, the goal of industrial policy should be the

diversification of the economy into new sectors as a way

of assuring an increase in productivity of the economy.

Thus it is important that the sectors covered by industrial

policy are developed to be competitive. Although this

sometimes implies some sort of temporary protection,

the success of an industrial policy must eventually be

measured by the exposure of sectors benefiting from

this industrial policy to international competition. By

this measure, a good many of the policies adopted by

countries in response to the crisis, including Brazil (see

the previous chapter) would be hard to be included in this

concept of industrial policy.

For the purpose of organizing these concepts,

public policies are classified as to their type: pro viding

public goods or market intervention; and their vertical

transversality (limited to a few sectors) or their

horizontal transversality (having a broader sectoral

spectrum) (see Figure 1).22

Providing quality education, investing in infrastructure,

assuring property rights and reducing the bureaucracyof doing business are examples of horizontal policies in

the provision of public goods. The creation of University

Schools of Engineering, for instance, implies a provision of

public goods, but of a vertical nature, because it satisfies

certain sectors (electronics, for instance), but not others.

Here a distinction between sectors and activities should

be made. Activities are actions that potentially impact

a number of sectors, but are not normally part of the

companies target activities (innovation, for instance).23In

turn, in the right lower quadrant of Figure 1 policies thatdistort prices for specific sectors (subsidies and trade

protection for certain sectors, for example) are included.

Finally, there are market interventions designed to

affect specific activities (subsidies for research and

development, subsidies for training the labor force,

subsidies for capital investment), but not specific sectors

(left lower quadrant).

That said, we can define industrial policy as actions

designed to affect the economys productive structure, so

as to increase production and the technological capability

in certain sectors. In other words, the industrial policy

is designed to be selective, that is, it is associated with

vertical policies, notwithstanding the fact that it can be

horizontal in terms of market intervention (the colored

area in Figure 1). Based on this definition of industrial

policy, some authors make distinction between light

industrial policy (right upper quadrant, associated with

public goods, and the left lower quadrant, which changes

the relative prices for activities, particularly research and

development), and heavy industrial policy (right lower

quadrant, associated with interventions that distort the

relative prices of the sectors).24

Thus, the question raised is: under which circumstances

are industrial policy actions justified? The answer has to

do with the correction of failures in the functioning of

the market and the provision of public goods, with the

balance to be made with regard to government failures.

If there are no significant market flaws (or if they are

smaller than the government failures), there is no need for

Industrial Pol icy and

Protectionism

TRANSVERSALITY

Horizontal Vertical

POLICY

TYP

E

LightIndustrial

Policy

Market

Interventions

HeavyIndustrialPolicy

LightIndustrialPolicy

Pro

visionof

Pub

licGoods

Figure 1: Classification of Public Policy

SOURCE: ADAPTEDFROMSTEIN (2011).


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15

industrial policy. The following section will identify the

principal market flaws that would theoretically justifythe use of the industrial policy, empirically testing

whether there is evidence that such distortions are

sufficient to justify the governments attention, and

if so, what policy type would be the most appropriate.

The answer to these questions depends on the type of

market failure at stake. Three types will be considered:

learning externalities, externalities among sectors, and

informational externalities.

2.RESPONDING TO MARKET FAILURES25

2.1 Learning Externalities 26

One of the oldest and most frequently used reasons

to justify the need for an industrial policy is the infant

industry argument. One of the pre-requisites for this

argument is the presence of externalities in dynamic

learning, that is, a reduction in the cost of production for

each individual company for the amount produced by all

companies over time i.e. learning by doing.27Pioneering

companies do not internalize the cost reductions their

production offers to other companies in the future,

and therefore there is the possibility that if the initial

production cost is sufficiently high, the economy will not

be able to produce these goods without the intervention

of the government.

In this case, providing protection to the sector that

is experiencing dynamic learning makes economic sense

if the learning is quick enough (which would reduce the

cost of policy). It should be remembered that even when

protection is the optimum choice, the level of protection

should be reduced over time, as the costs incurred by

companies are being reduced, and should be eliminated

when the learning possibilities are exhausted.28

The external ities associated with dynamic learning

have been repeatedly related to spillovers of knowledge29.

In addition, many times industries having the potential

for learning by doing have a choice to be developed

with modern technologies or with older ones. In this

case, excessive protection of a given sector may leadto development with outdated technologies or means

of production, with little potential for generating

externalities. It becomes clear, therefore, that policies

that distort relative prices export promotion or trade

protection, for instance do not necessarily lead to an

increase in public welfare.30 In these circumstances,

although these sectors can be developed, once they are

affected by industrial policy, they can end up not providing

significant gains in productivity to the economy.

2.2 Externalities Among Sectors and Problems

of Coordination

The reasons for industrial policy associated with the

infant industry are based on externalities that are

manifested within the industry (or sector). However,

externalities may exist among sectors, which, in the final

analysis, would also justify the use of industrial policy.

In the case of the infant industry, the industrial

policy may be viewed as a tool for resolving coordination

problems among private agents. The same may be

said about inter-sector externalities. But while the

externalities associated with the infant industry

argument are reduced and eventually eliminated as the

sector achieves a certain size, this does not usually occur

in the case of externalities among sectors. In other words,

although both are problems of coordination, the solution,

in terms of industrial policy, tends to be different in the

two cases.

The big push argument fits perfectly in the description

of externality introduced in the preceding paragraph.31

In brief, certain investments would only become

economically feasible if made simultaneously, and, in that

case, government action in the coordination of individual

decisions could be possible.

However, the argument only makes sense if the

economy is closed, that is, if it is not possible to purchase

intermediate inputs on the international market. This

means that it is relevant only for certain non-tradable

intermediate inputs, such as infrastructure, education,


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16

and services. In this case, either the argument declines

in relative importance in horizontal policies (in the caseof infrastructure and education) or it loses much of

its appeal if the intermediate input is available from

multinational companies via foreign direct investment.32

Thus, preference should be given to what has been

previously defined as light industrial policy. As it is an

issue of collective action, the government must only

adopt policies that assure that there is appropriate

coordination among the economic agents. Moreover, if

the externalities are associated with innovation, it would

make more economic sense to promote the activity, andnot the sector receiving the benefits.

Recently, externalities among sectors have been used

in a somewhat different way. To summarize very briefly,

certain products are linked among themselves, so that

the productivity for a certain product would be greater

if the country had already achieved high productivity

in a closely related product. A number of factors

could explain proximity among products comparable

intensities of factors of production, similar levels of

technological sophistication, and a shared supply chain and certain products would be located in higher density

areas of production (in other words, there would be many

products nearby).33

All other factors remaining constant, countries that

shift their productive structure towards a more dense area

of production space, and that are therefore better able to

avail themselves of externalities, tend to grow more rapidly.

Usually the more densely populated areas of production

are associated with the more sophisticated products or

where productivity is higher. Thus, countries that limit

their production structure to regions more distant from

the more sophisticated and higher productivity products,

usually produced by the rich countries, would have greater

difficulty converging with the income levels of more

advanced nations. Industrial policy, therefore, should try

to position the country as close as possible to the basket

of exports of the rich countries.34

However, these prescriptions should take into

consideration the presence of other countries (especially

large countries, like China) in the same region or

production space. In other words, eventually it might bebetter to remain in less dense or sophisticated areas of

the production area, where the competition with other

countries is less intense.35

Note that this more recent approach has some

resemblance with the more traditional supply chain

approach.36Basically, some sectors especially those in

manufacturing would have strong links to the rest of

the economy, because they require a lot of inputs from

other sectors in their productive process. Similarly, there

would also be sectors that are subject to many demandsfrom others. In this case, because of externalities, it

would make sense to shift the economy to sectors that

foster stronger supply chains.

2.3 Informational Externalities and

Diversification

Another type of market failure is connected with the fact

that the local use of technologies already used in other

countries is not immediate, and requires adaptation to

the new context. To put it another way, the production

functions for a given good are not identical in all countries,

because a good part of the technology is tacit and

depends on the economic and institutional environment

in which it is placed. This implies uncertainty about

whether a given activity can take place locally; in other

words, whether the firms involved in the new activity

will be sufficiently productive. And if information about

productivity is only revealed after the investment, and

the return on this investment is not entirely captured,

there is room for government intervention.37

This suggests that market equil ibrium generates

little investment in new activities and the level of

diversification is quite low. This is a similar problem to

that confronted by companies that invest in innovation

but here the return on investment may be protected

by patent and intellectual property laws. This suggests

an industrial policy that, in general terms, provides

incentives to investment in new sectors ex ante and

eliminates unproductive sectors ex post. Incentives


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17

should be given only to the pioneering company and not

to the imitators.Trade barriers and export subsidies areinadequate because it is not possible to discriminate

between pioneering companies and imitators. Loans and

guarantees on the part of the government, although they

are able to discriminate, suffer from serious problems

associated with political influence in the allocation of

funds, corruption and other moral hazards.

2.4 Barriers to Entry and Externalities

Associated with Exports

Some authors argue that there are externalities associatedwith export activity. In that case, the need of some kind

of public policy would be reinforced. Aitken, Hanson, and

Harrison (1997) use micro-data from Mexican companies

to study this problem and find evidence that the

likelihood of a company to export is greater if it is located

near a multinational company, but it is unchanged by the

proximity of a local export company.

This seems to indicate that the externalities are not

connected with the export activity in itself, but to some

other aspect of the multinational companies activity.

They may be generated, for instance, by the productiv ity

increase of domestic companies through the transfer

of technology and more modern organization models

(more details in the next section). This thesis is

reinforced by evidence that for companies from more

developed countries, normally more up to date in

terms of technology and organization, the externalities

associated to export are not significant.38

It is also possible to argue that there are barriers

to the entry of local companies in foreign markets.

In addition to tax barriers, import quotas and public

health standards that must be met, there are also

barriers to entry associated with the need to establish

business contacts and the knowledge of the foreign

market conditions. Thus the presence of multinational

companies seems to generate externalities associated

to the creation of new export connections (greater

diversity of products and destinations), at least for the

Chinese companies.39

Furthermore, if the cost for trying new products is

incurred by consumers, and if they know the qualityof the local product, but not that of the imported

product, this cost becomes a barrier to the entry of

other countries exports.40 In this case, some type of

subsidy for exports could be justified, but only when

the difference between the high quality product and the

low quality product is significant, when the difference in

the production cost between the products is low, when

the differentiation level between the exported product

and that produced abroad is high, and when the export

destination market is highly protected. In any event, thesubsidy should be reduced over time, as the asymmetry

problems are reduced. However, instead of subsidies,

it would seem to be more appropriate to take direct

measures to reduce the information asymmetry, such

as, for example, promotion of the country as a quality

goods producer or investments in the certification and/

or approval of products.

2.5 Externalities of Foreign Direct Investment

Many countries use policies to attract foreign direct

investment with the justification that there are

associated externalities that come with it. Basically,

multinational companies can generate spillovers to

domestic companies through three channels: (i) through

the generation of externalities from export activity;

(ii) through the increase in competition in the local

market; and (iii) through the transfer of technology and

organizational methods.

The first channel was the subject of the preceding

section. With regard to the second channel, Greenaway,

Sousa and Wakelin (2004) found indications that the main

channel by which foreign direct investment increased

the exports of British companies was through increased

competition in the domestic market. In either case, there

are other instruments that are better suited to assure

and reinforce competition in the domestic market than

promoting foreign direct investment, especially policies

to promote competition and opening the economy to

international competition.


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The third channel deserves greater attention. A

number of authors stress that externalities are onlyappropriated and used by domestic companies only

under certain conditions. For instance, multinational

companies spillovers are better leveraged if there is a

well developed domestic credit market that permits the

insertion of local suppliers into the production chain of

foreign companies.41Thus, if the governments intention

is to encourage foreign direct investment, this policy must

be combined with other actions that increase financial

intermediation in the domestic market.

Moreover, there is evidence that the foreign directinvestment increases the productivity of domestic

companies only if there is a sufficient stock of human

capital.42 In this case, the promotion of foreign direct

investment must be combined with educational and

labor training policies, otherwise the focus should be on

sectors in which there already are a reasonable number

of skilled workers.

The relationship between foreign direct investment

and the labor market works both ways. In fact, if

the skilled labor is a necessary condition for foreigninvestment to generate externalities for domestic

companies, multinational companies also generate

positive externalities for domestic workers in terms of

better wages.43

Finally, the evidence on the externalities of foreign

direct investment and the channels by which they

are disclosed are, to a great extent, inconclusive. 44

Thus, instead of polic ies to provi de incent ive s to

foreign direct investment, it may make more sense

to promote policies that eliminate the barriers that

prevent local companies from building relationships

with multinational companies, improving the access to

quality inputs, credit, and technology.45Since Brazil still

has many barriers to the free flow of direct investment

(foreign or domestic), it makes more sense to remove

them instead of offering some sort of subsidy to

encourage the inflow of foreign capital.

3.CONCLUSIONSIndustrial policy measures, particularly the heavy ones,

are only justified in the presence of market failures,

particularly with externalities.

It therefore might be useful to sort industrial policy

initiatives according to their purpose. If the purpose is that

of preserving already established sectors or diversifying the

industry into segments correlated to existing ones industrial

policy writ small the best option is to remove obstacles

preventing the development of these sectors instead of

protecting them. The priority should be given to initiatives

unlocking productivity growth rather than to actions to

compensate for the lack of competitiveness. Promotion for

investment in human capital, investments in infrastructure,

improvement of the business environment and reduction of

the complexity in taxation and the reduction of regulatory

uncertainties should be at the top of the list.46This is, in other

words, basically an agenda for light industrial policy.

However, if the goal is to make large investments through

the creation of completely new sectors in the economy

industrial policy writ large it is quite likely that the use of

heavy industrial policy measures is required. In this case, the

economic literature and historical experience suggest that a

few simple rules and careful implementation are needed.

Heavy industrial policies should be used for a finite

period when used at all, and the regime for promotion

and protection (such as import barriers and domestic

content policies) should be gradually removed. More than

just choosing winners, industrial policy should also be

able to eliminate the losers, because otherwise the pol icy

creates and develops sectors that are uncompetitive and

incapable of being inserted into the international market.

In addition, given the need for a well-prepared government

bureaucracy, with a complex institutional arrangement (to be

able to deal with the coordination of different government

authorities, and between them and the private sector), and

systematic monitoring, a focus must be maintained. It is not

possible to make too many strategic bets at the same time,

with the real possibility of not succeeding at any of them.


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1.INTRODUCTIONBased on the theoretical discussion and the empirical

evidence outlined in the previous chapter, a specific case

of industrial policy adopted in Brazil can be analyzed.

The Oil and Gas (O&G) sector was selected because it has

already accumulated more than ten years experience with

local content requirement (LCR) policies in exploitation

and production (E&P) activities,which provides the data

to analyze the results and identify the lessons for other

sectors.47An analysis of the literature on the issue was

complemented by a workshop held with companies of

the sector (hereinafter referred to as Workshop-O&G)

and interviews with government interlocutors.

2.INDUSTRIAL POLICY IN THE OIL AND GAS

(O&G) SECTOR

2.1 Survey of Industrial Policy Actions

(A) Local Content Requirement Policy in Exploitation

and Production (E&P)

After the opening of the petroleum and gas industry to

foreign investors, a number of rounds of bidding for the

oil and gas exploration blocks took place. From the first

auction, in 1999, all of the rounds included LCR. However,

the rules have been changed throughout this time.

These changes may be classified into at least three

categories. First, the nature of local content requirements

has been modified throughout the Rounds. Until Round 4,

although minimum local content criteria were taken into

account when qualifying companies to participate in the

earlier Rounds (and given a 15% weight), no commitments

were required. In Rounds 5 and 6, minimum local content

thresholds were fixed, with companies being authorized

to offer additional percentages in some activities, which

were considered in the determination of the winning bid.

Finally, beginning with Round 7, maximum and minimum

local content percentages were established on an overall

basis, with minimum thresholds detailed in items and

sub-items. However, unlike former rounds, it was possiblefor the regulator to authorize exceptions to compliance

with the LCR clause in the event that the product or

service was unavailable in the domestic market.48

Second, the definition of local content has been also

changed. In Round 1, the local content criterion was

established by the companys location (in the case of

products) or the place where the services were provided.

In Round 2, the local content of products began to be

measured in accordance with the definition of national

production goods, that is, machines or equipment wherethe value accounts for at least 60% of nationalization index.

In Round 3, the concept was expanded to services, using

the commercial presence definition (services provided

by a firm established in the country) that is, those in

which imported materials and services correspond to less

than 20% of the sale price. Final ly, in Round 7, the concept

of local content ceased to be dichotomous. For each item

and sub-item, the local content share is calculated as

the ratio between the sum of values for non-imported

components and the sum of product prices. In other

words, the local content definition became more rigorous.

Finally, the procedures required for proof of local

content have also been altered over the years. Up to

Round 2, no specific evidence was required. Beginning in

Round 3, the regulators began to require quarterly reports

showing what had been locally produced and what has

been imported. In addition, the submission of certificate

of origin by suppliers also began to be required. From

Round 7 on, the evidence of local content was required to

be certified by agencies accredited by the regulator.

(B) PROMEF and Congeners

Created in 2004, the Programa de Modernizao e

Expanso da Frota (PROMEF ) [The Fleet Modernization

and Expansion Program] is charged with the revitalization

of the Brazilian shipbuilding industry based on orders of

ships by Transpetro. In fact, the program was created by

Transpetro s need to modernize and increase its fleet to

reach its goal of providing 100% of Petrobras cabotage

requirements and 50% of its ocean service needs.

Case Study:

Goods and Se rvices In the

Oil and Gas (O&G) Sector


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PROMEF was developed based on three essential

premises: (i) to build ships in Brazil; (ii) reaching minimumlocal content levels (65% in the first stage and 70% in the

second); (iii) offering conditions to help domestic shipyards

to become competitive on a worldwide basis.49Although

it was developed based on the needs of Transpetro, it can

be analyzed as a public policy to promote shipbuilding

(and the shipbuilding parts industry). Thus the analysis

of the program will be placed in the context of a group

of the most recent measures adopted for supporting the

sector, which are summarized in Figure 2.

Within the scope of PROMEF, the funding both forTranspetro and the shipyards is provided by theFundo da

Marinha Mercante (FMM)[Merchant Marine Fund], whose

financial agent is the Brazilian National Bank for Economic

and Social Development (BNDES). The funding conditions

follow the general rules set forth for the funds of the FMM.

It should be noted that the funds from the FMM

usually come from the Adicional ao Frete para Renovao

da Marinha Mercante (AFRMM) [Merchant Marine Fund

Renewal Freight Surcharge] charged on freight services

provided within Brazil. However, with the increase offinancing from the fund, the Federal Government was

authorized to extend up to R$ 15 billion in credit to the

financial agents of the FMM (Law 12.249/2010).

Moreover, since economic agents have a clear perception

of the risks associated with funding domestic shipyards,the government created the Fundo de Garantia para a

Construo Naval (FGCN) [Shipbuilding Guarantee Fund],

Law 11.786/2008, later modified by Law 12.058/2009.

This is a fund to guarantee the credit risk the risk

associated with the uncertainty about the timely receipt

of the contracted value for reasons of noncompliance by

the Brazilian shipyard with the construction schedule

or performance and associated uncertainties about

noncompliance with all of the shipyards obligations or the

quality of the vessel of funding transactions for Brazilianshipbuilding with funds arising from the FMM. The FGCN is

a private fund, and the Federal Government is authorized

to contribute up to R$ 5 billion to its capital fund.50

Finally, Petrobras has other programs similar to

PROMEF. There is the Programa de Renovao da Frota

de Apoio Martimo (PROREFAM) [Maritime Support

Fleet Renewal Program], for the construction of platform

supply vessels in Brazil with a 75% local content ratio,

and the Programa Empresa Brasileira de Navegao

(EBN) [Brazilian Navigation Company Program], in whichBrazilian ship owners are contracted by Petrobras for 15

years, under the condition that they build their ships in

domestic shipyards.

LOCAL INDUSTRY

Funding from the FMMGuarantees from FGCN

Tax ReliefTechnological TrainingLabor Training

SHIPS

INPUTS

TRANSPETRO

BRAZILIAN SHIPYARDS

Minimum Local ContentRequirement (65%-70%)

Figure 2: The Fleet Modernization and Expansion Program (PROMEF) Schematic Summary

SOURCE: BRAZILIANINSTITUTEOFECONOMICS(IBRE) (2011).


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(C) Other Measures

While local content policies are the most conspicuousand important features of industrial policy for the O&G

sector, other measures have also been adopted. Without

intending to be exhaustive or offer a deeper analysis,

some of these measures are listed below.51

With specific reference to PROMEF, a series of tax

relief measures has been granted. These releases deal

with both the sale of vessels (in Brazil and to other

countries) and to the purchase of inputs for shipbuilding

(whether domestically produced or imported). In the case

of activities linked to Exploitation and Production (E&P),a similar program has been created in connection with

capital goods, with the institution of a special export and

import customs regime (Repetro). In both cases, the pol icy

is designed to reduce taxes levied on the locally produced

goods to align its tax obligations with those of imports

(for inputs) or exports (for end products). However, since

the Brazilian tax system is, to a great extent, a cumulative

one, these tax release only affect companies adjacent

to the sectors receiving the benefits and not the entire

chain. Moreover, there are difficulties in receiving the tax

credits, which weakens the tax release mechanism.

In addition, special credit lines have been created,

both for capital investment - the BNDES P&G and

Prominp Participaes, - and for working capital (Prominp

Recebveis), and for investment in innovation ( Inova

Petro).52 Specifically with regard to innovation, there are

also funds from the CT-Petro sector fund, which is funded

by a share of oil royalties. These funds may be used to

finance innovation in the sector (which also includes the

petrochemical industry). However, just as with a significant

portion of sector funds, only a small portion of these funds

is actually released by the government. Finally, there is

also a legal provision that, in the fields having an extra

share, 1% of company revenues will be allocated by those

companies for investment in research and development.

Still under the heading of innovation and investment

in human capital, there are a number of initiatives for

labor training put into practice by the Prominp[Program

for Mobilization of the Brazilian National Oil and Natural

Gas Industry]. In addition, under the PROMEF, there

is also the Rede de Inovao para a Competitividadeda Indstria Naval e Offshore (RICINO) [Network for

Innovation in Competitiveness of the Shipbuilding and

Offshore Industry], created in 2009. The Network covers

partnerships between an important research institution

in the area, the Centro de Excelncia em Engenharia

Naval e Ocenica (CEENO) [Center for Excellence in

Shipbuilding and Oceanic Engineering], and agencies

linked to shipyards and shipping companies.2.2 Policy Evaluation

(A) What are the Objectives? What is the Best Way to

Achieve them?

The first characteristic of the industrial policy associated

with the oil sector that comes to attention particularly

with respect to the LCR policy is the difficulty of clearly

identifying the objectives. On the one hand, one of the

objectives is clearly to generate domestic income and

employment growth. On the other hand, there is the concern

with the diversification of Brazilian economy in the directionof new sectors or production chains linked to oil, particularly

those that are more technologically intensive.

In fact, these concerns were raised by the O&G sector

participants during the Workshop-O&G,and by the authors

who addressed the theme.53 In the case of the PROMEF

these two objectives are more explicit (see section 2.1).

In principle, the two objectives are not incompatible,

but require different public policies.Taking the framework

described in the preceding chapter (see Figure 1), the

development of new sectors or production chains mayoccasionally need heavy industrial policies, particularly

if the externalities associated with these sectors are

large. In many circumstances these externalities are

not taken into account by private agents. It is precisely

the differences between private and social values of

the investment that generates the opportunity for LCR

policies. For already established sectors, it makes more

economic sense to use horizontal or light industrial

policies, which is the case for the Oil and Gas (O&G) sector,


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to help them become able to take advantage of the

increased demand generated by investment.But LCR are also associated with costs. If the

inputs are arranged in increasing order of international

competitiveness, the private decision of companies

will be to reach a certain level on the nationalization

scale. Public policy usually implies forcing companies

to advance more up the scale. This advancement has

benefits the above-mentioned externalities but also

has costs associated to the acquisition of relatively more

expensive inputs. Note that these costs are materialized

even in the cases of success in developing local suppliers.By way of illustration, there is extensive evidence

showing that, when the LCR policy in the Norwegian oil

industry was loosened, significant productivity gains

associated with greater degrees of freedom in the purchase

of inputs occured.54These gains indicate that there are costs

associated with industrial promotion policy, even when the

minimum LCR are not very high, as in the Norwegian case.55

Thus, local content policies are desirable where the

social benefits associated with them are greater than the

losses resulting from the increase in production costs. From societys point of view, there is an optimum local

content level, and moving beyond that point losses

exceed gains. In other words, policies for the promotion of

new industries should not have the maximization of local

content as the goal, but rather gains to society. Excessive

use of LCR tends to generate negative results, and, to the

limit, makes the sector subject to the initial investment

unfeasible in terms of international competitiveness.

In addition, LCR policies tend to bring more benefits

in situations in which the difference in competitiveness

between the local inputs subject to the policy and their

imported counterparts is relatively small. In this case,

the penalties in terms of costs tend to be smaller.

(B) Which Sectors?

The distinction among goals may also be translated

in terms of differentiation between production chains

and sectors contemplated by the policy. Figure 3 briefly

describes the value and supply chain of the E&P industry.

In the center sits the operator, and farther away from the

center, the less specific to the oil sector the product orservice becomes. Thus, for products and services closer

to the center, the externalities associated with industrial

policy tend to be stronger, and some sort of heavy

industrial policy (particularly that of LCR) may make sense.

However, for products and services farther from the

center, light industrial policies and/or horizontal policies

may be more appropriate. For example, notwithstanding

the benefits to the metallurgy industry from increased oil

sector demand, it should be not subject of local content

policy, but rather of measures making it capable of takingadvantage of an increased demand.

This perception was also externalized by a large number

of the economic agents of the sector during the Workshop-

O&G. One of the concerns raised refers to the fact that

the local content rule in E&P has an impact on the entire

production chain, but the operators have only limited

control of their direct suppliers. The same issue has been

raised by direct suppliers with regard to their suppliers.

Obviously, not all sectors near the center of Figure 3

should necessarily be subject to local content policy. Aspointed out in section 3 of the previous chapter, given the

costs associated to heavy industrial policies, they should

be used in moderation. They should be limited to cases

in which the sector development implies a significant

increase in terms of the existing capabilities that cannot

be achieved with light industrial policies alone. A more

detailed discussion of the sectors that should and those

which should not be subject to local content policy is

beyond the scope of this study. Some surveys in this

regard including considerations of costs and benefits

have already been made.56In addition to that, there is

already a reasonable awareness of the bottlenecks in

each sector.57

(C) Sunset Clauses

Once the sectors to be covered by local content policy

have been defined, it is important that the incentives be

properly created. In particular, the theoretical literature

(see the preceding chapter) and the international


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experiences suggest that policies of this kind should

be temporary, and that the protection of the domestic

market should be gradually reduced.

The contraposition of Brazils experience with

industrial policy and those of East Asian countries helps to

illustrate the point. Take the example of South Korea. The

companies and sectors that were the focus of industrial

policy have always been exposed to mechanisms that

combined incentives and penalties. Some type of goal

was always set, normally associated with exports, which

if not achieved, implied penalties or the elimination

of benefits. Furthermore, the government signaled, in

credible fashion, that protection would be reduced over

time and this in fact occurred. The two mechanisms

led to significant gains in productivity, required to meet

the export targets and to protect itself in the domestic

market against the anticipated reductions and eventual

removal of protection.58 Note that this is exactly the

policy prescription set out in the preceding chapter.

In Brazil, however, the domestic market was insulated

from international competition for many years, and no

signs of reductions in the levels of protection were given

to companies. Thus, although Brazil has succeeded in

diversifying its economy, it was unable to achieve a level

of international competitiveness in a number of sectors

contemplated by the industrial policy.

Meanwhile in the Oil and Gas (O&G) sector, there

Documents

Domestic Industry Development in the Context of the International Crisis: Evaluating Strategies