brazil in global value chains timothy j. sturgeon, ph in global value chains timothy j. sturgeon,...

Brazil in Global Value Chains Timothy J. Sturgeon, Ph.D Senior Researcher, MIT [email protected]

MIT-IPC Working Paper 16-001 June 2016

292 Main Street, E38-506, Cambridge, MA 02139 ipc.mit.edu

Brazil in Global Value Chains

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Abstract After a several years of rapid growth and rising prosperity in the mid-2000s, driven mainly by a commodities export boom and rising household and government spending, Brazil has re-entered a period of economic crisis and political turmoil. But the sources of Brazil’s economic malaise run deeper than the current crisis. Brazil has an inward-looking economy, where, with only a few exceptions, production is focused on the domestic market. As a result, and again with exceptions, Brazil does not have a robust set of internationally competitive, efficient, or innovative domestic firms at any level of the value chain. In most technology-intensive sectors, Brazil relies on global lead firms (brands) to develop products and organize production, and in many of these, global suppliers provide key inputs, either by importing or by producing locally in the service of local content requirements. Innovation, judged in terms of the creation of internationally competitive products suitable for export, is weak in all but a few sectors. Given that this situation is unlikely to change quickly, this paper asks how Brazil can most effectively expend its limited political and financial capital to move into strategically important, profitable, higher value-added activities across a range of industries? How can Brazil’s economy escape its inward focus, and become more internationally competitive? How can Brazil increase exports of technology- and knowledge-intensive products and services? An obvious place to look for answers is innovation, and our research specifically asks how the new SENAI Innovation Institutes (ISIs) can emerge as test-beds for new ideas about how to organize and structure innovation projects to help private industry in Brazil become more internationally engaged and competitive. Based on three in-depth the industry studies, Biopharmaceuticals, ICT, and Oil & Gas, we recommend the ISI’s take on an “innovation partner” role, mainly with small and medium-size businesses, in two areas: 1) supplier upgrading, where smaller firms are brought into the innovation system in ways that meets the requirements laid out by larger global suppliers and lead firms downstream in the supply chain; and 2) platform innovation, where smaller firms are helped to develop their own products and services by accessing and learning how to build on global technology platforms in ways that meet the emerging standards of the “digital economy” as embodied by concepts such as Manufacturing 4.0.

This research was sponsored by SENAI. The IPC is grateful for their support.

Esta pesquisa foi patrocinada pelo SENAI. O IPC agradece pelo seu apoio.


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Table of Contents

Introduction – The Current Context ............................................................................................ 1The IPC’s Industry Research – The Global Value Chain Perspective ..................................... 2GlobalValueChains–Whatarethey?..............................................................................................................2GVCsandDevelopment–OpportunitiesandChalleneges.......................................................................5Opportunitiesfortechnologicallearning,marketexpansion,andindustrialupgrading5Lowvalueaddedtraps.................................................................................................................................5BarrierstoInnovation..................................................................................................................................6The“AdaptiveState”......................................................................................................................................7

Brazil’s Current Position in GVCs ............................................................................................... 7Trade...............................................................................................................................................................................7ForeignDirectInvestment...................................................................................................................................11The“BrazilCost”......................................................................................................................................................12Brazil’sInward-Focus–aCharacterizationofEightIndustries.........................................................13

Recommendations and Possible Strategies for Brazil .............................................................. 15ImprovingR&DfundingmechanismsinBrazil..........................................................................................15Supplierupgrading:leveragingBrazil’sforeigndirectinvestmentforupgrading....................17Movingtotheheadofthevaluechain:platforminnovation...............................................................18PlatforminnovationinBrazil?................................................................................................................22

Roles for the ISIs .......................................................................................................................... 23Concluding Comments ................................................................................................................ 23References ..................................................................................................................................... 26Appendix ....................................................................................................................................... 28

List of Tables Table 1. Main Trends Driving Global Value Chains .......................................................................................................... 4 Table 2. World Exports in Three “GVC Industries,” 1992, 2008, and 2014 ...................................................................... 8 Table 3. World Exports in Three “GVC Industries,” 1992, 2008, and 2014 ...................................................................... 9 Table 4. Countries with More Than US$300B in Total Foreign Direct Investment Flows, 1970-2014, US$ millions ... 12 Table 5. Brazil and Comparator Economies, World Bank Ease of Doing Business Rank. 2015 ..................................... 13 Table 6. Cost and Time Requirements for Imports and Exports for São Paulo in Comparison to Latin America and High

Income OECD Economies, 2015 ............................................................................................................................ 13 Table 7. Brazil’s Position in Eight Industry Global Value Chains ................................................................................... 14 Table 8. Defining Innovation Based on “Oslo Manual”, 3rd edition, 2005 ...................................................................... 19 Table 9. Selected Platform vs. Product Companies .......................................................................................................... 20

List of Figures Figure 1. A simple four-stage value chain with four sourcing possibilities ........................................................................ 3 Figure 2. Multinational Firms and their Vertically-Linked Foreign Subsidiaries ............................................................... 4 Figure 3. Vertical specialization and the “smiling” curve of value added .......................................................................... 6 Figure 4. Vertical specialization and the “smiling” curve of value added for a $600 iPhone 4 .......................................... 7 Figure 5. Brazil’s Trade Balance in Three “GVC” Industries, 1989-2014, US$ thousands ............................................. 10 Figure 6. Brazil’s Trade Balance by Technological Categories, 1995-2014 .................................................................... 10 Figure 7. Brazil’s Foreign Direct Investment Inflows and Outflows, 1970-2014 US$ million ........................................ 11 Figure 8. R&D Center Investments in Brazil by Multinational Firms, 2010-2014 ........................................................... 16 Figure 9. Headquarters Region of Platform Companies with more than US$1B Market Cap ......................................... 21 Figure 10. Brazil’s Export Basket, 2014 and 2008 ........................................................................................................... 28 Figure 11. Brazil’s Export Destinations, 2014 and 2008 .................................................................................................. 29


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List of Acronyms ANATEL – National Agency for Telecommunications () and the ANEEL – National Agency for Electric Energy (), the ANP – National Petroleum Agency () are just three government agencies that have BNDES – Brazilian Development Bank (BNDES) CATI – National Committee for IT CNI – Brazilian National Confederation of Industry EMBRAPII – Brazilian Corporation for Industrial Research and Innovation FAPESP – São Paulo Research Foundation FDI – foreign direct investment FINEP – Funding Authority for Studies and Projects GDP – gross domestic product GVC – global value chain ICT– information and communications technology IPC – Industrial Performance Center ISI – Innovation Institutes MIT – Massachusetts Institute of Technology RECOF – Customs Regime for Industrial Warehousing under Computerized Control RTO – Research and technology organization SENAI – National Service for Industrial Training SME – Small and medium-sized enterprise


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Introduction – The Current Context

After a several years of rapid growth and rising prosperity in the mid-2000s, driven mainly by a commodities export boom and rising household and government spending, Brazil has re-entered a period of economic crisis and political turmoil. From 2005 to 2010, GDP increased more than 40%, from US$ 892 billion to US$ 2.2 trillion, while GDP per capita increased even faster, by 42.5%, from US$ 4,733 to US$ 11,124.1 This pushed Brazil well up the World Bank’s list of upper middle-income countries.2 Demand from China for mineral and agricultural commodities, along with rising world oil prices in the run up to the 2009 financial crisis, drove Brazil’s merchandize exports, foreign exchange earnings, and tax receipts to record levels. However, with slow recovery from the global financial crisis in 2008, sluggish post-crisis growth in China, and plummeting oil prices after April 2014, Brazil followed its largest neighbor, Argentina, into severe and protracted economic crisis. Since 2011, both GDP and GDP per capita have fallen by more than 11%. Like water draining from a swamp, an extensive corruption scandal was revealed, centered mainly on construction projects financed by the state oil company, Petrobras. The scandal and cascade of investigations that followed eventually led to a vote for the impeachment of Brazil’s President, Dilma Rousseff, on unrelated charges, in May of 2016, followed by a degree of political paralysis and uncertainly unusual even for a country plagued by regular upheavals. But the sources of Brazil’s economic malaise run deeper than the current crisis. Brazil has an inward-looking economy, where, with only a few exceptions (commercial aircraft, oil & gas, and to a lesser extent ICT services) production is focused on the domestic market. As a result, and again with exceptions,3 Brazil does not have a robust set of internationally competitive, efficient, or innovative domestic firms at any level of the value chain. In most technology-intensive sectors, Brazil relies on global lead firms (brands) to develop products and organize production, and in many of these, global suppliers provide key inputs, either as imports or by producing locally in the service of local content requirements. Innovation, judged in terms of the creation of internationally competitive products suitable for export, is weak in all but a few sectors. Given that this situation is unlikely to change quickly, our research has had to ask what steps Brazil can take to improve its international competitiveness over the short term. How can Brazil most effectively expend its limited political and financial capital to move into strategically important, profitable, higher value-added activities across a range of 1 Figures from http://data.worldbank.org/indicator/NY.GDP.PCAP.CD/countries/BR?display=graph and http://unctadstat.unctad.org/CountryProfile/GeneralProfile/en-GB/076/index.html 2 According to the World Bank, upper middle income status is afforded to countries with per capita GDP in the range of $4,086 to $12,615. See: http://data.worldbank.org/news/new-country-classifications 3 In addition to Petrobras for deep water oil & gas development and Embraer’s success in regional jets, a list globally competitive Brazilian firms might include WEG (industrial equipment), Welle Laser (industrial lasers), Stefanini (ICT services), Embraco (compressors for busses), Marco Polo (busses) and young ICT firms such as Tempest (cyber-security software).


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industries? How can Brazil’s economy escape its inward focus, and become more internationally competitive? How can Brazil increase exports of technology- and knowledge-intensive products and services? An obvious place to look for answers is innovation, and in fact, the MIT IPC Accelerating Innovation in Brazil project is focused on just that, using the lens of 25 new Innovation Institutes (ISIs) supported by the Brazilian National Confederation of Industry (CNI)’s National Service for Industrial Training (SENAI). Each ISI has a technology or product focus, and a stream of initial funding from the Brazilian Development Bank (BNDES) to support projects with industry. The focus on innovation in general, and the ISIs as test-beds for new ideas, allows the research to explore questions of how to organize and structure innovation projects to help private industry in Brazil become more internationally engaged and competitive while taking the current economic, political, and policy context of Brazil into account. The MIT IPC research to-date has focused on three industry GVCs: biopharmaceuticals, ICT hardware and services, and Oil & Gas. Companion white papers provide extensive detail on this research. They cover the three GVCs at the global and Brazil levels, and offer a set of preliminary recommendations for how relevant ISIs might best engage with each industry in Brazil. Preliminary research has also been conducted on Brazil’s textile and apparel industry, and lessons were also learned from an earlier study covering aerospace (mainly commercial aircraft), ICT hardware, and medical devices (Sturgeon et al, 2013). While industries are different, and must be analyzed on an individual basis, as they are in depth in the accompanying white papers, there are also crosscutting issues, parallel trends, and shared policy dilemmas that can be usefully identified. This overview paper provides this larger context for the detailed industry work, identifies crosscutting issues, and presents two broad strategies for improving Brazil’s position in GVCs.

The IPC’s Industry Research – The Global Value Chain Perspective

To explore Brazil’s position in the global economy more deeply, and consider in detail the ways in which innovation might play a role in upgrading that position, two perspectives are required: an industry perspective and a global value chain (GVC) perspective. Industries have different structures, regulatory and technological features, labor force and skill requirements, and therefore have different loci where innovation can play a positive role.

Global Value Chains – What are they?

Prospects for economic recovery in Brazil hinge on economic growth that is both inclusive and sustained. We begin with the premise that positive economic engagement with the outside world will be a prerequisite for better economic performance. This is because Brazil’s internal market, while large, is not big or sophisticated enough to support a full set of internationally competitive domestic industries. In fact, no economy is currently developing in this way (Whittaker et al, 2010). The reason is simple. A larger number of tradable goods and services are being produced in geographically fragmented


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GVCs, where goods and services might cross borders several times before final goods and services make their way to end users. Thus, GVCs refer to the sequence of value-added activities, or steps, that comprise the creation, delivery, and end-use of a given product or service. While value chains can be entirely local or domestic, value is increasingly added to products and services in more than one location prior to end use. In some industries, such as ICT and autos, GVCs may span several or even dozens of countries before products find their way to end customers. In addition, exporters are making fewer products for arms-length exports and more products to the specification of companies often referred to as “global buyers”— a category that includes large retailers (e.g., Wal-Mart) and branded merchandisers (e.g., Nike). Either way, the importance of knowing and meeting the requirements of global ‘lead firms’ has become paramount, and significant opportunities have emerged for developing countries to upgrade their operational capabilities and knowledge assets by participating in GVCs. Figure 1 shows a simplified four-stage value chain, and notes that there are four possible sourcing options for each (in fact, almost any) business function: in-house domestic, domestic suppliers, international affiliate and international suppliers. The two main metrics for global engagement, trade and foreign direct investment (FDI), are represented in the right hand portion of the “sourcing option” boxes. Sourcing from international affiliates drives FDI and intra-firm trade, while sourcing from international suppliers drives inter-firm trade, especially in intermediate goods and services.

Figure 1. A simple four-stage value chain with four sourcing possibilities

Source: Sturgeon, 2013 Table 1 summarizes the main trends driving GVC, and identifies some of the key firm-level actors: lead firms, global buyers, global suppliers, and platform leaders. GVC’s are characterized by a “dual unbundling” (Baldwin, 2012) of formerly integrated corporate structures (outsourcing) and formerly integrated national industries (offshoring). While trade and FDI have long been features of the international economy, both have grown enormously in the past 20 years and some truly novel features have emerged, such as the internationalization of suppliers and the emergence of a more open and shared “global supply-base” (Sturgeon and Lester, 2004). It is worth noting that GVCs have been enabled by information and communication technologies (ICT), which facilitate the


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modularization and relocation of work and improve the functional integration of far-flung activities (Sturgeon, 2002; Gereffi et al, 2005; Dicken, 2011). It is also worth noting that some countries and regions, especially Latin America and Sub-Saharan Africa, are poorly integrated in GVCs, with very weak representation of lead firm headquarters and as production and export hubs for subsidiaries, as shown in Figure 2. Table 1. Main Trends Driving Global Value Chains

Outsourcing • Vertical specialization: work and risk passed from lead firms to suppliers • Strategic search for high value business functions by “Lead Firms” • Suppliers struggle with low profits and high fixed costs • From manufacturing to services to R&D

Offshoring and rising foreign direct investment (FDI) by: • Lead Firms (multinational brands) • Global Suppliers (multinational suppliers) • Global Buyers”, which source internationally without FDI (e.g. Nike or Wal-Mart) through

intermediaries or directly from an increasingly competent global supply base What’s new?

• Rise of the global supplier and global supply base • Rising intermediate goods and services trade • More countries entering the global trading system, but more specialization and functional coordination

Not all countries play the same roles or are equally included!

Figure 2. Multinational Firms and their Vertically-Linked Foreign Subsidiaries

Notes: A “vertical” relationship is where the parent and subsidiary produce the same product. The size of the circles in each country indicates the total number of parent companies located in that country that own vertically linked subsidiaries in other countries. The thickness and color intensity of the lines represent the number of bilateral vertical subsidiaries between each parent country and a corresponding host country. Source: Blyde, 2014, based on analysis of Dun and Bradstreet, http://voxeu.org/article/latin-americas-missing-global-value-chains


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GVCs and Development – Opportunities and Challeneges

GVCs are changing the context for industrial development. Because GVCs are fragmented geographically, countries can specialize in specific business functions in the value added chain, such as R&D or manufacturing. Since business functions are associated with different degrees of autonomy and control, profitability, environmental impact, skills, wages and employment, specialization in GVCs can affect the economic and social development prospects of entire societies. As GVCs drive structural change in the world economy, both opportunities and challenges arise for developing countries.

Opportunities for technological learning, market expansion, and industrial upgrading

On one hand, GVCs can drive rapid development, and carry leading-edge industrial competencies to new places (World Bank, 2015). The trade, investment, and knowledge flows that come with GVCs have provided new pathways for rapid learning and industrial upgrading for a range of countries, even small countries (e.g., Singapore and Taiwan). GVCs can provide domestic firms in developing countries with better access to information, new markets, and opportunities for fast technological learning and skill acquisition. Because transactions and investments linked to GVCs typically come with quality control systems and global business standards that exceed those in less developed economies, local enterprises and workers can be “pushed” to acquire new competencies and skills. As GVCs have matured, and the global supply-base has become more capable and assessable, it have become possible for firms in developing countries to “move to the head” of GVCs by leveraging the globally available knowledge and service assets as inputs to their own goods and services.

Low value added traps

On the other hand, participation in GVCs cannot guarantee profitable, sustainable growth. In fact, GVCs can create obstacles to continuous learning and drive uneven development over time, even as they trigger rapid industrial development and employment growth early on. Learning might be rapid at first, but over time, limits can be acutely felt. Because specialization in low value added activities can be persistent, GVCs can wall off domestic companies in developing economies from innovation, new industry creation, and high value-added activities in general; and workers from engaging in highly paid, technologically sophisticated, intellectually satisfying work. Even countries and regions that are deeply connected to GVCs, such as China and other export-oriented economies in East Asia, East Europe, North Africa, and Latin America (e.g. Mexico) can fall into such “low value added traps.” This is because a greater share of value (and profits) tend to accrue to the lead firms in GVCs that control branding, product conception, and retail distribution; as well as to any “platform leaders” that provide core technologies, advanced components, and intellectual property that are key inputs for others in the chain. While there are a growing number of important multinational lead firms and successful technology platform leaders emerging from the developing world (e.g., the Chinese white goods producer Haier and the Taiwan-headquartered mobile handset chipset design house MediaTEK), GVCs are still dominated by firms based in industrialized countries, as


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Figure 2 shows. Firms that provide routine assembly tasks and other simple services within GVCs tend to have lower profits, pay their workers less, and tend to be more vulnerable to business cycles. This idea was first articulated by former Acer CEO Stan Shih as the ‘Smiling Curve’ of value added (see Figure 3), and demonstrated very powerfully by the research of Linden et al (2011) through the case of the Apple iPhone, which estimated that China’s value added to a US $600 iPhone 4 (mainly assembly and packaging) was only US $6.54, about 1% of the retail price (see Figure 4).

Barriers to Innovation

Furthermore, suppliers and services providers in GVCs, and the countries and regions where they are concentrate, may never be exposed to innovation-related activities in the GVC such as basic research, product conception, design, marketing, and customer contact and after-sales service. Entrenchment in narrow, routine, low-value-added activities can lock firms and national industries into unprofitable and technologically shallow segments of the value chain. Again, if low-value-added activities dominate a specific country or region, then consequences for economic performance and social welfare can be profound and persistent. Figure 3. Vertical specialization and the “smiling” curve of value added


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Figure 4. Vertical specialization and the “smiling” curve of value added for a $600 iPhone 4

Source: Data from Dedrick, et al. 2009

The “Adaptive State”

Successful development in the era of GVCs will depend on how quickly and well entrepreneurs and policy makers are able to understand emerging dynamics of specific industry GVCs, recognize opportunities and occupy promising niches, take advantage of inputs and capabilities from outside the country, and develop innovative strategies and policy solutions in concert with a wider range of actors, both domestic and foreign. This will be Brazil’s major challenge going forward.

Brazil’s Current Position in GVCs

Brazil is weakly integrated in GVCs, especially in regard to outward-oriented trade and investment flows. This section provides some evidence for these statements, discusses the drivers of high costs and low productivity in Brazil, and sketches out of how eight Brazilian industries fit into GVCs.

Trade

While international trade has been a feature of the international economy since antiquity, flows have become, not only larger, but more detailed, fragmented, and explicitly coordinated in the past 20 years with the rise of GVCs. First, the global economy is increasingly bound up in trade. World merchandise trade grew by 8% per year from 1995 to 2014, while world GDP grew by only 5.5%. Second, in regard to goods, three complex


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assembly industries, electronic hardware, motor vehicles, and textiles/apparel/footwear have been the most important drivers of GVCs. As Table 2 shows, these three industries’ share of world merchandise exports remained nearly constant at about 45% since 1992 (the next largest category is fuels, including crude oil, which accounts for about 14%), with electronic hardware being the most important and fastest growing by a significant margin. Over this period, exports in the three industries overall have grown, on an annual average basis, at about the same rate as the rest of merchandise trade (7.9% per year), but this masks a more rapid growth of intermediate goods (8,5% per year), with intermediates in electronic hardware and motor vehicles making the difference. Table 2. World Exports in Three “GVC Industries,” 1992, 2008, and 2014

1992 2008 2014 CAGR 1992-2008

CAGR 2008-2014

CAGR 1992-2014

World GDP 25,374,800 63,128,600 78,106,300 5.86% 3.61% 5.50%

World Merchandise Exports 3,786,844 16,148,864 18,996,581 9.49% 2.74% 7.98%

Total Exports in 3 Industries 1,705,303 7,018,218 8,565,801 9.25% 3.38% 7.99% Electronic Hardware 728,370 3,407,782 4,208,324 10.12% 3.58% 8.71% Motor Vehicles 630,512 2,649,143 3,013,625 9.39% 2.17% 7.73% Textile, Apparel, and Footwear 346,421 961,293 1,343,852 6.59% 5.74% 6.67% World Merchandise Exports Less 3 Industries 2,081,541 9,130,646 10,430,780 9.68% 2.24% 7.98%

Exports by Value Chain Stage in 3 Industries

Final Goods 1,077,053 4,184,676 5,069,200 8.85% 3.25% 7.65% Intermediate Goods 628,250 2,833,542 3,496,601 9.87% 3.57% 8.52%

Exports by Value Chain Stage and Industry

Electronic Hardware Final Goods 505,154 1,808,475 2,266,554 8.30% 3.83% 7.41% Electronic Hardware Intermediates 223,216 1,599,307 1,941,770 13.10% 3.29% 10.85% Motor Vehicle Final Goods 394,711 1,654,568 1,776,595 9.37% 1.19% 7.43% Motor Vehicle Intermediates 235,801 994,575 1,237,030 9.41% 3.70% 8.21% Textile, Apparel, and Footwear Final Goods 177,188 721,633 1,026,051 9.17% 6.04% 8.72% Textile, Apparel, and Footwear Intermediates 169,233 239,660 317,801 2.20% 4.82% 3.05%

% of World Merchandise Exports

Total Exports in 3 “GVC Industries” 45% 43% 45%

Electronic Hardware 19% 21% 22% Motor Vehicles 17% 16% 16%

Textile, Apparel, and Footwear 9% 6% 7% World Merchandise Exports Less 3 Industries 55% 57% 55%

% of 3 Industries’ Exports by VC Stage

Final Goods 63% 60% 59%

Intermediate Goods 37% 40% 41%

% of 3 Industries’ Exports by VC Stage & Industry

Electronic Hardware Final Goods 69% 53% 54% Electronic Hardware Intermediates 31% 47% 46%

Motor Vehicle Final Goods 63% 62% 59% Motor Vehicle Intermediates 37% 38% 41%

Textile, Apparel, and Footwear Final Goods 51% 75% 76% Textile, Apparel, and Footwear Intermediates 49% 25% 24%

Note: all values in millions of US dollars at current prices and exchange rates. Sources: 3 Industries: World Bank MC-GVC Database with calculations by Lara Loewenstein. World Merchandise Exports: UNCTADstat, http://unctadstat.unctad.org/wds. World GDP: World Bank World Development Indicators, http://data.worldbank.org/data-catalog/world-development-indicators


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While world merchandise exports have slowed since the global financial crisis of the late 2000s (from 9.5% per year, on average, prior to the crisis to about 8% per year since), exports in two of the three industries (electronics and textile/apparel/footwear) have outpaced trade overall (compare 2.8% overall to 3.4% for electronics and 5.7% for textile/apparel/footwear). Intermediate goods flows were stronger than final goods flows across the entire period, and after the crisis, a signal that GVCs are intensifying and becoming more elaborate. This was true post-crisis even for the motor vehicle industry, where the slowdown was mainly caused by reductions in finished vehicle exports. Surprisingly, after growing the most weakly of the three industries for the entire period, a sign of growing domestic fiber and fabric production in large producing countries, world exports of apparel and footwear intermediates rebounded strongly post-crisis, growing at a clip of 4.9% per year from 2008-2014. As Table 3 shows, Brazil’s overall export performance has exceeded the growth in aggregate world merchandise trade, growing at more than 9% per year during the 1992-2014 period, in comparison to about 8% per year for the world. However, Brazil’s export performance in the three “GVC industries” has been poor, growing at only 3.8% per year in the period, in comparison to about 8% for the world. Furthermore, the share of the three industries in Brazil’s export basket has been falling, from 40% in 1992 to just 14% in 2014, as Brazil’s exports have become increasingly dominated by primary commodities and resource-based manufactures, the strength of which can be seen in the last row of Table 3 and also in Figure 6 below.

Table 3. World Exports in Three “GVC Industries,” 1992, 2008, and 2014

1992 2008 2014 CAGR

1992-2008 CAGR

2008-2014 CAGR

1992-2014

World Merchandise Exports 3,786,844 16,148,864 18,996,581 9.49% 2.74% 7.98%

Brazil Merchandise Exports 35,793 197,942 225,101 11.28% 2.17% 9.15%

World Exports in 3 “GVC Industries” 1,705,303 7,018,218 8,565,801 9.25% 3.38% 7.99%

Brazil Exports in 3 “GVC Industries” 14,282 47,591 31,333 7.81% -6.73% 3.81%

share 40% 24% 14% Electronic Hardware 1,312 7,246 2,985 11.27% -13.74% 3.99%

Motor Vehicles 7,800 34,524 24,393 9.74% -5.62% 5.58%

Textile, Apparel, and Footwear 5,170 5,821 3,955 0.74% -6.24% -1.27%

World Merchandise Exports Less 3 Industries 2,081,541 9,130,646 10,430,780 9.68% 2.24% 7.98%

Brazil Merchandise Exports Less 3 Industries 21,511 150,351 193,768 12.92% 4.32% 11.03% Note: all values in millions of US dollars at current prices and exchange rates. Sources: 3 Industries: World Bank MC-GVC Database with calculations by Lara Loewenstein. World Merchandise Exports: UNCTADstat, http://unctadstat.unctad.org/wds. Moreover, Brazil has not participated in this rebound in “GVC trade,” at least not on the export side of the ledger. An analysis of Brazil’s trade balance in the three industries shows negative and falling performance across the board since the global financial crisis in 2008 (see Figure 5).


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Figure 5. Brazil’s Trade Balance in Three “GVC” Industries, 1989-2014, US$ thousands

Source: World Bank MC-GVC Database and calculations by Lara Loewenstein. Like most resource-dependent economies, Brazil is striving to increase production and exports in technology- and knowledge-intensive sectors, products, and activities. But as Figure 6 makes clear, Brazil’s trade profile is increasingly skewed toward low value-added, low technology industries. In fact, the effect of the commodities boom was to decrease the relative importance of medium- and high-technology exports. After the financial crisis of 2008-2009, higher value added exports entered a period of absolute decline with sluggish global demand for commercial aircraft and the introduction of market protection measures in Argentina (Verotti Farah, 2013) which dampened regional exports of motor vehicle parts and mobile phone handsets currently produced in Brazil by multinationals (see “high-tech” and “medium tech” trade balance in Figure 6).

Figure 6. Brazil’s Trade Balance by Technological Categories, 1995-2014

Note: technological categories based on Lall. For product lists see: http://unctadstat.unctad.org/EN/Classifications/DimSitcRev3Products_Ldc_Hierarchy.pdf Source: Author calculations based on UNCTAD accessed at http://unctadstat.unctad.org/wds on June 2, 2016


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Foreign Direct Investment

Without the low operating costs that can be found in places such as China, Vietnam, and Mexico, export-oriented investments have not taken place in Brazil. But with a population of more than 204 million, Brazil is the world’s 5th most populous country, and its upper middle-income status makes its market arguably more attractive than larger yet poorer countries such as India and Indonesia. For this reason, multinational lead firms such as Samsung, Ford, GE, and many others have been willing to make substantial investments in Brazil to produce for the domestic market. Brazil’s policy apparatus has evolved to capture as much of this activity as possible through a combination of import taxes, R&D tax credits, and very detailed and often escalating local content requirements. To meet these requirements in the context of GVCs, lead firms have been followed to Brazil by many of their most important suppliers, such as Foxconn (producing iPhones), Flextronics (assembly of various electronic hardware), Baker Hughes (oilfield services), and so on. While this creates manufacturing employment in brazil, it crowds hot participation by domestic suppliers. As Figure 7 shows, Brazil was opened to inward foreign investment only in the mid-1990s, and this was followed by a short-lived increase on outward investment in the early 2000s. Since the financial crisis, however, inward flows have continued to rise while outward flows have all but dried up. This provides context for Brazil’s overall ranking in inward and outward global FDI flows (see Table 4). When summing all new inflows between 1970 and 2014, Brazil ranked 8th in the world by 2014, with a total of US$ 676 billion (in current dollars). In terms of outward flows, Brazil ranks a distant 35th, with just US$ 73 billion, below its BRIC competitors of China (#7 with US$ 1.7 trillion), Russia (#13 with US$ 546 billion), and India (#25 with US$ 128 billion) and a sign of weak competitiveness on the part of firms and a dearth of support for outward investment from Brazil’s policy regime. Figure 7. Brazil’s Foreign Direct Investment Inflows and Outflows, 1970-2014 US$ million

Note: figures are in constant dollars. Source: UNCTAD, http://unctad.org/en/Pages/DIAE/FDI%20Statistics/FDI-Statistics.aspx


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Table 4. Countries with More Than US$300B in Total Foreign Direct Investment Flows,

1970-2014, US$ millions

Rank as of 2014

Inward Flows US$M

Rank as of 2014

Outward Flows US$M Balance

Ratio Outward to

inward 1 United States 3,925,115 1 United States 4,875,637 950,522 124%

2 China & HK 2,516,796 2 UK 2,089,216 391,047 123%

3 UK 1,698,169 3 Germany 1,484,657 670,914 82%

4 Belgium 856,449 4 Japan 1,480,772 1,355,122 1,178%

5 Canada 817,727 5 France 1,412,425 745,367 212%

6 Germany 813,743 6 Netherlands 1,106,056 414,374 160%

7 Netherlands 691,682 7 China & HK 1,719,016 (797,780) 68%

8 Brazil 675,655 8 Canada 862,172 44,445 105%

9 Spain 671,170 9 Spain 827,561 156,391 123%

10 France 667,058 10 Switzerland 730,909 434,381 246%

11 Singapore 622,816 11 Belgium 713,005 (143,445) 83%

12 Australia 563,727 12 Italy 570,091 218,587 162%

13 Russian Fed. 510,326 13 Russian Fed. 546,661 36,336 107%

14 Mexico 490,292 14 Sweden 516,081 155,643 143%

15 Sweden 360,438 15 Singapore 336,828 (285,988) 54%

16 Italy 351,504 25 India 128,506 (199,329) 39%

17 India 327,835 31 Brazil 73,774 (601,881) 11%

Note: Excludes tax havens and banking centers: British Virgin Islands, Cayman Islands, Bermuda, Bahamas, Netherlands Antilles, and Luxembourg Source: UNCTAD, http://unctad.org/en/Pages/DIAE/FDI%20Statistics/FDI-Statistics.aspx

The “Brazil Cost”

In Brazil, exports have been limited by high costs, not only for labor but for what has come to be known as the “Brazil Cost,” a catch-all term for the high cost of doing business in a country plagued by excessive and inefficient bureaucracy, low productivity, lack of qualified workers, high taxes and transport costs, high capital costs, and a host other factors.4 This is reflected in the World Bank’s Ease of Doing Business Index (see Table 5), where Brazil ranks 116th out of 189 included economies. While this is not unusual for large developing economies, Brazil’s fares particularly poorly across a range of indicators that would impact globally engaged companies, including foreign investors, importers, and exporters.5 Brazil performs worst in the areas of starting a business (101 days, compared to 29 for Latin America & Caribbean as a whole, with 90 of those days coming from obtaining a permit from the local municipality) and complying with taxes (2,600 hours, compared to 361 for Latin America & Caribbean as a whole, with most time spent complying with social security, corporate income tax, and VAT payments).

4 See https://en.wikipedia.org/wiki/Brazil_cost for a list. 5 Brazil’s ranking is elevated by relatively good protection for minority investor protection, which measures the strength of minority shareholder protections against misuse of corporate assets by directors for their personal gain.


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While most factors listed in Table 5 factors make the integration of Brazil in GVCs more difficult, a detailed look at the World Bank’s “trading across borders” measure shows that Brazil’s performance most negatively affected by high trading costs and the time required for compliance with import documentation (see Table 6).

Table 5. Brazil and Comparator Economies, World Bank Ease of Doing Business Rank. 2015

Ease of Doing

Business

Starting a

Business

Dealing with Construction

Permits

Getting Electricity

Registering Property

Getting Credit

Protecting Minority Investors

Paying Taxes

Trading Across Borders

Enforcing Contracts

Resolving Insolvency

BRIC Brazil 116 174 169 22 130 97 29 178 145 45 62 Russia 51 41 119 29 8 42 66 47 170 5 51 India 130 155 183 70 138 42 8 157 133 178 136 China 84 136 176 92 43 79 134 132 96 7 55 Top 4 Singapore 1 10 1 6 17 19 1 5 41 1 27 N. Zealand 2 1 3 31 1 1 1 22 55 15 31 Denmark 3 29 5 12 9 28 20 12 1 37 9 S. Korea 4 23 28 1 40 42 8 29 31 2 4 Note: for economies with populations with populations over 100 million as of 2013 (BRIC countries) are based on data for 2 cities; Brazil’s rankings are based on São Paulo and Rio De Janerio. Source: World Bank, http://www.doingbusiness.org/rankings

Table 6. Cost and Time Requirements for Imports and Exports for São Paulo in Comparison to Latin America and High Income OECD Economies, 2015

Sao Paulo Latin America & Caribbean

OECD High income

economies Cost to export (USD) Border compliance 959 493 160 Documentary compliance 226 134 36 Cost to import (USD) Border compliance 970 665 123 Documentary compliance 107 128 25 Time to Export (hrs) Border compliance 49 86 15 Documentary compliance 42 68 5 Time to Import (hrs) Border compliance 63 107 9 Documentary compliance 146 93 4 Note: Values determined by case studies of trading oilseed and fruit to China and motor vehicle components to Argentina from São Paulo through the Port Santos. Source: World Bank, http://www.doingbusiness.org/data/exploreeconomies/brazil/#close

Brazil’s Inward-Focus – a Characterization of Eight Industries

As we have seen, Brazil’s economy is inward-focused. Of the eight Brazilian industries listed in Table 7, two are identified as being almost entirely domestic: biofuels and textile/apparel/footwear. These resource- and labor-intensive (respectively) sectors are focused on the domestic market and mainly populated by Brazilian lead firms and suppliers. Among the more technology-intensive industries that make up the rest of


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Table 7, only commercial aircraft (Embraer) and ICT services are identified as having an export orientation, and the latter only marginally so.6 Table 7. Brazil’s Position in Eight Industry Global Value Chains

Market Orientation Lead Firms Key Inputs

Meaningful Product

Innovation in Brazil?

Apparel/Footwear/Textile Domestic Domestic Domestic Low Biofuels Domestic Domestic Domestic High Biopharmaceuticals Domestic Domestic Global Suppliers Low Commercial aircraft Global Domestic Global Suppliers High ICT Hardware Domestic Global Global Suppliers Low ICT Services Domestic Global Global Platforms High* Medical Devices Domestic Global Global Suppliers Low Motor Vehicles Domestic Global Global Suppliers Low Oil & Gas Global** Domestic Global Suppliers High Notes: Lead firms are product level firms such as Ford, Embraer, and GE. Global suppliers are multinational first tier suppliers such as Foxconn, Flextronics, Schlumberger, Bosch, and Yazaki. * Product innovation in ICT services in Brazil, as elsewhere, tends to be in narrow market segments such as banking and cyber-security, and often built on licensed technology platforms from global platform Leaders such as Microsoft, Oracle, and SAP. ** While most Oil & Gas produced in Brazil is consumed in Brazil and the country is a net importer (of light crude), the price is set globally. While biopharmaceuticals, commercial aircraft, and oil & gas are all led by Brazilian firms, including state-linked “national champions” such a Bionovis, Orygen, Petrobras and Embraer, these industries are highly reliant on a set of “global suppliers” for key inputs. All other industries in Table 7 (ICT hardware, ICT Services, Motor Vehicles, and Medical Devices) are led by the local affiliates of “global” lead firms such as Samsung, GE Medical, Ford, and IBM, firms that depend heavily on their stable of global suppliers for key inputs, both outside and inside of Brazil. In most of these industries, most meaningful product innovation takes place outside of Brazil. Petrobras and Embraer do engage in meaningful innovation, in deep water oil production and regional jet development (respectively), but again, rely heavily on key knowledge-intensive inputs (parts, platforms, and sub-systems) from global suppliers, supplied both via imports, and locally produced content. It has become increasingly evident that Brazil’s industrial policies are not working well. While good worker protection in the apparel sector appears to be a bright spot, Brazil’s high consumer prices, negligible exports of higher value, technology- and knowledge-intensive goods and services, low productivity, and weak innovation can all be linked in part to Brazil’s closed economy, which hinders the development of a full complement of internationally competitive firms. While there appears to be growing consensus that

6 While global IT services firms such as IBM and Accenture dominate the Brazilian market, there are significant examples of local IT services lead firms operating and selling internationally (e.g., Stephanini and TOTVS), with products typically built on global IT platforms such as Microsoft Azure, Oracle, and SAP.


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Brazil’s industrial policies are in need of revision, the debate on how to change them is being muted by the paralysis brought on by the current political crisis.

Recommendations and Possible Strategies for Brazil

Improving R&D funding mechanisms in Brazil

While there are structural barriers to innovation in Brazil in many industries because core R&D tends to remain in traditional innovation clusters located in advanced economies, there are a multitude of exceptions, counter-trends, and opportunities that stakeholders in Brazil can recognize, build on, and accelerate. One is the nascent trend toward the international fragmentation of R&D. Large global companies are beginning to shift more R&D to developing countries, including Brazil, for more than localization work.7 Some are even setting up competitions where countries, states, and municipalities are invited to offer incentive and workforce training packages in exchange for the establishment of new R&D facilities. Government mandated R&D spending requirements are a major driver of R&D in Brazil. The 1991 Informatics Law was the first piece of Brazilian legislation to offer firms attractive fiscal incentives in exchange for local R&D spending. However, the law has proven to be an attractive template for other industries seeking to boost investments in R&D. The National Agency for Electric Energy (ANEEL), the National Agency for Telecommunications (ANATEL) and the National Petroleum Agency (ANP) are just three government agencies that have recently begun to require that firms invest a certain percentage on R&D. As a result, current R&D spending requirements range from 4% of revenues in ICT hardware, to 1% in Oil & Gas, .5% in motor vehicles, .4% electricity generation and .3% in electricity distribution. This policy has been relatively successful in bringing R&D investments to Brazil (see Figure 8). Between 2010 and 2014, we calculate approximately $2.9 billion invested. Multinational firms have established substantial captive research centers of their own, including GE’s Brazil Technology Center, IBM Research Brazil, and Microsoft Research’s Advanced Technology Lab, or spent earmarked R&D funds with global suppliers such as Flextronics Institute of Technology, or with domestic research and technology organizations (RTOs) such as CESAR. Some of the captive centers established in Brazil work on global R&D projects, while others work mainly provide localization work. While the spillovers for Brazil remained to be explored in future research, these investments are important first steps toward building Brazil’s R&D capacity.

7 Localization, sometimes referred to as “adaptive engineering,” refers to the additive design work required to adapt products to local markets. Often this is as simple as altering power supplies and documentation language, but sometimes it is more extensive, such as ruggedizing auto suspensions or increasing gas tank capacities for challenging driving conditions. An example is work from the Brazilian labs of the global automotive suppliers Magneti Marelli (Italy) and Delphi (USA) on the “flex fuel” engines that can tolerate a wide range of petrol formulas, including the high ethanol biofuels prevalent in Brazil.


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Other sources of R&D funding include direct government funds, which come in the form of loans or grants via bodies such as BNDES, FINEP, and state-level research foundations such as FAPESP; as well as public-private funding programs such as Embrapii and the SENAI “innovation” calls. Figure 8. R&D Center Investments in Brazil by Multinational Firms, 2010-2014

Source: Calculations by Ezequiel Zylberberg and Renato Lima de Oliveira, IPC. Because policy-driven R&D funding is substantial and has been flowing for some time, the market for R&D services in Brazil is quite crowded, especially in ICT. In 2013, 126 university departments and RTOs certified by the National Committee for IT (CATI) worked on projects in collaboration with industry. But the market is also concentrated, with the ten largest RTOs and universities accounting for 63 percent of all outsourced R&D linked to the Informatics Law. As more R&D funding flows in Brazil, and inward FDI continues to grow (see Figure 7),8 SENAI’s ISIs my have opportunities to work with newly arriving multinationals without local internal R&D capabilities. As this suggests, much of the policy-driven R&D in Brazil serves the needs of large, often multinational firms. Startups and SMEs tend to be underserved by existing RTOs. In fact, there is currently no mechanism for incentivizing research projects with local suppliers, start-ups, or product-based SMEs. This underserved market represents an opportunity for the ISIs. 8 Especially in Oil & Gas with Petrobras selling assets such as its liquefied gas subsidiary Liquigás and no longer required to bid on all new oilfields in Brazilian territory.


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To improve the effectiveness of Brazil’s industrial and innovation policies, several adjustments are recommended. First, local content rules could be simplified. Overall targets should replace detailed lists of inputs, and lead firms, together with suppliers, could decide which products and activities are best suited for production in Brazil. In this way, Brazil might develop specialties in GVCs for the domestic market, and then push into exports. Second, uncertainty over what constitutes R&D has undermined the effectiveness of R&D earmarks. The Brazilian government should provide a clear, but very broad (not over-specified or industry specific) definition of what constitutes R&D. Third, earmarks in R&D funding streams should be created for start-ups and SME, including smaller suppliers. Finally, local content rules should be updated with credible and actually enforced sunset clauses to increase competition and productivity. A set of globally-linked, internationally competitive start-ups and smaller suppliers in Brazil, with direct access to policy-driven R&D funding streams, could help multinationals in Brazil meet local content requirements and increase exports, and also serve domestic firms in support of the local innovation and production ecosystem. Our research has identified two different but ultimately complementary strategies for accelerating innovation in Brazil: supplier upgrading and platform innovation. The SENAI ISIs can play a role in both strategies.

Supplier upgrading: leveraging Brazil’s foreign direct investment for upgrading

Because of tight supply-chain dependencies in technology-intensive sectors, local content requirements largely work to create protected spaces for multinational firms — both lead firms and global suppliers — with the benefits for Brazil mainly coming from manufacturing employment positioned at the bottom of the value added, or “smile” curve (see Figure 3). For suppliers to major exporters, such as Embraer and Samsung, key parts and sub-systems can be imported duty-free and with expedited customs clearance under the RECOF program, further decreasing opportunities for local firms. When local suppliers are used, they have little incentive to increase productivity or innovate, because their cost advantage relative to imports dampens competitive pressure. For these reasons the general story for local suppliers and SMEs in Brazil, as in many other countries, is one of poor integration into GVCs (Sturgeon and Lester, 2004). This is true even in China when foreign invested enterprises dominate exports and the import content of exports is high (Dean et al., 2007; Sun and Grimes, 2015). So market space for local firms and SMEs in general has narrowed over the past 20 years, even with strong local content requirements. However, the situation in Brazil is more challenging because high costs and low productivity reduce the potential for exports. It is important to keep in mind that global lead firms have come to use the same, overlapping set of global suppliers in multiple locations. As a result, supplier affiliates in different locations compete intensively for exports. For example, if a global automotive seat frame supplier in Brazil has costs significantly higher than Thailand or Mexico, and seat frames are needed in a final assembly plant in the United States, then the lead firm will select the seat frame from Thailand or Mexico (all else being equal). In the context of GVCs,


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Brazil’s high costs put a cap on the scale of production, dampen exports, and raise prices for consumers. To counter this, domestic supplier development programs should be aggressively expanded and strengthened. Requirements for local content could add performance-based inclusion incentives for lead firms to use and help develop the local supply-base. To be sure local firms are included, a requirement to spend a meaningful percentage of subsidized R&D dollars with start-ups and SME could be instituted. The new SENAI ISIs can play a role by helping local suppliers and SMEs with process innovation. Since the focus of the ISIs in on innovation, not technical assistance, this should push beyond, yet be in keeping with, process or organizational improvements such as new machinery or lean production practices. At the same time, radical improvements can be problematic if they create proprietary methods that move away from global standards. When local firms innovate to meet the requirements of global lead firms and suppliers, this can be mitigated, especially in the ISI can play an “knowledge broker” role by transferring knowledge about global standards to local firms and helping them gain appropriate certifications. In addition, a global push for open standards is gaining steam under various labels including “manufacturing 4.0,” “cyber-physical production,” and the “industrial internet.” These efforts are being led by a set of important manufacturing and ICT companies including Siemens, Bosch, Cisco, Intel, Amazon Web Services, Accenture and EMC. The vision is to generate and share production and supply chain information across factories, facilities, and networks of firms participating in GVCs. One idea is for sensor-laden production tools to automatically generate and share information in “big data” pools that can increase transparency, ease collaboration across enterprise and geographic boundaries, and ultimately boost productivity, reduce waste, and open up new pathways for innovation. While significant questions remain about cyber-security, IP protection, and standards agreements, projects that fully engages these new trends might provide Brazilian suppliers with some novel options for GVC upgrading through process innovation. We recommend caution, however, because current efforts are uncertain and in their infancy.

Moving to the head of the value chain: platform innovation

Innovation drives the creation of new products and industries where first-mover advantages over international rivals can come into play, driving employment growth and wealth creation. Innovation spurs the formation of young, fast-growing “gazelle” companies and can rejuvenate established firms as well. While this is received wisdom, it is still useful to step back and ask, what is innovation? When a broad definition is used, the concept of innovation can extend far beyond R&D and science-based innovation centered on materials, components, products and processes. One such broad definition is provided by the OECD’s 2005 “Oslo Manual” on measurement of scientific and technological activities, which proposes guidelines for


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collecting and interpreting technological innovation data. The Oslo definition of innovation includes product, processes, marketing, and organizational innovations (see Table 8).9 Our approach sums up the non-traditional aspects of innovation (marketing and organization) as business model innovation. Table 8. Defining Innovation Based on “Oslo Manual”, 3rd edition, 2005

• An innovation is the implementation of a new or significantly improved product (good or service), or process, a new marketing method, or a new organizational method in business practices, workplace organization or external relations. The minimum requirement for an innovation is that the product, process, marketing method or organizational method must be new (or significantly improved) to the firm.

• Innovation activities are all scientific, technological, organizational, financial and commercial steps which actually, or are intended to, lead to the implementation of innovations. Innovation activities also include R&D that is not directly related to the development of a specific innovation.

• An innovative firm is one that has implemented an innovation during the period under review. Four types of innovation: 1) Product innovation is the introduction of a good or service that is new or significantly improved with respect to

its characteristics or intended uses. This includes significant improvements in technical specifications, components and materials, incorporated software, user friendliness or other function al characteristics. Product innovations can utilize new knowledge or technologies, or can b e based on new uses or combinations of existing knowledge or technologies.

2) Process innovation is the implementation of a new or significantly improved production or delivery method. This includes significant changes in techniques, equipment and/or software. Process innovations can be intended to de crease unit costs of production or delivery, to increase quality, or to produce or deliver new or significantly improved products.

3) Marketing innovation is the implementation of a new marketing method involving significant changes in product design or packaging, product placement, product promotion or pricing. Marketing innovations are aimed at better addressing customer needs, opening up new markets, or newly positioning a firm’s product on the market, with the objective of increasing the firm’s sales.

4) Organizational innovation is the implementation of a new organizational method in the firm’s business practices, workplace organization or external relations. Organizational innovations can be intended to increase a firm’s performance by reducing administrative costs or transaction costs, improving workplace satisfaction (and thus labor productivity), gaining access to non-tradable assets (such as non-codified external knowledge) or reducing costs of supplies.

Source: Tiwari, 2008 To provide an example of why a broad definition of innovation could be important, we can focus on a set of business model innovations in the U.S. current economy embodied in emblematic “platform companies” (Parker, et al, 2016) generally founded in the 2000s such as Uber, Airbnb, Facebook, and Instagram. Other examples abound, including Twitter, Google, Amazon, PayPal, WhatsApp, and Netflix. While the business models of these companies vary, they have, in general, combined a set of marketing and organizational innovations with novel linkages to external resources — including user- and third-party-created content and data — to create a new set of innovative business models. A common thread is that these companies combine existing products, services, and ICT infrastructure in new ways. They are largely built on top of existing systems, and 9 The Oslo Manual is widely accepted and deployed by data agencies and academic researchers, for example in Eurostat’s Community Innovation Survey.


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often solve information problems and provide a linking function. Table 9 compares five young platform companies with a corresponding (in terms of market focus) set of much older “product-based” companies according to employment and market capitalization. In platform innovation we see an innovative business model that is not science- and technology-based as traditionally conceived. Although successful platform companies generally create network effects through software that provides users with a good experience, they can also be seen to be operating in, and in some ways substituting for (and disrupting) traditional market segments such as taxis, hotels, media, and consumer photography. Since many generate profits mainly as platforms for advertising, they can be seen to be encroaching on this industry as well. Table 9. Selected Platform vs. Product Companies Firm Year Founded Employment* Market Cap Market Focus

BMW 1916 116,000 $53B

Personal mobility GM 1908 216,000 $60B Google** 1998 56,000 $377B Uber 2009 5,000 $60B

Marriot 1927 200,000 $17B Accommodation Airbnb 2008 3,000 $21B

Walt Disney 1923 185,000 $165B Media Facebook 2004 12,691 $315

Kodak** 1888 145,000 (heyday) $30B Consumer

Photography Instagram*** 2010 13 (at acquisition) $1B Notes: *Employment does not including drivers/car owners (Uber), property owners/managers/maintenance workers (AirBnB), users/content producers (Facebook and Instagram). ** Google’s driverless car business is in its infancy; the company, as the largest and most powerful platform company, is included here mainly for comparative purposes. *** Employment and valuation at heyday. **** Employment and value at time of acquisition by Facebook. Source: adapted from Van Alstyne (2016) and White (2016) for Google and General Motors (GM). While platform business models raise significant questions regarding employment, public safety, and broad social impacts, the model is clearly generating wealth and having an impact on traditional industries. A feature of successful platform innovators, most built on the ultimate platform (the internet), is the rapid shift to “hyper-scale,” where network effects propel the most successful platforms to market dominance (Parker et al., 2016). This raises the question of how much market space there is for developing countries in the “platform economy” and if market protections and restrictions, such as those placed in Internet companies in China, are a viable industrial policy. It is worth noting that platform companies based in the United States currently dominate the new “platform economy” by a wide margin (see Figure 9).


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Figure 9. Headquarters Region of Platform Companies with more than US$1B Market Cap

Source: Van Alstyne, 2016 Another worry is the apparent disjuncture between successful innovation and large-scale employment by platform companies (see 3rd column of Table 9). Some also warn, rightly, about lower profitability stemming from difficulties in monetizing services and collecting licensing fees for the use of platform and embedded modules, as well as “modularity traps” that reduce product distinctiveness when products are based on widely used modules (Gower and Cusumano, 2002). Arbache (2016), writing specifically about Brazil, warns of “digital commodification” and that “using digital technologies can make little or eventually no significant difference to competitiveness if that technology is accessible by many.” While these are all viable concerns, we take a broader, and more positive view of platform innovation in developing countries. When non-consumer facing platform leaders such as Intel, Oracle, and SAP are included in the analysis, as they are in Figure 9, it is clear that platform-based products and services can arise at various stages in the value chain. For example, Intel’s chipsets for the PC industry, combined with Microsoft’s Windows operating system, have long provided a platform upon which personal computer companies have developed new desktop, notebook, and tablet systems, albeit with some loss of profits and product distinctiveness. At an even more basic “upstream” level companies such as the UK-based ARM, sell specialized code, or “IP blocks” for inclusion in application-specific semiconductors designed by downstream chip design firms. Moving further downstream from chip sets, computers, and servers, to the enterprise computing space, Microsoft Azure, SAP, and Oracle platforms allow IT services firms to build customized systems for clients for corporate computing, enterprise resource planning, and database management systems. Google’s Android operating system, in combination with mobile phone chipset companies such as Nvidia and Qualcomm, have allowed handset companies such as Samsung, LG, and HTC to design a wide range of handsets and tablets suitable for world markets, while handset makers other than Apple that could or would not make the transition to Android, including formerly dominant Nokia (along with Motorola, Siemens, Sony-Ericsson, and Research in Motion’s Blackberry) have all but disappeared.


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Even dominant “hyper-scale” social media platforms such as Facebook and internet search companies such as Google can be embedded in upstream products and services, thus becoming “modules” in more highly integrated products and services. For example, a service for traffic light monitoring and maintenance can embed (for a licensing fee) functional elements such as Google Maps to quickly and inexpensively add powerful system elements that, because they are nearly ubiquitous, meet user expectations. In other words, hyper-scale platforms can sometimes be seen as system elements to be leveraged rather that behemoths to be competed against. Cloud storage, sometimes running remote applications in a “software-as-a-service” model, can provide start-ups and other under-resourced companies with vast storage and computing resources to both improve productivity and increase the functionality of their product offerings.

Platform innovation in Brazil?

Since suppliers tend to toil in low value added segments of the GVC, and multinational firms have extensive R&D outside of Brazil, a useful question is how Brazilian-based firms, including start-ups and product-based SMEs can “move to the head” of GVCs by developing their own, globally-compatible and competitive products and services. One answer could be product innovation that draws on platforms and other technology-intensive resources resident in the global supply-base. While GVCs have created a complex set of business relationships among large, globally-operating firms at multiple levels of the value chain, they have also created a new global supply base that is relatively open to buyers. In other words, while it can be difficult for smaller local firms to enter and upgrade in GVCs as suppliers, Brazilian lead firms, even small product-based firms, have the potential to draw on the global supply base and leverage the globally available knowledge and service assets that now reside in platforms as inputs to their own goods and services. There are many examples of this approach, including the ‘fabless’ semiconductor design firms in the U.S., Taiwan, and Israel that use the services of merchant semiconductor fabrication plants (foundries) to produce their designs. Most prominent, however, are the new digital “platform companies” that that provide a market linking function by leveraging the connecting power of the internet. The impression, from project interviews, is that there is a general bias in Brazil toward innovation in basic research and science. The Brazilian innovation system, in broad strokes, is not strong in commercialization or scale up. Platform innovation, because it draws in highly functional system elements, provides innovators with a leg up, both in terms of product functionality and alignment with global standards. And, products that meet global standards can be suitable for large-scale production and export because they are accepted on world markets. While this discussion mainly uses examples from the ICT sector, the concept is relevant in other sectors as well, including commercial aircraft (e.g. Embraer’s use of Pratt and Whitney jet engines and may other system elements sourced from the global supply-base), Oil and Gas (Brasa’s has sourced topside modules from China to overcome production delays in its shipyard), and motor vehicles (automakers’ sourcing of braking systems from Bosch, to provide one of hundreds of possible examples). While it is true


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that there are costs to using these modular system elements, in terms of licensing fees and product distinctiveness, and that hyper-scale platforms can be difficult to compete with directly, there appear to be vast new product spaces to be created, and old one to be disrupted, at many levels of the value chain. Expenses such as platform license and cloud storage fees paid to entities outside Brazil are seen by the country’s tax authorities as imports of business services, and as such are subject to a 25% tariff. From our interviews with SMEs in Brazil, these taxes were seen as a significant burden and barrier to scale up required for growing in Brazil and in international markets. Reducing or eliminating import tariffs on business services would seem to be a wise and perhaps achievable policy goal.

Roles for the ISIs

Each of the industry studies, Biopharmaceuticals, ICT, and Oil & Gas, have identified small and medium-size businesses as an important target client base for the ISIs. While multinationals are important as a window into new technologies, markets, and business practices, as well as sources of revenue, the ISIs may find that there is less crowding out with SMEs and greater room for impact. Strengthening Brazil’s supply chains and improving supplier productivity through process and product innovation should be a priority for the ISIs. As discussed in the research and technology organizations (RTOs) white paper, this will require addressing long-term funding structures and partnerships for the ISIs. In the ICT white paper prepared by Ezequiel Zylberberg for this project, a distinction is made between RTOs that act as “contract research organizations” for their clients and those that act as “innovation partners.” In the first approach outlined here, supplier upgrading, requirements are mainly laid out by larger global suppliers and lead firms downstream in the supply chain. For this reason, the main role for the ISI could be knowledge brokerage, including helping suppliers access new technologies, build know-how, connect with experts, and meet the emerging standards of the “digital economy” as embodied by concepts such as Manufacturing 4.0. For the second strategy, platform innovation, a knowledge brokerage role is also needed as a way to connect Brazilian product-level start-ups and SMEs with appropriate components, platforms, services, and other resources available in the global supply-base. Help with licensing agreements and component and platform integration could also be very useful. With both strategies ISI would be clearly positioned in the “innovation partner” role.

Concluding Comments

While Brazil’s problems go deeper than its role in GVCs, the perspective offers a useful jumping off point for ongoing policy debates. Indeed, many in Brazil’s policy community have referenced upgrading in GVCs, and a more effective embrace of the “digital revolution,” as levers to move the country out of its currant malaise. The conversation needs to begin, of course, with the current situation. Brazil’s industrial policies, and especially its local content regulations, have spurred high levels of inward


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FDI since the mid-1990s. Without strong efforts to upgrade the domestic supply-base, this has largely served to increase production and employment in Brazil, with the main benefit to Brazilian society coming from manufacturing employment. The system provides Brazilian consumers with world standard products, but at inflated prices. Local content policies also retard Brazilian firms’ ability to access knowledge intensive intermediate goods and services, and this increases costs, lowers productivity, and isolates Brazilian-designed products from world markets. Local content policies aimed at specific products and industries are not new or even uncommon. Although they are against the spirit of WTO rules, which discourage sectoral industrial policies by signatories, agreements commonly allow countries to introduce changes gradually, through “progressive liberalization,” and developing countries such as Brazil are given longer to fulfill their obligations. Import taxes are generally allowed, as long as they are transparent and stable. Finally, sectoral policy initiatives are generally tolerated unless they involve large export subsidies that effectively “dump” products on the markets of trading partners in economically and politically important industries. In other words, while trade disputes do arise, WTO signatories do have a significant level of flexibility. The localization policy regime that has arisen in Brazil, however, while no less assertive than other countries in regard to local content targets, it is unusually detailed and cumbersome. In keeping with other aspects of the Brazil Cost, local content requirements are time consuming to comply with, difficult to understand, overly detailed and proscripted, constantly shifting, and often lack or have ineffectual sunset clauses.

However, as the case of China shows, low costs and process excellence does not guarantee that a country’s domestic firms will shift into higher value added functions in GVCs, since gains tend to be captured by the lead firms that define products and orchestrate the global supply chain. And we know Brazil will never compete on the basis of costs. Thus, it is important to ask how Brazilian firms can lead GVCs, rather than only working in isolation (as in the apparel) industry, or as a source of labor for large multinationals serving the domestic market. With the waves of outsourcing and globalization that occurred in the 1990s and 2000s, a new global supply-base has come into being. As the case of Embraer shows in regional jets, product innovation need not rely solely on the ideas and capabilities of the firm, cluster, or national supply-base, but can combine these with resources drawn from global palette of knowledge-based inputs available in the global economy. This can include advanced materials and components, machinery, contract research (RTOs), consulting, and so on. This is especially true for start-ups and SME, which may not have the resources to develop internal capabilities and capacities for software development, manufacturing, logistics, or any number of mission-critical business functions. But Brazil has to be open to such knowledge-intensive inputs. Empirical research has also shown that access to a range of competitively priced foreign intermediate goods has been crucial to achieving higher productivity in both industrialized countries and recent developers such as India and China (Goldberg et al, 2008; Miroudot et al, 2009).


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A question is if ISI, and ISI Directors, can become agents of change in Brazil. The ISIs could demonstrate how updated and improved set of industrial policies, especially local content rules, R&D spending incentives, and import taxation rates for knowledge-intensive intermediates and business services, can contribute to accelerating innovation in Brazil. These benefits could be demonstrated in the context of specific projects. This paper has argued for the importance of taking a GVC approach to understanding Brazil’s role in the global economy, identified some of the regulatory and institutional impediments to upgrading, and made some suggestions about how ISIs might help accelerate innovation in Brazil in ways that improve the country’s position in higher value added segments of GVCs. These ideas are preliminary, however. They need to be tested with stakeholders in Brazil, and held up to the mirror of the actual capabilities and ongoing activities at the ISIs.


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References

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Appendix

Figure 10. Brazil’s Export Basket, 2014 and 2008 a) 2014

b) 2008

Source: MIT Observatory of Economic Complexity, http://atlas.media.mit.edu


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Figure 11. Brazil’s Export Destinations, 2014 and 2008 a) 2014

b) 2008

brazil in global value chains timothy j. sturgeon, ph in global value chains timothy j. sturgeon,...

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