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155 Deindustrialization and Dutch Disease: the case of Brazil José Alderir da Silva Abstract: The objective of this paper is to identify whether deindustrialization in vogue in the country is caused Dutch disease. Capital inflows and valuation of the Brazilian international commodity prices has provoked the appreciation of the real exchange rate in the last decade. However, its effects on the manufacturing industry suggests that the Dutch disease in Brazil occurred only in relative terms, given that the country's productive structure has not lost also important links may have caused reprimarization. Moreover, it is necessary measures to prevent more harmful effect on the industry and therefore on the growth and development of Brazil. Keywords: Deindustrialization, Dutch disease, exchange rate, Brazil GEL: F14, F13, L16. 1. Introduction Brazil has undergone in recent years with a slowdown in its industry 1 , known in the literature as deindustrialization. This deindustrialization can be derived from several factors such as, increased labor productivity, income elasticity of demand, outsourcing, new international division of labor, reduction of investment and finally, the Dutch disease.Various studies argue that trade and financial openness in the decades of 1980-90 combined with the appreciation of commodities prices in most recent period, powered by demand from China and India, has provoked to deindustrialization via Dutch disease (PALMA, 2005; SHAFAEDDIN, 2005; BRESSER-PEREIRA, 2008; MARCONI and BARBI, 2010). Despite the almost continuous appreciation of the exchange rate since 2004, the trade balance only recently started to reduce. Phenomenon compatible with the Dutch disease, i.e., exchange rates appreciated trade surplus.Therefore, the objective of this article is to identify if or not Brazil was contaminated by the Dutch disease in recent years? If yes, what is the antidote to cure Brazilian? If not, how do we prevent possible contagion?It is argued in this study that the Brazilian industry has losing space to imported products in traditional sectors and intensive technologies, characterized as premature deindustrialization, but in early stages. The Dutch disease in fact has been a major cause, given the appreciation of international prices and capital inflow in the period. Though, it is still only a small fever, since the industry has not lost important links of the productive chain, so that the reprimarizationstill a ways off of the Brazilian economy. But, if there is no a change in the current macroeconomic arrangement, this can turn a simple fever virus difficult to cure. This article is organized in four sections besides this introduction. The first section is laid the theoretical basis for research support. In the second section we argue that premature deindustrialization has done gift in the Brazilian economy. In the following section, we identify the Dutch disease in Brazil. Finally, the fourth section, the final considerations. 2. Deindustrialization and Dutch Disease 2.1. Deindustrialization 1 The industry term in this study refers to the processing industry.

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155

Deindustrialization and Dutch Disease: the case of Brazil

José Alderir da Silva Abstract: The objective of this paper is to identify whether deindustrialization in vogue in the country is caused Dutch disease. Capital inflows and valuation of the Brazilian international commodity prices has provoked the appreciation of the real exchange rate in the last decade. However, its effects on the manufacturing industry suggests that the Dutch disease in Brazil occurred only in relative terms, given that the country's productive structure has not lost also important links may have caused reprimarization. Moreover, it is necessary measures to prevent more harmful effect on the industry and therefore on the growth and development of Brazil. Keywords: Deindustrialization, Dutch disease, exchange rate, Brazil GEL: F14, F13, L16. 1. Introduction Brazil has undergone in recent years with a slowdown in its industry 1 , known in the literature as deindustrialization. This deindustrialization can be derived from several factors such as, increased labor productivity, income elasticity of demand, outsourcing, new international division of labor, reduction of investment and finally, the Dutch disease.Various studies argue that trade and financial openness in the decades of 1980-90 combined with the appreciation of commodities prices in most recent period, powered by demand from China and India, has provoked to deindustrialization via Dutch disease (PALMA, 2005; SHAFAEDDIN, 2005; BRESSER-PEREIRA, 2008; MARCONI and BARBI, 2010). Despite the almost continuous appreciation of the exchange rate since 2004, the trade balance only recently started to reduce. Phenomenon compatible with the Dutch disease, i.e., exchange rates appreciated trade surplus.Therefore, the objective of this article is to identify if or not Brazil was contaminated by the Dutch disease in recent years? If yes, what is the antidote to cure Brazilian? If not, how do we prevent possible contagion?It is argued in this study that the Brazilian industry has losing space to imported products in traditional sectors and intensive technologies, characterized as premature deindustrialization, but in early stages. The Dutch disease in fact has been a major cause, given the appreciation of international prices and capital inflow in the period. Though, it is still only a small fever, since the industry has not lost important links of the productive chain, so that the reprimarizationstill a ways off of the Brazilian economy. But, if there is no a change in the current macroeconomic arrangement, this can turn a simple fever virus difficult to cure. This article is organized in four sections besides this introduction. The first section is laid the theoretical basis for research support. In the second section we argue that premature deindustrialization has done gift in the Brazilian economy. In the following section, we identify the Dutch disease in Brazil. Finally, the fourth section, the final considerations. 2. Deindustrialization and Dutch Disease 2.1. Deindustrialization 1The industry term in this study refers to the processing industry.

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The traditional orthodox theory, besides the excessive orientation on the supply side, do not give importance to the possibility of a specific sector to lead economic growth, what is relevant is that the economy will grow, regardless of the sector that lead. As growth is determined by the market, this is who determines what the most dynamic sector in any given moment. Therefore, the government should not favor determined sectors through policies that aim to protect, sustain or expand. Being the long-term growth determined by factor accumulation and technical progress, the discussion of who determines the growth in the short term is irrelevant.On the other hand, the heterodox theory believes that the industry has a crucial role for growth, considered the engine of economic growth. Hence, the government not only can but must carry out sectoral policies (KALDOR, 1967). Thus, the weakening of the industry would be detrimental to the long-term economic growth. However, the economic development is inherent deindustrialization, which can be divided into three phases. Initially agriculture concentrates greater share in employment and output in national totals. But as its productivity increases the industry tends to gain prominence, increasing its relative share in income in relation to agriculture and services. This occurs, according to Adam Smith, because the desire of feed for all men is limited by the size of your stomach. Then the industrial sector gives way to services, since at some point the share of services exceeds the share of industry in GDP. This third phase is what is called deindustrialization natural connotation of economic success. However, it is expected that the situation in this country has a modern and diversified productive structure, with relatively high productivity and sufficiently to avoid problems of balance of payments as well as a per capita income similar to that of developed countries.Nevertheless, the term deindustrialization also has a negative connotation (deindustrialization premature), i.e., deindustrialization can occur before its productive structure is modernized and diversified, so that per capita income has not yet achieved satisfactory levels, similar to developed countries. This relative loss industry can be identified from two concepts of deindustrialization disseminated in the literature. Rowthorn and Wells (1987) defined it as the persistent fall of share of industrial employment in total employment of a country (or region). Tregenna (2009) defined the deindustrialization as the consistent reduction of both the share of employment as of the value added of industry in total employment and GDP, respectively.Within these concepts, deindustrialization can occur by the interaction of diverse factors: an increase in labor productivity in the industrial sector, income elasticity of demand, outsourcing, new international division of labor, reduction of investment and “Dutch disease2”.All these factors can lead to deindustrialization natural or premature, however it is necessary some observations. First, deindustrialization in the natural sense of development, does not imply that the industry disappears. The importance of the industry is reduced only in relative terms. This is despite of industrial employment in fact be reduced, industrialized countries continue so industrialized as before. Hence, deindustrialization can occur even industrial output is growing in absolute terms.Moreover, as it comes from the premature deindustrialization, the country's productive structure can be reprimarizada. This happens in countries rich in natural resources and/or on macroeconomic policies aimed at trade liberalization and financial3. In these circumstances, the future of the domestic industry is compromised, with the great challenge to reindustrialisation (Tregenna, 2011). Second, deindustrialization premature is usually accompanied by specialization and regression of the productive structure, frequently caused by what is known in the literature as “Dutch disease”. But, premature deindustrialization can occur even in the absence of Dutch disease.

2In this paper we focus on this last factor. For a better understanding of other factors see Nassif, 2008. 3See Palma (2005); Shafaeddin (2005) andDasguptaand Singh (2006).

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2.2. Dutch Disease The term “Dutch disease” was first mentioned in the English weekly magazine “The Economist” in 1977 to describe the harmful effects on the Dutch industry arising from discovery of large natural gas reserves in the North Sea in the years 1960-70. The inflow of foreign exchange in the Netherlands, caused by natural gas exports, caused the appreciation of Dutch currency (Forint), reducing the competitiveness of its industries and thus causing deindustrialization 4 .So, initially we define as the Dutch disease specialization of a country that already has a certain degree of industrialization or not, in the production of intensive in natural resources and/or workmanship which to generate competitive advantages derived from Ricardian rents, modifies the list of exports and thus generating increased revenue in foreign currency that ends over appreciatedthe real exchange rate. This overvalued exchange rate reduces the competitiveness of industry given the rest of the world, resulting in the retraction of production/export of tradable goods more technology-intensive and higher value-added. Namely, there is a kind of “reprimarization or regressive specialization” of the export. In the absence of factors to reverse the process described, the structure and productive industry reprimarizada is scrapped, with only minors aggregation chains with the rest of the economy, such as the food industry5. And therefore, the discovery of natural resources instead of “blessing” becomes the “curse” for the country6.Thus, deindustrialization caused by Dutch disease always has a negative connotation. Since the loss of industry participation in employment and/or added value will be relative and absolute (OOMES andKALCHEVA, 2007). Nevertheless, the Dutch disease does not necessarily imply a deficit in the trade balance, since the surplus of primary goods is sufficient to cover the deficit in manufactured goods. Corden and Neary (1982) pioneered the modeling of the Dutch disease. In this model, the definition of deindustrialization is no less important. Later, the model was enhanced by Corden (1984). In summary, the specific model the existence of three sectors: 1) the tradable booming sector7, 2) the tradable sector lagging (industry), and 3) non-tradable goods sector (services).By hypothesis, the growth of the tradable booming sector is derived from technical progress, resource discovery and/or changes in the prices of products of this the sector. Suppose that, for example, it occurs the discovery of natural resources that increase the growth of the booming sector. This boom initially increases the income of the booming sector and generates the exchange rate appreciation, reducing the competitiveness of tradable manufactured goods and thus causing the Dutch disease in the terms traditionally. Moreover, part of the extra income will be spent booming sector within the sector itself, and another part will be spent on non-tradable goods sector, especially services. Given the supply of these goods, the increased demand is reflected exclusively in the increase of domestic prices. Consequently, ceteris paribus, the real exchange rate becomes more appreciated. This process is referred to in the literature as the effect of spent. This overvalued exchange rate leads to drop in the share of industrial employment in total employment and output in GDP. So, deindustrialization premature prevails in the economy and, depending on the income elasticity of demand

4Other cases were analyzed in the literature, such as the discovery of gold in Australia in the nineteenth century (Blainey, 1970) and the flow of gold from America to Spain in the sixteenth century (Forsyth and Nicholas, 1983). 5Bresser-Pereira (2007) considers the Dutch disease is a market failure which, when not properly neutralized, constitutes an important obstacle to economic growth. But, this market failure can be corrected by the administration of the exchange rate. 6The discovery of natural resources does not necessarily imply a curse. The curse is manifested in countries that have a backward society with weak institutions that foster corruption, underdeveloped financial systems and even in non-democratic countries (Frankel, 2012). 7Rich in natural resources.

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for services8, the productive structure can be reprimarizada. In this case, the demand for manufactured goods is fully satisfied through imports. However, this effect cannot be worn if the income elasticity of demand for services is equal to zero and if the exchange rate appreciation is controlled by the government, with the central bank possessing sufficient international reserves to prevent the fall of the real exchange rate. So the industry is preserved and deindustrialization is halted.Though, the effect spent is not the only arising from the discovery of natural resources. It also has the effect of moving resources. The booming sector to increase output and continue increasing the income will need to hire more labor, making the real wage in the sector more than the others, reducing employment in these and increasing employment in the booming sector. Nevertheless, the profitability of capital also tends to change in favor of the latter sector, reducing the capital in tradable and non-tradable sectors. Thus, there is a reduction in output and employment in the two sectors not affected by the boom and the increase in output and employment in the booming sector. In other words, is the (effect) movement of resources (capital and labor) from other sectors to the sector rich in natural resources. Consequently, this effect causes, depending on the degree of use of these factors in the growing field, deindustrialization premature and reprimarization productive structure. But, without necessarily occur to currency appreciation. When the two effects are considered simultaneously, the movement of resources tends to intensify the appreciation of the real exchange rate. The fall in employment and capital in the non-tradable sector reduces its supply and thus generating an excess demand that ends up reflecting new price increase and, consequently, increasing the appreciation of real exchange rate. Share of employment in the sector of tradable dispensed is absorbed in the service sector, thus generating deindustrialization.The final size of a boom is weighted by effect of spent and movement of resources. The weights of each effect is determined by the income elasticity of demand for services and the degree of utilization of capital and labor in booming sector9. Krugman (1987) to treat the revenues from natural resources such as external transfers to the economy in question, argues that the greater the volume and duration of such transfers, the harder it will to recover the pattern of specialization previous. If transfers hang for a long time, structural change can be permanent.In another pioneering study, Palma (2005) elaborates a new concept of Dutch disease. Palma to analyze a sample of 105 countries identified that the Dutch disease can also arise in macroeconomic policies disastrous. The author divides the sample into two groups: 1) countries pursuing a surplus in the manufacturing sector to cover the deficit in other sectors, and 2) countries that although they are able to generate a surplus in primary commodities or services, pursuing a strategy of industrialization in pursuit of a commercial surplus in manufacturing. In his analysis, Palma observed in a group of countries, industrialized and industrialization phase that deindustrialization is caused by a phenomenon additional. (...) which is associated either with a sudden surge in the exporting of primary commodities or services (particularly in countries which had not previously developed these sectors), or – as in the Southern Cone of Latin America – with a sudden shift in economic policy. (Palma, 2005: p. 21). Summarizing, this phenomenon is related to the Dutch disease. Thus, the Dutch disease can be understood as a process in which the discovery of natural resources and/or services (such as tourism and financial services) makes the country moves from one group to another. In other words, the group of countries

8The income elasticity of demand for services varies between 0 and 1. The closer to 1, the greater the risk of being productive structure reprimarizada. 9Corden (2012) also examines the effect of spending involved in international trade and capital inflows. The greater the import spending and greater the entry capital (and / or the lower exit) greater will be the spent domestic and vice versa. In this analysis, the author also incorporates the control of the exchange rate by the Central Bank.

159

seeking a surplus in the industry for the group is able to generate a trade surplus in primary goods. In other words, there is regression of the productive structure. On the other hand, the Dutch disease, in some Latin American countries, originated in drastic changes in the economic policy regime, particularly the trade and financial liberalization in these countries during the 1990s. Brazil and the three countries of the Southern Cone (Argentina, Chile and Uruguay), were the most industrialized countries of the region. But, after the changes in economic policy regime, became also in countries with higher levels of deindustrialization.In turn, a radical shift in the ‘policy regime’ (mostly implemented after the 1982 debt crisis) brought about the end of industrial and trade policies and, in particular, changes in relative prices, in real exchange rates, in the institutional framework of the economies, in the structure of property rights and in market incentives in general. This shift led them to abandon their industrialisation agenda, bringing them back to their ‘natural Ricardian position’; i.e., a position associated with comparative advantages more in accordance with their traditional resource endowment(Idem: p. 50-51). Nonetheless, some countries although they are abundant in natural resources and labor were able to neutralize the Dutch disease and develop the manufacturing industry. Second Palma, these countries (China, India and Turkey) “swam against the tide” of deindustrialization. Bresser-Pereira (2008) develops a model of Dutch disease, based on the existence of Ricardian rents, distinguishing two equilibria for the exchange rate: A rate of current equilibrium10and another equilibrium exchange rate for the industry11. Countries abundant in natural resources and labor has a lower production cost in relation to imported goods, generating Ricardian rents derived from exports. These exports generate an excess of foreign exchange in the country which makes the appreciated exchange rate level superior to what would make it industrial goods competitive. In this way, the economy tends to specialize in sectors intensive in natural resources and abundant labor. However, the intensity of the Dutch disease depends on the degree of Ricardian rents and exchange appreciation. The higher the Ricardian rent, the greater the differential between the two rates equilibrium exchange previously defined and therefore more perverse the Dutch disease, and vice versa. In a country without Dutch disease, the two exchange rates are equal. The Dutch disease can occur in economies who discover natural resources in the following situations: 1) countries that have never produced manufactured goods and may even perpetuate the Dutch disease, 2) that although industrialized economies, was unable to neutralize the Dutch disease to discover a resource abundant new primary and 3) economies favored by the change in the terms of trade derived from increase in commodity prices. In the last two situations, there will be an exchange appreciation without a reduction in the trade surplus, and deindustrialization becomes inevitable and exporting firms of industrial goods imported components increase in production, gradually transforming the manufacturing industry on a domestic industry “maquiladora12” (BRESSER-PEREIRA, 2008).However, the intensity of the Dutch disease, besides being different from country to country, will be different inside each country, depending on the international price of the good or goods that give rise to it. The higher the international prices of a commodity, the more appreciated the current equilibrium exchange rate and the more serious the Dutch disease (Bresser-Pereira, 2008: p. 10). In the Ricardian model, property owners enjoyed exclusively rents of lands more fertile. In the case of Dutch disease, consumers are also benefited by buying tradable goods relatively cheaper. Since the appreciated exchange rate reduces the prices of imported goods. But, different from the Ricardian model,

10Defined as the rate that balances the current transactions account. 11Defined as the rate that allows the industry be competitive. 12An industry automaker manufactured goods, for which inputs and components are imported.

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Câmbio

164

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165

which mark-ups are high. In the case of in developing countries, such as Brazil, these sectors are associated with commodity producing sectors, and not necessarily to the dynamic sector of the economy, manufacturing (Oreiro&Missio, 2010). Second Bresser-Pereira and Marconi (2008), the overvaluation of the exchange rate has led to deindustrialization through the Dutch disease harming the manufacturing sector of higher technological level. Sectors that are leading the development should not lagging behind. According to the authors, while China is becoming the world's factory, India in universal software producer, Brazil is becoming the international farm.The Figures 15 and 16 synthesize well the argument of the authors. The share of basic products in Brazilian exports is becoming the “driver of economic growth”, a role that ought to be of industry. The share of commodities grew by almost 90% in the 2000s, an average of 34%. The share of semi-manufactured products remained stable throughout the decade, averaging 14%. However, the major concern is with the products manufactured. The share of these in 2000 was 59% in 2010 was reduced to 39%, an degrowth of 33% in ten years. In 2011-12 the fall was interrupted, but the worsening international crisis may lead to further decreases in a short period. Figure 15: Exports (Quantum, 2006 average) and TCRE. Figure 16: Share of Exports by factor aggregate (%).

Source: Ipeadata (2013). Source: Ipeadata (2013). In sum, the share of basic products surpasses the share of manufactured products in 2010, the government's attempt to depreciate the exchange rate and international crisis contributed to that the difference it were reduced, however, did not reverse the shares. Therefore, there is an tendency to reprimarization of the export in the period under study.When analyzed in terms of quantum, basic products follow the same trend, outperforming definitely manufactured in 2007. On the other hand, manufactured goods that showed certain reaction declines. Filgueiras et al (2012) argues that this process began in the first Lula government, when the trend to exchange appreciation returned and consolidated, and especially during the second Lula government, when the Effect-China went on to manifest itself in more fully in the world economy. In this scenario, the growing difficulties in the manufacturing industry to compete within and outside the country, while agricultural commodities increased their participation in exports. Nevertheless, the above data warrant comments. First, the subsectors of the manufacturing industry that lost share in the export subsectors were the traditional competing through price. Second, the export basket of the country continues diversified. Commodities still have little representation in the export basket, about 25%, so that the regressive specialization is not confirmed. But it takes measures to neutralize the exchange appreciation, otherwise the productive structure runs the risk of be reprimarizada and industry scrapped. Third, the import penetration in the country is relatively low compared to the world average. But it is worrying, since a policy aimed at consumption exchange rates and ends up appreciated having as a

40

60

80

100

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Manufaturados SemimanufaturadosBásicos câmbio

12

22

32

42

52

62

Manufaturados Semimanufaturados Básicos

166

consequence the substitution of domestic production by product imporados. Finally, one can not affirm that reprimarization is occurringbut merely that there was gain of commodities driven by increased demand for commodities and new discoveries of oil reserves in Brazil. Thus, we conclude this work that exists in Brazil perculiar a species of Dutch disease, although it is harming the domestic industry, its effects are distinct between subsectors, given that the traditional industry has been the main hampered by exchange rates overvaluation.Nevertheless, it is necessary to neutralize the Dutch disease before it takes larger proportions. The government has been trying prevent exchange appreciation through capital controls, but some authors17, the introduction of a tax on exports of commodities such as Australia and Argentina recently did, it is essential to eliminate the overvaluation.But the problem goes far beyond the industry appreciated exchange rate, this only camouflages a number of structural problems in the Brazilian economy, as the lack of adequate infrastructure, high cost of labor, high tax burden, poor education, spreads above one higher interest rates in the world. A competitive exchange rate helps industry temporarily, but the resolution of these problems generate lasting benefits for the industry and the economy, making the country more competitive and developed with high per capita income.

5. Conclusions

This study aimed to contribute to the debate on the process of deindustrialisation and Dutch disease in Brazil. Concluding that the Dutch disease in vogue in the country is only relative, since the industry has not lost important links of the production chain, which we took to confirm the hypothesis reprimarization the productive structure of the country. However, necessary to neutralize currency appreciation and mostly to solve structural problems that this disease did not aggravate.In the second semester of 2012 in an attempt to stimulate private investment and reduce the cost of industry, the government implemented a series of adjustments18, as: 1) reduction of interest rates on loans and thus increase the profit margin, 2) release of social security charges payroll specific sectors, 3) greater trade protection to specific sectors; 4) exemption of import tax for machines and equipment, 5) reduction of electricity rates; 6) package of concessions in infrastructure. Yet are temporary measures only postpone the problem, but not resolves19. Therefore, the main concern of economic policy that aims devalue the exchange rate in order to make the industry more competitive Brazilian should be performed through three instruments: first, utilize new forms of controlling inflation than the exchange rates, for example, control credit, reducing the degree of indexation of public services and through fiscal instruments to control inflation costs, and second, most control in speculative inflows and / or an interest rate close to the world average in the case of the latter, for reduce the fiscal cost of loading of international reserves and stimulate investment, third, and depending on the external situation, the tax on exports of commodities. Another way to increase the efficiency of the domestic industry than devaluing the exchange rate, would be to tax imports of competing products from national and / or reduce the export tax product sectors. These measures generate inclusive space in the balance of payments20. Are policies that involve numerous difficulties and therefore require rigid government actions with purpose to sustainable development in Brazil.

17SeeBresser-Pereira (2008). 18This is different from the Lula government,Dilma's government tries a new growth strategy, as well as led by consumption, changing industry profitability. 19See in Serrano& Summa (2012) criticisms of these adjustments. 20However, the second option would be preferable the former, as this latter is a policy type beggar-thy-neighbour.

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José Alderir da Silva, Graduated in Economics from the Universidade Federal Rio Grande do Norte (2011). Master student in Economics from the Universidade Federal Rio Grande do Norte (2012). His interest includes economics with emphasis on Regional Economics and Economic Development. In particular themes related to economic policy, trade policy and regional development.Affiliation: Universidade Federal do Rio Grande do Norte – Brazil.E-mail: [email protected]: street JonaldoMatias de Oliveira, n. 502 – Parnamirim/RN-BR.Phone: 84-88224052.