Monday, 8 August 2016

Micro Level Trends – Brazil's Automotive Sector – “Brasil 66”...Sixty Six Years of Economic Power Lifting (Part 1)

As previous host of the 2014 Football World Cup and now 2016 Olympic Games, Brazil continues to sit front and centre of the world stage.

The Brazilian spirit behind the country's seeming effortless dominance in football encompasses both celebration and tribalism, and under this totemic banner other national teams' fans adopted the Samba Spirit since the mid 1990s onwards, with a proliferation of Carnival Drums and Mexican Waves. The Latino Spirit became the de facto spirit of the World Cup long ago, and indeed could be said to be the instinctive voice of all peoples.

So, whilst Brazil has been heavily criticised for its organisational capabilities to deliver, there appears no better destination to uphold the Olympic evocation of worldwide goodwill.

“Order and Progress” are the motto of the national flag, and though questions still abound about the innate capability to become a notionally 'advanced economy' given the massive challenges that exist, the last 20 years of development has demonstrated much.

Given its vast and often previously intractable distances, the impact of the automobile in Brazil has been enormous. From the 1920s Ford Model T trucks that carried cargo of wood and rubber for Ford Model A bodies and tyres made thousands of miles north, to the notionally “home grown” 1950s pick-up trucks that enabled new possibilities for entrepreneurialism, to the legendary VW micro-bus which for half a century between 1960 to very recently carried children and adults to new schools and modern workplaces, to the 1980s resurgence of the 'Ute' (half car, half truck) which provided for another long era of entrepreneurialism, to the “big little car” which has been the staple of personal and family transport since the 1960s ( VW Brasilia and FIAT 147 Panorama) the ideal still popular today in many of the smaller (A to C) segment sizes.

Although vehicles had been notionally called 'Brazilian' since the late 1920s with the 'finishing' end-assembly of imported American trucks and cars, the fact is that the country's auto-sector as proper did not begin in earnest until the planning and practicalities of the 'Import Substitution' era; which came into being proper in the post WW2 period.

Thereafter, the end-assembly operations of GM, Ford, and similar original export efforts of Volkswagen and Toyota was overtaken when the modern scale industry was effectively born with Volkswagen's large factory at Sao Bernardo do Campo.

It was completed in 1959 with the Type 2 micro-bus (van, flat-bed and crewcab) its first product, but that ideal had been born, and planned by the (then) Rio based government, a decade earlier, with careful industry diversification planning and foreign producer negotiations.

The auto-sector's role to progress socio-economic development and so a fundamental part of the economic 'heavy lifting' had begun as the 1950 post-war ambition.

Now, at the point of the Olympic crescendo, it could be said that the domestic auto-sector celebrates its own “Brasil 66”.

Far more detail about the auto-sector will follow in Part 2, but for the moment it is important to convey exactly how Brazil developed industrially and economically, though in a somewhat erratic manner through often very divergent political effort.

This Part 1 provides that insight before Part 2 delves relays the major players and trends of the auto-market over the past century or so and posits the question as to how Brazil should look to develop the competitive advantage and so USP of its domestic production in the search for attractive global exports.

Thus, whilst the Olympic opening ceremony provided a snapshot of Brazilian history, it is very worthwhile providing greater pertinent detail of the country's modern era.

The Politics of Socio-Economic Development -

The 18th century saw Brazil's first modern 'export drive' in cotton, sugar and minerals (including diamonds and gold) largely upon the remaining Portugese demand and new trading links with England.

The 19th and early 20th centuries provided the industrialisation revolution, primarily within the state of Minas Geras and focused around the trading port of Sao Paulo, so underpinning its second and far more internationalist export sucesses, including brazil-wood for dyes, coffee, soya beans, rubber, diamonds, gold, iron ore, orange juice, fruits and frozen chickens, much headed to the USA and Europe, and thereafter China and Asia.

The worldwide depression following the 1929 stock market crash invariably brought economic malaise and frustration at the apparent failings of 'Old Republic' politics.

Underpinned by the Military and 3 states, a coup d'etat took place in October 1930, exiling the elected president from only seven months earlier. GetulioVargas was hailed as the new leader and moulded what would be known as the 'Second Republic'. This action was deemed necessary to avoid further fracturing of the vital urban–rural inter-relationship, known as the “coffee with milk” policy, given the social unrest and demand for worker's rights and representation.

Over much of the following 25 years (as also seen in Portugal and Spain) Vargas sought to balance the highly conflicting politics brought about by the divided popularity of Communism and Facism. Vargas coined the term “Estado Novo” (the New State) for the renewed ideals.

To quell the anger of newly urbanised unemployed ex-rural folk - made redundant from agricultural mechanisation - was the primary theme of “import substitution”, so toward an attitude of self-development.

Implementation was through tight coordination fiscal power was centralised within the government (then based in Rio de Janeiro) with much of the Italian system replicated for harmonising labour's rights and responsibilities, to add both economic and industrial stability. Simultaneously the economic agenda called for far greater diversification and broad scale full industrialisation to raise internal B2B and B2C capabilities for internal growth and improvement.

The ability to close the substantial gap between itself and the previously industrialised Europe and America would be crucial in building the motherland. But with this came recognition that for the most part commodities exports would for years to come provide the basis from which to expand.

The UN's ECLA (Economic Commission for Latin America) cited that South America had for too long structurally relied upon America and Europe, and that positive but looser ties were necessary to have Latin countries “rise to their feet” through inward focus and self-reliance. An obvious and simple conclusion that would prove far harder to achieve via a subtle balancing act of domestic and foreign interests.

Nonetheless, with recognition of the importance of steel, and a wealth of coal and iron ore available to feed the blast furnaces, Brazil's first step would be the creation of the publicly owned National Steel Company and so investigations regards location, capacity, the purchase of willing foreign expertise etc were undertaken.

[NB this would be only the first step, since all future mid and high value manufactured goods for domestic and export consumption in the years to come would be predicated upon enormous start-up costs (build and foreign service fees) and a massive programme of self-education]

And so in keeping with ECLA's conclusions, Brazil started to commit to a series of self-development measures, critically prohibitive import trade barriers. The people of the country would thus experience a very visible material stagnation before a latter-day upturn based upon more and more domestically produced goods.

Brazil largely escaped WW2, but recognising the shift of power of the allies versus the axis powers when the US entered in 1942, Vargas provided Brazilain troops for the Italian Campaign near the war's close. An obvious tokenistic ploy so as to in return obtain American know-how to develop the long planned integrated steel plant.

Built in the 1940s and based in Volta Redonda in Rio de Janeiro state, it would be the vital enabler for “building tomorrow”. This re-enforced a somewhat previously soured and tenuous relationship with the USA, and thereafter Brazil irrevocably sided toward Capitalism over Communism.

The national oil company Petrobras was also formed in 1953 with the slogan “the oil is ours” and given sole extraction rights. From the start the firm expanded its expertise in oil extraction from shale, but was guided toward deep well land and off-shore drilling for continuity of supply. A national electrical company and telephone company was formed by consolidating what had been separate regional private firms. Record infrastructure spend through public and private organisations.

The government had become the country's largest employer and this labour control, together with the provision of low interest rate loans allowed the “Import Substitution” policy to gain ground.

However, within that sphere the debate regards Trade Protectionism versus an Open Door policy grew. Vargas's own rural attitude of self-reliance tilted policy and action toward a devoted inwardness until his apparent suicidal death in 1954; which Brazil's poor typically blamed upon 'powerful internationalists'.

In 1956 Juscelino Kubitschek took over as President with the slogan “Fifty Years Progress in Five Years”. The centre-piece of this was provision of a new capital city deep in the forest hinterland. Called Brasilia it acted as a shining beacon of development, with no doubt the ability to maintain control from a distance with less fear of another coup d'etat. His economic advisor was Celso Furtado, a man well known by neighbouring nations through ECLA , with a distinct pro pan-Latino sentiment.

Whilst imported vehicle 'finishing' and 'end-assembly' work had been seen in the 1930s and 1940s, the time had come to properly create the foundations of a Brazilian motor industry. Special treatment of foreign auto-makers was provided to gain FDI, the now home-built vehicles providing a major boost to the idea of 'import substitution', even if effectively the same foreign vehicles.

A major programme of road building and associated infrastructure was undertaken to create a virtuous circle of mobility, better organised and stepped value-creation and so economic development and thus the idealised spread of wealth. Inevitably that miracle-growth also brought inflation and corruption.

In what remained of the old, and critically burgeoning new, private sector one landmark was the development of the indigenous auto-sector. This allowed many associated parts supply and services firms to flourish, and was kick-started by the first major auto-plant built by Volkswagen, producing the Type 2 van and soon after the Type 1 “Beetle” / “Fusca”. Brazil as a commodities-rich region could then provide for the full manufacturing value-chain from sheet steel in body structures to the silica in glass production to the rubber in tyres and suspension bushes to the chromium for the plating of decorative trim items.

[NB This industrial platform was the base for later industrial extrapolation into other engineering areas such as bus and coach specialisation, railway carriages, subway carriages, niche specialist vehicles, weaponry and aeronautical].

In period additional efforts were made in old industries such as textiles to raise scale, improve quality and reduce price for mass affordability.

However, the visible gains of wealth were seen not by the many but the few, the Brazilian elite and new middle classes, but given that sizeable portions of the populace and labour market were still rural. Bot here and in the industrialised centres, the high supply of low skilled labour greatly surpassed general demand, so maintaining a trend for low and poor wages.

General Branco was favoured by Congress and it was believed that a new 1965 election would suffice. But having seen the foibles and corruption of civilian rule, Branco et al abolished the mass of competing political parties to create the singular 'ARENA' party; itself shadowed in opposition by one other, the 'MDB'. A more authoritarian yet arguably controllable system was put in place to provide strong and direct party links throughout Brazil, with greater proportion of the country's revenues retained for central spend from Brasilia. The rife 50% annual inflation rate was tamed through fiscal reform and monetary restriction, whilst a strong anti-Communist attitude also prevailed to maintain stability.

An even more 'hard-line' rule followed Branco, under General Costa e Silva with economic recommendations from of Antonio Netto (ex-University of Sao Paulo). Netto 'pump-primed' the agriculture sector with negative and low rate credit (obtained via the nation's pension fund and various foreign loans) so creating a fast growth period between 1968-1974 averaging a 11% rise per annum, even though at the direct cost of government coffers. Production costs were reduced through the control of wages, with exports highly promoted.

General Medici came next, continuing Netto's programmes but with new focus upon new development within the Amazon. Political repression ensued to avoid destabalising the successful economic formula, which in turn expanded national pride across much of the demographic spectrum.

Medici was followed by General Geisel with a decree to re-introduce full democracy, and to tackle the problems of stagflation and vitally the high cost of petroleum. Borrowing from the domestically sourced (Petrobras) petro-dollars which has provided a substantial cash cushion and international capital markets to invest into yet more state sponsored projects to restart growth. Thus state owned companies had become even more predominant, from banking to mining.

However it was this expanded initiative, together with municipals' budgetary over-spend which re-sparked the high inflation trend, a consequence of monopolies, oligopolies and bureaucracies devoid of the usual periodic imperative for cost-cutting seen in competitive free-markets.

A critical outcome of such state control and captive markets and buyers, was that without true competition prices were set to ensure strong annual profits, with in leaner years, product and service quality dropped at constant prices to ensure those large profits.

The reinstated democracy saw a promotion of oppositional power across the regions, and with that the loss of focused central-control, the dispersal of now more autonomous regional funds spend in a more profligate way, the consequence of diluted political responsibilities. The subsequent increase in governmental costs and increased corruption amongst democratically elected civilian leaders at the local level only served to snowball economic woes.

Another phase of stagflation appeared and by 1982 FDI had effectively stopped. The ability to serve the internationally borrowed national debt pile had become an enormous problem and the 'Lost Decade' arrived.

An ex-auto worker then became prominent, when Luis Inacio da Silva (or “Lula”) and followers broke the engrained governmental control over labour rights. Along with the Catholic Church and others the mass feeling was that the once rightly controlling military rulers had themselves become “lax behind the wheel”. 'Lula' helped form the Worker's Party (PT) with other labour-orientated parties created, prompting “diretas ja!” (“direct elections now”). Disparate new ideologies also undermined militaristic singular rule and so a fragmentation the in-power of the in-situ PDS party.

This economic paralysis undermined the Military's previous leadership and “right to rule”, with subsequent political reforms passed to try and create a new era of hope.

In March 1985 Jose Sarney took charge when the president-elect died. Sarney was a civilian who had previously been head of a military aligned party, facing the ongoing state of severe stagflation. A set of young economists presented the Cruzado Plan which once again froze wages and prices whilst increasing the income of the lowest paid. New B2C and thus B2B demand re-filled what had been idle excess industrial capacity, and with return of better times Sarney became popular. But as the economy recovered and new capacity was required to fulfil new additional demand, Sarney refused. Instead he seemed to support the age old spectre of profiteering through high demand out-stripping limited supply. The resulting price rises and led again to rabid inflation and once again to a fractured the national economy. By the time of Sarney's departure in 1990 inflation was running at a an unbelievable hyper-inflation rate of 80% per month!

New President Fernando Collor de Mello sought to initially tame this by temporarily freezing all savings accounts, so as to re-inject cash back into the disfunctional, badly priced, economy and toward productive ends. The remaining elements of the “import substitution” programme was repealed, and privatisation of industry and an 'open door' foreign trade mentality resumed. The long era of state-led growth aided by protectionism was coming to an end. The strength of the military was cut in reaction to the end of the super-power's cold war friction, and mproved relations were nurtured with Argentina. The Latin Common Market 'Mercosul' Pact was agreed with Argentina, Uruguay and Paraguay, thus providing both improved cross border access and improved competition to counter profiteering. But economic problems remained and Collor was impeached from office for corruption.

Thereafter this neo-liberal stance continued under the short tenure of Itama Franco who sought to quell the still virulent 20% monthly inflation rate. He appointed Fernando Henrique Cordoso as Head of the Treasury, and many of the previous Cruzado Plan's authors returned as new advisors. A new “Real Plan”stabalisation programme was named after a new currency, itself a faith-based anti-inflationary instrument.

The Real Plan did indeed provide results, especially for the urban poor. Cardoso had previously studied how Latin America's historical economic relations with the advanced western nations had meant that countries such as Brazil had been locked into such dependency. Instead he sought a dualistic approach, an economy with less direct dependence upon the old world capital hubs of New York, London, Milan etc (echoes of ECLA), and a new path toward broader international relations with new, more mutually positive EM trade arrangements and financing.

New political regulations were installed allowing 'provisionary measures' to take long term effect as long as Congress did not object. The Real Plan was then instituted every 30 days for 13 months until Congress passed the necessary legislation. Cardoso is today seen as the man who broke the previous historical vicious circularity whereby national deficits were partly paid-down via tacitly accepted inflation but thereby re-energising the inflationary spiral.

As the prime mover in addressing Brazil's economic problems, Franco was democratically succeeded by the popular Cardoo (or 'FHC') at the beginning of 1995. His reform agenda reached into every sphere of government and continued to promote private commerce, with mantras of reduced public spending and much improved efficiencies. State firms were privatised and to supervise the possible greed of new private companies new regulatory bodies were created per industrial sector to ensure accordance to laws and by-laws and to guard market fairness.

In 2002 the previously heralded “Lula” (Luiz Inacio Lula da Silva) of the Worker's Party won the election. Given his background, this apparent marked “shift to the left” greatly concerned the capital markets, creating an initial reflex action of spiralling borrowing rates and so inflation expectations. However Lula resolved to maintain the 'open door' trade policy, fiscal budget responsibility of 'FHC' and vitally suppress inflation, so calming the economic environment.

What was fascinating was that with an ongoing strong growth story, improved welfare programmes, expanded employment opportunities, improved earning power for many at the bottom and access to consumer credit, meant that Lula was relatively unscathed by apparent involvement in the 'Mensalao Scandal' (the origins and routing of politically supportive funding). For the masses it seemed that his professional indiscretions were as nothing compared to the greater good achieved in running the country.

'Lula' won a second term in office in 2006 with an approval rating of 80%, and continued efforts at expanding infrastructure building, and improved wholesale and consumer credit. All was fine until the 2009 Financial Crisis when growth dramatically slowed and initiatives such as tax relief was provided for the automotive and construction, so staving off the initial impact of the crisis. He has also sought to grow Brazil's relations worldwide, refusing to bow to the pressures of 'western friend or foe' orthodoxy, and so greatly raising Brazil's stature with other EM and 'Pioneer' countries.

In 2010 fellow Worker's Party representative Dilma Rousseff won the Presidency, as the first elected female leader. With the manifesto of continuing to sail a steady course, her immediate challenges in office were to react to the European Sovereign Debt Crisis' effects upon Brazil and the delayed return of strong trade with the USA given its own lengthy post 2008 malaise; to ensure the 2014 and 2016 World Cup and Olympics 'delivery cities' would be well planned. Additionally her “Brazil Without Poverty” policy seeks to improve the lives of the remaining 16m people at the very bottom of the social scale, with other targets at poverty related child welfare and the broad use of qualification certificates to engender education and personal development.

However, the initial low level criticism about initial failures of these programmes, in 2013 became over-shadowed by mass protests. These were directed at apparent failures in transportation (primarily bus fares), healthcare services and educational services.

She won a second term, but with another wave of protests in 2015 regards the 'social stasis' and her involvement in the Petrobras Scandal – protest actions deliberately directed at the Olympics and its diverted monies - her approval rating has plummeted.

Synopsis of Today -

For all the hype and true goodwill of the Olympic Games, Brazil today sits in real fear of economic retrogression. Today's problematic picture foretold by the horrific drop in the country's Bovespa stock market in preceding years, as the commodities export slump took hold with ripple effects through business, consumer and government circles. The Bovespa seeing a strong rally in 2016 in the run-up to the Games, but uncertainty about ongoing traction thereafter.

Exactly how to maintain this positive trend will require clear insight, when the Brazilian temptation may be to taint or even discredit the ideology of globalisation, and possibly once again look inwards and backwards to the era of self-reliance, protectionism as the apparent answer.

However, Brazil is a very different place today, with far greater commercial and economic diversification, segments which themselves have grown by being export seeking, and good diplomatic relations with all the G20 countries and far beyond.

What should be recognised by the Brazilian government is the level of economic 'heavy lifting' the indigenous automotive sector has achieved over many past decades, its steady 'self-fulfilling' domestic demand obviously also supported by exports to foreign shores.

When Vargas moulded the ideals of the Brazilian automotive industry it was for domestic consumption and growth. Today, beyond the social outcries and Olympic cynicism, and beyond the news stories about the Petrobras Scandel, Brasilia itself needs to consider how to better reshape the auto-industry to befit a bigger mutual vision of Brazil's own needs and its role in “Tomorrow's World”.

To Follow -

Part 2 will look to the fundamental historic character of the Brazilian auto-sector, and posit how that character might be better evolved and itself exported.