Why is Brazil’s economy closed to trade?

According to traditional macro-level measures of trade penetration (share of exports and imports in GDP), Brazil is an unusually closed economy. For Brazil this measure was only 27.6% in 2013 – a figure among the lowest in the world. Notably, Brazil’s trade openness lags far behind its peers among the BRICS countries, all of which reached trade-to-GDP ratios of at least 50% in recent years.

Figure 1. Brazil’s relative closedness to trade

Source: WDI.

Brazil’s size is often used to explain the country’s relative closedness. As the comparison with other large economies already indicates, this argument does not hold up to close scrutiny. While it is true that large economies tend to exhibit lower percentages of exports and imports to GDP, this feature fails to explain the exceptionally low levels of trade penetration observed in Brazil.

Looking at 2013 data from 176 countries available through the World Bank’s World Development Indicators (WDI) database, the average trade-to-GDP ratio is 96%. Even among the six countries with a larger economy than Brazil, the average is 55%.

Using the same WDI data and running a simple, univariate OLS regression of trade penetration and GDP on all available countries, we can show that less than one-sixth (15%) of Brazil’s deviation from the mean can be explained by the size of its economy alone. In other words, just looking at size of GDP we would expect Brazil to have a trade-to-GDP ratio of 85% – three times the observed 28%.

Conducting a multivariate OLS regression controlling for GDP as well as other dimensions of country size (surface area and population), Brazil’s lack of openness still cannot be adequately explained – Brazil’s expected trade-to-GDP ratio in this model is still about twice the actual value (62%). Controlling for other structural features often associated with trade openness – such as the urbanisation rate and the share of GDP produced in the manufacturing sector – even increases the expected openness slightly to 64%.

The only approach we discovered to fairly accurately predict Brazil’s low level of openness is by also controlling for whether or not a country is located in Latin America and the Caribbean (using an LAC dummy variable in the regression). This comes in as a significant negative factor, reducing Brazil’s predicted openness to 31%. However, all this tells us is that Brazil is not alone – other Latin American countries also have a low trade penetration relative to the rest of the world (controlling for size and other characteristics).

Micro-level indicators

A more interesting perspective on Brazil’s lack of trade openness can be obtained by looking at the number and characteristics of exporting firms.

The first result is that very few Brazilian firms export (see World Bank 2014). The share of exporters among all formal-sector firms is less than 0.5%. Indeed, the absolute number of exporters in Brazil – less than 20,000 – is roughly the same as that of Norway, a country of just over five million people compared to Brazil’s 200 million. This means that, while in Norway there is one exporting firm for about every 250 Norwegians, the ratio in Brazil is one for every 10,000 Brazilians.

Of course, Norway and Brazil are vastly different countries. Norway is one of the richest countries in the world; its GDP per capita is almost ten times that of Brazil. Norway’s total GDP is about a quarter of Brazil’s, indicating that Norway can be more aptly described as a small open economy. Norway is also a small country close to and well connected with many more countries in its region compared to Brazil. On the other hand, Norway is also a commodity exporter, with the petroleum sector accounting for more than half of total exports. In the case of Norway, a strong natural resource sector appears to coexist with value chain integration and dynamic exporters in other sectors.

Looking at a larger set of countries, we observe that Brazil is indeed an outlier. Brazil’s number of exporters relative to the population is low even when controlling for GDP per capita.

Figure 2. Brazil’s relative lack of exporting firms

Charts and data from World Bank (2014); Data source: Exporter dynamics database

Out of all Brazilian exporters, a much smaller number of firms make up the overwhelming share of exports – the top 1% of exporting firms generates 59% of total exports, while the top 25% of firms account for 98% of exports (Exporter dynamics database).

We also observe little dynamism among Brazilian exporters. Even given the small number of exporters, Brazil has a very low entry rate – very few firms become new exporters. On the flipside, Brazilian exporters have a very high survival rate, meaning that the few firms that export are likely to continue doing so.

Why do so few firms export?

To understand why Brazil is so closed to trade and has such a small number of exporters, we will need to take a closer look at how Brazilian firms engage with the outside world (see World Bank 2014). One interesting indicator is the ratio of domestic value added in exports (or its inverse, the imported content in exports).

This measure serves as an indicator of integration into transnational value chains. Countries that are integrated in those chains will show a lower share of domestic value added in exports as their exports include components and intermediate goods previously imported from other countries.

In Brazil we observe a very high share of domestic value added in total exports. Now this could be in part due to the fact that Brazil exports a lot of raw materials which typically have a very high degree of domestic value added as they constitute the origin of a value chain. However, even when only looking at Brazil’s manufacturing exports (about a quarter of total exports) Brazil’s domestic value added is still extremely high (93%); indeed, it is the highest among the economies covered by the OECD-WTO Trade in Value Added database.

Brazil’s absence from global production networks and resulting density of domestic value can only in part be explained by the relative distance (geographical as well as institutional) from major economic centres – like other LAC countries. However it is also in large part a result of policy decisions past and present on trade and local content (World Bank 2014, Canuto 2014).

Figure 3. Brazil’s lack of integration into global production networks

Source: World Bank (2014).

The high level of domestic value added in exports shows that the fragmentation of the production process along cross-border value chains, a very important part of the second wave of globalisation (Baldwin 2011), has largely bypassed Brazil.

In part this can be explained by the difficulty encountered by firms attempting to trade across Brazil’s borders. Brazil’s precarious logistics and high transaction costs related to international trade are incompatible with the logic of cross-border value chains.

Over the past decade Brazilian firms have also faced serious competitiveness challenges such as real appreciation and defensive trade policy reactions (Canuto et al. 2013a, 2013b). This means that only the most efficient firms or larger firms benefitting from significant economies of scale are able to overcome barriers to export. This should explain some of the concentration of exports among a small number of large firms.

How could opening up support Brazil’s growth agenda?

Opening up and integrating more deeply in global value chains would result in the closure of less competitive production chain segments and their substitution with imports, eliminating the deadweight loss associated with inefficient domestic production. On the other hand, the businesses left standing would be more competitive, while final products available to the domestic market as well as for exports would be of lower cost and higher quality (Fleischhaker and George 2014). Furthermore, in dynamic terms, integration in global value chains would allow scarce domestic resources such as skilled labour to be reallocated to the most productive firms and activities, increasing overall productivity.

The productivity gains and cost reductions in the global economy due to participation in global production networking have been significant, increasing the opportunity cost associated with the ongoing closedness of the Brazilian economy. The alternative approach, which would be to support vertically integrated supply chains through protectionist measures, are likely to be futile in the longer term. For example, despite rising trade barriers, Mercosur’s coefficient of imports from China has continued to increase in recent years. Furthermore, private investors seem to understand this, as they shy away from activities that are viable only under permanent protection.

In Brazil, given its labour shortages and aspirations of rising purchasing power, productive activities would be strengthened by the availability of cheaper local consumer, intermediate, and capital goods. Brazil’s immersion in global value chains would allow the country to leverage its comparative advantages which clearly exist in natural resource-associated industries but which could also emerge in specific activities in manufacturing or services once industries have access to cheaper inputs. Of course, public policy support remains essential. However, this support should be more horizontal in nature, rather than further encouraging the ongoing high density of production chains and perpetuating the extraordinary closedness of the Brazilian economy.

Authors’ note: Cornelius Fleischhaker is a Junior Professional Associate with the Macroeconomics and Fiscal Management Global Practice of the World Bank, specialising in Brazil and other Latin American countries. The opinions expressed here are his own and do not reflect those of the World Bank.

References

Baldwin, R (2011), “Trade And Industrialisation After Globalisation’s 2nd Unbundling: How Building And Joining A Supply Chain Are Different And Why It Matters“, NBER Working Paper 17716.

Canuto, O, M Cavallari, and J G Reis (2013a), “Brazilian Exports Climbing Down a Competitiveness Cliff”, World Bank Policy Research Working Paper 6302.

Canuto, O, M Cavallari, and J G Reis (2013b), “The Brazilian competitiveness cliff”, VoxEU.org, 27 February.

Canuto, O (2014), “The High Density of Brazilian Production Chains”, World Bank Let’s Talk Development blog, 13 November.

Fleischhaker, C and S George (2014), “Five Steps to Kickstart Brazil”, Bertelsmann Foundation.

World Bank (2014), “Implications of a changing China for Brazil: a new window of opportunity?”, World Bank Working Paper 89450.

This article is published in collaboration with VoxEU. Publication does not imply endorsement of views by the World Economic Forum.

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Authors: Otaviano Canuto is Senior Advisor on BRICS Economies in the Development Economics Department, World Bank, a new position established by President Jim Kim to bring a fresh research focus to this increasingly critical area. Cornelius Fleischhaker is Junior Professional Associate with the Macroeconomics and Fiscal Management Global Practice, World Bank. Philip Schellekens is Senior Country Economist for Brazil, World Bank.

Image: A view shows the Planalto Palace designed by architect Oscar Niemeyer in Brasilia April 2, 2014. REUTERS.