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Brazil aware its relation with China raises the risk of “Dutch Disease”

Monday, April 11th 2011 - 21:09 UTC
Full article 5 comments
President Rousseff arrived Monday in Beijing for a week long state visit President Rousseff arrived Monday in Beijing for a week long state visit

President Rousseff arrived in Beijing Monday to begin a state visit to China that will incorporate Thursday’s summit of BRIC leaders. However Ms Rousseff’s trip to China is symbolically important since it is her first overseas visit outside Latin America and underlines the growing importance of the Brazil/China relationship, points out Capital Economics.

From an economic perspective, this is best illustrated by the boom in trade between the two countries.

China overtook the US as Brazil’s most important export market in 2009 and last year Brazil shipped over 30bn US dollars of goods to China (up from just 4.5bn in 2003).

Admittedly, imports from China have boomed at the same time. They reached 25bn last year, meaning that total trade between the two countries was worth over 55bn.

Even so, Brazil is still one of the few countries to run a trade surplus with China (around 5bn last year, equivalent to 0.3% of Brazilian GDP).

Yet the Brazil-China relationship is not simply a trade story points out Capital Economics. Investment flows, particularly from China to Brazil, have picked up in recent years too. It is difficult to get a precise handle on the scale of foreign direct investment (FDI) flows from China since much of it goes via third-party states for tax reasons.

But some estimates suggest that FDI into Brazil from China may have been as high as 17bn last year (0.8% of GDP), up from just 15mn or so in 2005. This is especially important given Brazil’s low investment rate and, in time, should help to shift production up the value chain.

However contrary to the popular narrative China’s development has not been all good news for Brazil. For a start, many of the benefits are probably overstated. Most obviously, while increased FDI from China should help to shift Brazilian production up the value chain, much of the extra value-added will probably show up as profits that are subsequently repatriated back to China.

What’s more, exports to and investment from China has been concentrated in the commodities sector.

This raises the risk of ‘Dutch Disease’, where commodity-led growth pushes up the real exchange rate, redirects labour and capital towards the natural resources sector and squeezes the manufacturing sector (where employment and productivity growth tend to be faster).

This is part of the reason why Brazil’s currency Real looks so overvalued and why its manufacturers are struggling to compete.

But there is another aspect to Brazil’s ‘currency war’. The strength of the Real is due in large part to rapid capital inflows, the blame for which is commonly laid at the door of loose monetary policy in the West.

But China’s huge current account surplus – and its export of capital overseas – is an equally, if not more important, driver of inflows into Brazil. This in turn explains why Brasilia is placing more pressure on Beijing to allow the reminbi (Yuan) to rise.

So while this week’s meetings provide an opportunity to trumpet the mutual benefits of one another’s development, it would be unwise to ignore the hidden tensions concludes Capital Economics.

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  • Fido Dido

    simple explanation of the Dutch disease is the deindustrialization of a nation's economy that occurs when the discovery of a natural resource (North Sea gas) raises the value of that nation's currency, making manufactured goods less competitive with other nations, increasing imports and decreasing exports. What people also must know is, the profits of gas exports were invested in “welfare” rather than in more productive areas of the economy.

    Apr 11th, 2011 - 11:04 pm 0
  • Forgetit87

    What raises such a risk isn't only, or even mainly, trade with China. It's rather currency valuation. I find utterly mysterious how most economic analyses of the BR economy fail to take that into account. D. Disease is being caused by inflows to capital markets, not commodity exports. And as the currency value goes up due to speculative capital, manufactures lose competitiveness. Up until '06, manufactures made up about 55% of total exports. But as FDI and speculative inflows picked up in 2007, that percentage has fallen steadily. As for the trade surplus against CN, that was the case only in 2010, and it was due to the spike in iron ore prices. Up until '09, Brazil, just like most other countries, ran a trade dificit with China.

    ”This (...) should help to shift production up the value chain.“

    Um... WHAT? CN isn't interested in buying high value added products. It doesn't want to buy steel, for instance: it wants to import iron ore to later export steel. Trade with CN has actually moved Brazil the value chain DOWNwards. CN only commits to buying high-value added products when it's interested in acquiring technology. That's what happened to Embraer in CN. Though the last decade CN promised to order Embraer some few jets, it later set a joint venture with Embraer so as to force it to transfer technology to a Chinese SOE, the China Aviation Industry Corporation II.

    ”exports to and investment from CN has been concentrated in the commodities sector.“

    Then it shouldn't have been said above that Chinese FDI helps BR boost its investment rate.

    ”This is part of the reason why BR’s currency Real looks so overvalued...”

    No. The reason manufactures suffer has little to do with CN; it has to do with speculative capital from mostly western countries. BR has had a wide current account deficit since 2007: that means more money leaving, than entering, BR by trade it. That is, if it was up to trade alone, the real wouldn't be overvalued and manufactures wouldn't be struggling.

    Apr 12th, 2011 - 12:45 am 0
  • lpc1998

    Trade should be on a willing buyer and seller basis. Similarly with investments. Then no one will owe someone else a living. This will remove any justification for unhappiness.

    Apr 12th, 2011 - 02:18 am 0
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