China’s phenomenal economic growth has made it the second largest economy in the world in a relatively short time. In the process, its impact on Brazil has been significant. The two countries have long been allies; China recognised Brazil as a ‘strategic partner’ in 1993, the first country in the Latin American region to be accorded this status. The commodity related interdependency between the two countries is so high that it has even lent itself to the official name for a classification of ship type – Brazil developed massive ships called “Chinamax” to ply mineral ore from Brazil to Chinese ports. Over time “Chinamax” has become the standard name for ‘very large ore carriers’. In this article, China Brain explores how the relationship between the two countries is evolving and why tension has been rising in recent years.
The rhetoric from the two nations is still overwhelmingly positive. As the Brazilian foreign minister put it in 2004, “We are talking about the relationship between the largest developing country in the Western hemisphere and the largest developing country in the Eastern hemisphere”. Brazilian exports to China rose massively from $1.1bn to over $21bn in the first decade of the twenty first century. At present China is Brazil’s largest trading partner, although, crucially, Brazil is not even among China’s top ten trading partners. In the following sections we explore the nature of this asymmetry and what it means for the countries involved.
‘Primarization’ of the Brazilian market
90% of Brazilian exports to China are primary products such as iron ore and soybeans that satisfy the Middle Kingdom’s need to build its new skyscrapers and feed its giant population. Brazilian commodity businesses have long been riding high off the back of China’s growth. Contrast this to Chinese imports into Brazil – in 2009, only 1.6% of total Chinese imports were primary goods. The majority were relatively low cost consumer appliances, which have put price pressure on local manufacturers. Many Brazilians now see Chinese companies as direct competitors and a threat to their own employment. The combination of these two forces is threatening to move Brazil further down the technology ladder and regress into a less industrialised market.
A possible explanation for this ‘primarization’ is that as a resource-abundant country, Brazil’s comparative advantage over China is only in primary goods. But studies indicate this is not always the case. Machado and Ferraz (2006) identified 58 products that Brazil was not exporting to China despite having a comparative advantage in their production. In these cases it was the Chinese government’s import substitution-protectionist policies that were barriers because China imposes escalating tariffs on processed products.
Unfortunately, any attempt to even the playing field between the two countries is fraught with danger. In 2010, when Argentina tried to restrict import on Chinese manufactured products, China retaliated by stopping soybean oil imports from Argentina. Trade relations did not normalise till Argentina ultimately relented six months later. Brazil cannot afford to make the same mistakes. If China closed its doors to Brazilian goods, however temporarily, the impact on Brazils’ economy would be disastrous.
Battling in third markets
Brazil and China are not only competing in their respective domestic markets; they are competitors in other nations too. Here the battle is fierce, and highly tilted in favour of China. Between 2003 and 2010, Brazil’s share of the US market fell by 0.15 points while China’s rose by 6.54 points. In Argentina, China has already displaced Brazil as the chief supplier of home appliances. This is why both Brazilian manufacturers and government officials have begun to voice their concerns, leading to China developing a serious ‘image problem’ in the Latin American business sector.
China can counter this image problem if it intelligently disseminates information on how its inelastic domestic demand for commodities has boosted prices globally. So when Brazil now sells commodities in third markets, they can piggyback on the global price hike led by rising demand in China. Studies show that if China’s impact on the global market prices on commodities was removed, Brazil would have lost between $9bn and $14bn in income since 2007. This is a significant figure in Brazil’s $2.5tn economy.
Direct investment evolves
Initially, China’s relationship with Brazil was one based on the import of Brazilian produced products. Prior to 2009, Chinese FDI in Brazil was nominal. But from 2009 to 2010, it rose sharply by $310m, making the current stock value of Chinese firms in Brazil $20bn. This may actually represent the lower end of the scale of the true value because a lot of the funds are transferred through off shore accounts in tax havens and the real value of Chinese FDI is notoriously difficult to estimate.
The main areas of Chinese investment into Brazil have been natural resources like mining, oil, gas, etc. Coupled with investment into Brazilian agribusiness, like Chinese state group BBCA sinking $320m to build a maize processing factory in Brazil, it shows a continuation of Chinese export strategy into FDI strategy. Rather than buying commodities from Brazilian producers, Chinese businesses are now buying Brazilian mines and companies so they can serve their own needs more directly.
Chinese investment into the Brazilian manufacturing sector is also rising. Chinese automotive company, Chery Automobile Co, plans to build a factory for engines and gearboxes in Brazil. Technology company, Huawei, has already set up business in Brazil, relying on more than 90% Brazilian employees to run the company to good effect. In the beginning of 2011, Huawei’s local revenue reached $1bn, proving the future for Chinese technology companies in the Brazilian market is promising. Financial acquisitions are also increasing, albeit slowly – only last month, China Construction Bank Co. signed a deal to take control of a small Brazilian bank called Banco Industrial e Comercial.
Brazilian FDI into China, on the other hand, has remained steady for the past decade at $500m, i.e. only 0.04% of the total stock of FDI into China. This comparatively lower FDI is explained by the difficulties foreign firms face when navigating the unfamiliar rules and nuances of the Chinese market.
Unfortunately, the Chinese government still limits which sectors foreign firms can invest in. Sectors they consider strategic, such as energy and advanced communication technology, are strictly off limits. Firms working in other industries however have been lured in by the inexorable expansion of the Chinese market. One such example is Brazil’s sole business jet aircraft manufacturing firm, Embraer, which operates in China from the Harbin region. The firm projects that within the next two decades, Chinese airlines will require over 1000 new jet aircrafts (which is 15% of global delivery of jets). Embraer does plan to tap into this market. But despite the phenomenal projected growth in China, Embraer’s biggest FDI to date has been in the United States so progress in China has been limited.
Brazil and China’s trade relationship, even in its present form, is beneficial for both parties but inherently lop sided. Brazil’s narrow specialisation on commodities, plus its over-dependence on the Chinese market, may turn out to be dangerous. After decades of unbridled double-digit growth, the Chinese market is beginning to slow down – some analysts put this year’s projected growth at 7.5%. Not only will this lower the demand for Brazilian commodities in China, it will also have a negative impact on the price of commodities in the global market. Brazil will then have to deal with significant fallout from its over-dependence on China.
Brazil can avoid this catastrophe by diversifying its exports and producing higher technology products, as well as commodities at different stages of processing. Though reports suggest Brazil has been making tentative efforts to diversify, their ultimate success will also depend considerably on the flexibility (or not) of the Chinese government in opening up more sectors for direct investment.