House of Commons - Trade and Industry

Select Committee on Trade and Industry Seventh Report

1 INTRODUCTION

1. We decided to examine the opportunities for trade and investment between the UK and Brazil as part of a wider programme of inquiries into trade with what have been termed the 'BRICs'—Brazil, Russia, India and China.[1] As our inquiry progressed we realised that trade relations with Brazil ought to be viewed in a wider context, and we expanded our terms of reference to consider trade and investment opportunities with Mercosur, the South American trade bloc. We retained a special emphasis on Brazil, as that bloc's economically and politically dominant member.

2. Our inquiry focused on two broad areas:

— the difficulties faced by and opportunities available to UK businesses wishing to trade, or forge investment links, with Brazil and the other Mercosur countries, with particular reference to opportunities in the information technology, life-sciences, oil and gas, aerospace and financial services sectors; and

— the UK Government's role in assisting businesses, including the relative responsibilities of UK Trade and Investment (UKTI) and the English Regional Development Agencies (RDAs); although broader issues of trade and investment promotion are considered in our parallel inquiry into the new UKTI strategy, which focused on support for manufacturing exports.

3. We initially took written evidence on Brazil and as the inquiry was broadened took further evidence on Mercosur as a whole. We also visited São Paulo in Brazil and Buenos Aires in Argentina as part of the inquiry, and took oral evidence from UKTI, the Confederation of British Industry (CBI), the Minister for Trade and Investment, and the Government's Chief Scientific Adviser. As a case study, our visit and evidence sessions also helped inform our inquiry into UKTI's strategy,[2] and vice versa.

Mercosur/Mercosul

4. Mercosur is the Southern Common Market, occasionally referred to as the Common Market of the Southern Cone, and is a contraction of the Spanish Mercado Común del Sur. In Portuguese the bloc is known as 'Mercosul', a contraction of Mercado Comum do Sul. Although this report focuses on Portuguese-speaking Brazil, the bloc is referred to as Mercosur throughout as that name is more widely used.

5. Following bilateral BrazilArgentina cooperation in the mid-1980s, neighbouring Paraguay and Uruguay joined them in signing the Treaty of Asunción in March 1991. The ultimate goal was an EU-style common market and customs union between them[3] and a common tariff on goods imports from outside the bloc. In 1994 the Treaty of Ouro Preto gave shape to the bloc's institutions, made Mercosur a legal entity under international law, and formalised the customs union which came into effect on 1 January 1995. However, the development of Mercosur has been slow and uncertain. It is often referred to as being an imperfect customs union because the common tariff has many national exceptions, its customs territories remain separate, and goods are not free to circulate as they are within the EU.

6. The Trade Minister told us that the Government welcomed the developing relationship between the Mercosur countries, while noting that "each of these countries is entirely different."[4]

MEMBERSHIP

7. Venezuela became Mercosur's fifth member on 4 July 2006. This saw Mercosur expand from around 235 million people with a total GDP of just over $1 trillion to 261 million people and GDP of $1.14 trillion.[5] It accounts for 75% of South America's total GDP.[6] Venezuela was previously a member of the Andean Community of Nations (CAN),[7] the other major trade bloc in South America now made up of Bolivia, Colombia, Ecuador and Peru (see Fig. 1). Bolivia recently applied for Mercosur membership, a request currently being considered by a working party,[8] and if it succeeds Bolivia would probably have to leave the Andean Community, as Venezuela has (the future of Mercosur is looked at in Chapter 6 below). Chile is a member neither of Mercosur nor the Andean Community, but is an associate member of both.

8. The CAN countries have granted Mercosur members associate membership status and Mercosur has reciprocally granted CAN members associate membership. For both blocs, associate membership requires an intention to reach a free trade agreement (FTA), and political declarations in favour of forging a free trade area covering the two blocs were considered sufficient to meet this criterion. The two blocs signed an economic complementarity agreement in October 2004 as a step towards a FTA, which would reportedly eliminate tariffs between them within 15 years.[9] However, UKTI told us that at present these FTAs do not mean a great deal in terms of market access.[10] Chile, an associate of both blocs, has bilateral free trade agreements with each, although it is unclear whether its agreement with Mercosur has been put into effect.[11] Also, Mexico currently has observer status within Mercosur, but is in the process of becoming an associate member. Our Report does not directly consider associate or observer Mercosur members, but useful data on these markets feature in the written evidence we received.[12]

Figure 1: Trade blocs in South America & relationship with Mercosur

9. Like other regional blocs, including the EU and the North Atlantic Free Trade Agreement (NAFTA), Mercosur has significant asymmetries. The table below gives basic country data for the bloc's members, illustrating the dominance of Brazil:Figure 2: Key data for Mercosur countries, 2005

	GDP (US$ billion)	Population (millions)	Area (km²)	Goods trade (%GDP)
Argentina	183.3	38.7	2,780,400	37.5
Brazil	794.1	186.4	8,514,880	24.7
Paraguay	8.2	6.2	406,750	53.7
Uruguay	16.8	3.5	176,220	40.8
Venezuela	138.9	26.6	912,050	58.4
Mercosur total	1,141.2	261.4	12,790,300	*43.0 ()**
Brazil as %	69.6%	71.3%	66.6%	-

Source: World Bank World Development Indicators 2006 database & TWB5L para 3 (Mercosur exports)
Notes: * average for Mercosur countries; - not applicable

10. As the CBI said, within Mercosur "one needs to divide out Brazil and the other countries."[13] Brazil is the largest country in Latin America, and the fifth most populous country in the world, after China, India, the US and Indonesia.[14] It also has shared borders with ten other countries.[15] It accounts for around 70% of the bloc's total GDP, population, and area; prior to Venezuela's membership Brazil was even more dominant, accounting for almost 80% of total GDP and population, and 72% of total area. Brazil accounted for around 72% of total Mercosur merchandise exports of $190 billion in 2006, and 66% of total Mercosur merchandise imports of $134 billion.[16]

11. Argentina and Venezuela are medium-sized within the bloc, with broadly similar GDP levels, although Argentina has an area three times that of Venezuela, and half as many people again. Paraguay and Uruguay are comparatively small, together accounting for just over 2% of the bloc's GDP, less than 4% of its population, and around 5% of its total area. Although Brazil has by far the largest economy in Mercosur, per capita GDP is higher in Argentina ($15,000, comparable with Eastern European countries Lithuania and Latvia) than in Brazil ($8,600). Uruguay has the second highest per capita GDP in the bloc ($10,700), with both Venezuela ($6,900) and Paraguay ($4,700) having lower per capita GDP than Brazil.[17]

INSTITUTIONS

12. Mercosur has a six-month rotating presidency, currently held by Paraguay, with an administrative secretariat based in Montevideo, the Uruguayan capital.[18] The bloc's institutions include:[19]

— Common Market Council, of members' foreign ministers, giving a political direction to integration;

— Common Market Group, the 'executive branch' managing integration, run by members' officials, with working sub-groups;

— Trade Commission, to implement Mercosur's common trade policy;

— Joint Parliamentary Commission and Economic and Social Consultative Forum, both consultative bodies to the Common Market Council;

— Dispute Settlement Court, established in 2004.

— The Mercosur Parliament, held its first monthly session on 7 May 2007 in Montevideo, the Uruguayan capital. The body is consultative only, with two 36-member chambers each with nine representatives drawn from the legislatures of Argentina, Brazil, Paraguay and Uruguay (due to its accession process Venezuela's involvement is limited). Direct election is planned in the future.[20]

Brazil's economy

13. Perhaps unsurprisingly given the economic crises that Brazil has experienced in the past—the contagion effects of the 1998/99 Asian financial crisis, a collapse in investor confidence and a mass investment withdrawal followed by devaluation of the Brazilian Real in January 1999—stability rather than high growth has been the economic policy priority. Brazil is in a stronger economic position today than in its recent past, having successfully maintained macroeconomic stability with consistent growth. UKTI noted that Brazil has seen "consolidated macro stability built upon the pillars of a strong primary budget surplus, a flexible exchange rate and a non politicised, although not officially independent, central bank."[21] Although the target for annual growth has been 44.5% the Brazilian economy grew by 2.9% in 2006.[22] A plan which aims to increase growth to 5% was announced earlier this year and is discussed below.

14. While this level of growth is broadly comparable with those seen in Western Europe, it has consistently been below that of the other BRIC economies, and is projected to continue to be below those countries' growth levels:Figure 3: Output (annual percentage changes), BRIC countries

	2005	2006	2007 (proj.)	2008 (proj.)
*Brazil ()**	2.9	3.7	4.4	4.2
Russia	6.4	6.7	6.4	5.9
India	9.2	9.2	8.4	7.8
China	10.4	10.7	10.0	9.5

Source: IMF, World Economic Outlook, April 2007, table 1.1
Note: Data reflect recent revisions to Brazil's GDP statistics[23]

Despite this, Brazil has the second highest total GDP among emerging markets after China, and higher per capita GDP than either China or India.[24]

15. Brazil's recent growth has been led by exports, with major products including metallurgical products and soybeans; and trade as a proportion of Brazil's GDP has risen to 26% in 2004 from 13% in 1996.[25] There were both fiscal and current account surpluses in 2005. Inflation has also been brought under control, down from 16.0% in 1996 to 6.9% in 2005.[26] Brazil's "sovereign debt risk has fallen to record lows",[27] and its stock market was the seventh best performer globally in 2005 with gains of 60%.[28] Past external debt-related problems have led Brazil to focus on paying off its external debt, repaying both its entire $15.5 billion debt to the International Monetary Fund in December 2005 and its Paris Club debts.[29]

16. Elected in 2000 and recently re-elected for a second term running until the end of 2010, President Lula da Silva has confounded some critics of his political stance. UKTI said Brazil was pursuing an "economic third-way between outright populism or 'leftism' in the Chavez or Castro mould" and "full-blooded capitalism embodied by the US".[30] There "have been some doses of nationalism", but these have been "the exception rather than the norm."[31] While there has been "a greater emphasis on social justice goals"—creating jobs, reducing poverty by raising the incomes of the poor, and reducing hunger—this "has not hinged on economic intervention, but rather on solid economic policies and subsequent growth (particularly in government revenues)."[32] Poor families have benefited from cash transfers for healthcare and education services from the Bolsa Família (Family Grant) programme, meeting its target of reaching 11 million families (45 million people) as of June 2006,[33] making it "one of the largest social transfer programmes in the world".[34] The minimum wage has also been increased (as have public pensions, which are linked to the minimum wage). These policies have seen estimates of poverty levels on some measures fall from 28% of the population in 2003 to 23% in 2005.[35]

17. Nevertheless, concerns continue to be expressed about the Brazilian economy. Brazil has a comparatively high tax burden by developing country standards, and comparable with developed countries, which is widely seen as stifling growth. The tax burden on business in Brazil is 36% of GDP, higher than in India, Mexico, Russia and Turkey, and more than double that of China (17% of GDP).[36] UKTI called the quality of fiscal structure the "key macroeconomic challenge" for Brazil, with "implications for all aspects of the economy".[37] This issue, among others, is examined further in Chapter 3.

18. Brazil is also accused of continuing underinvestment in infrastructure. The CBI told us that less than 25% of Brazil's roads could be considered good, that its railways needed modernisation, and that investment was needed in ports, roads, and electricity production and transmission.[38] The World Bank has said that while Brazil is currently investing 1% of GDP into infrastructure, it needs to invest 3.2% to avoid further deterioration of structures and services.[39] The Financial Times also noted that at less than 3% of GDP Brazil's capital investment levels were "well below the commitments being made by more rapidly growing countries in Asia".[40] The Economist has talked of Brazil's 'Stockholm syndrome'—"a love for a state that holds the economy hostage", and has recommended reducing the size of the state, increased investment, improved education services, formal independence for Brazil's Central Bank, reduced import tariffs, and tax simplification.[41] A McKinsey report suggested that Brazilian growth could be raised to 7% with a national commitment to reform and a long-term economic vision that would address the size of Brazil's informal economy, reduce government consumption, reform judicial and public services, and develop infrastructure.[42]

THE FIVE YEAR GROWTH PLAN

19. On 22 January 2007, President Lula da Silva announced an Acceleration Programme for the Country's Growth (known as the PAC) to raise growth to 5% by 2008. This will see £121 billion (504 billion reais[43]) of investment from 2007-2010 on infrastructure including roads, ports, electricity generation, and housing. The PAC also includes: tax incentives for investment, with £1.5 billion (R$6.6 billion) of tax cuts in 2007 and around £2.8 billion (R$11.5 billion) from 2008 targeted at "construction, infrastructure and small businesses"; simplification of business registration; streamlined issuing of environment licences; limits on the growth of public spending through a cap on the minimum wage (and therefore on Brazil's public pensions) to rise with inflation and economic growth, and a cap on government wages to inflation plus 1.5%; and also a forum to look at pension reform.[44]

20. The Financial Times noted that public investment in the plan was driven by the hope that it would stimulate private sector investment through tax breaks for construction and water and other infrastructure spending.[45] The Economist called the PAC "overly timid", arguing that much of the expenditure announced in the plan had previously been planned, and that it failed to tackle "the cause of low growth: excessive spending and debt, which depress investment by keeping taxes and interest rates high", and tax and social security complexity.[46] The Financial Times also noted that the PAC would not address the "bankrupt pensions system and spiralling government spending".[47] There was, however, some support for the PAC as a means to ensure economic stability in Brazil.[48]

21. The Trade Minister told us that, while the UK Government supported the PAC and would work with the Brazilian Government, the two had held discussions over prioritisation within it.[49] Noting that the political situation in Brazil was key to its implementation, the Trade Minister said that the UK Government "would like them to take on the two themes of investment in infrastructure and incentives to and encouragement of private sector investment, looking to the creation of public/private partnerships and dealing with procurement issues and financial services."[50] The Brazilian government minister responsible for the PAC has recently suggested that there is a risk that a number of its targets could be missed: out of 1,646 measures, 53% were on track and 39% needed attention, with the remainder giving "cause for concern".[51] The last includes two hydroelectric dams, where there have been problems with the granting of environmental licences.

Brazil: A BRIC in the wall?

22. As noted above, our inquiry is one of a series into the key emerging markets, the 'BRICs'.[52] With origins in a 2001 Goldman Sachs report,[53] the acronym gained broader recognition though a 2003 paper extending the previous 10-year forecast analysis to 2050. This found these four countries had the potential to be among the world's seven largest economies by 2050, with Brazil's economy having the potential to eclipse Italy's by 2025, France's by 2031, and those of the UK and Germany by 2036.[54] When Goldman Sachs reassessed the BRICs' progress in 2005 it found that China could be the world's largest economy by 2050, India third (behind the US), Brazil fifth (behind Japan), and Russia seventh (after Mexico), with the UK in ninth place. Of a 'Next 11' of other major developing countries that was examined only Mexico and South Korea were thought to have the potential to be as important as the BRICs.[55]

23. There have been suggestions that the BRIC acronym has origins in convenience rather than reality, or that it is a re-branding of what were formerly merely emerging markets following the economic crises of the 1990s.[56] Goldman Sachs state that:

all

24. However, some maintain that grouping these countries masks the significant differences between them; as the Trade Minister acknowledged, the BRICs "have their own differentiations in terms of growth, size of market, size of labour force and the sectors where they concentrate their efforts".[58] He said that while each had its own barriers to trade and investment, "One thing that unites them all is that they will be substantial growth areas, not just in the next five years but for decades to come."[59]

25. Recent debate has heavily focused on China and India, dubbed "Chindia",[60] rather than on Brazil or indeed Russia. For some the emergence of China and India is bringing "a real shift in the power balance", Russia and Brazil "are marginal economies propped up by high commodity prices" and undermined by a lack of long-term investment.[61] A recent City of London report noted that the BRICs are very different from each other: Brazil supplying raw materials to the world, and having an expanding population; Russia's energy reserves vital to world energy markets, though with a shrinking population.[62] Meanwhile China and India were "transforming not only the dynamics of the world economy, but also the balance of power", and "poised to be the drivers of a potential new centre of economic gravity, covering the whole of Asia".[63] In particular, Brazil's comparatively slow rate of economic growth of 2-3%, "lethargic"[64] compared with the breakneck growth rates seen in India and China, has led some to question its right to be a member of the same club as the other BRICs. Other terminology has been proposed, including 'CHIME' (China, India and the Middle East),[65] 'CIBS' (China, India, Brazil and South Africa),[66] and even 'CEMENT' (Countries in Emerging Markets Excluded by New Terminology)—as "if you want to build a wall, you need both bricks and cement".[67]

26. However, Brazil has recently seen rising growth, a doubling of exports since 2003, falling interest rates, more manageable public debt, and reductions in income inequality, and poverty.[68] The Economist also noted that "in many ways Brazil is the steadiest of the BRICs", with democracy and no serious disputes with neighbours, and that its slower growth could be explained by being richer and more urbanised than the other BRICs.[69]

27. Moreover, although Brazil's progress may not be as spectacular as that of China and India, its importance as an economic power should not be underestimated: in 2005 Goldman Sachs estimated that Brazil could overtake the GDP of Italy, France, Germany and the UK by 2040.[70] In a further reassessment of BRICs' progress in December 2006, Goldman Sachs said that they "remain confident" about Brazil's potential for growth, and that President Lula's second term would "sustain sound macroeconomic policies and make some progress on structural reforms" with real GDP growth of around 3.5%. As this is consistent with their estimate of the BRIC countries' potential growth rate (3.7%), they concluded that "Brazil does belong in the BRICs".[71]

28. As the Trade Minister remarked, Brazil is "not an India or China, but in terms of the global economy and its growth and where it is geo-politically set in Latin America it is a major global player and is seen and treated as such by the World Bank, IMF, stock exchanges and big investors around the world."[72] He also said that the different challenges facing each of them meant that he was "not quite sure that the concept of a synergy between them is the right way to go. We have to treat all of them as massive markets with different barriers but also great opportunities, and we need to deal with them differently."[73] UKTI noted that "even if Brazil is not meeting the globalisation challenge in a manner comparable to China and India, one must not lose perspective about its place in the world."[74]

29. Throughout our inquiry, the critical importance of market knowledge of Brazil, and to a certain extent the other Mercosur countries, was repeatedly emphasized. We also heard of a persistent 'perception lag' after past economic and political problems in Latin America, even that UK businesses have a blind spot for the continent. The general lack of knowledge about Brazil and the other Mercosur markets contributes to the perception that they are simply 'too difficult to do business with'. Lack of knowledge and outdated perceptions among UK businesses appear to us to be the main reasons underlying the lack of UK engagement with Brazil compared with our competitors. We have seen many examples of opportunities in Brazil and the rest of Mercosur that could be exploited, and indeed are being exploited by competitors. We hope that by raising awareness of both the opportunities and risks involved in these markets, this Report and its supporting evidence will make a useful contribution to those companies who are considering trading with or investing in Brazil, Argentina and the other Mercosur countries.

1 See Trade and Industry Committee, Trade and Investment Opportunities with India, Third Report of Session 2005-06, HC 881 I & II and Government Response, Fifteenth Special Report of 2005-06, HC 1671 2005-06, and also Trade and Investment Opportunities with China and Taiwan, Fourteenth Report of Session 2002-03, HC 128 and Government Response, First Special Report of Session 2003-04, HC 142. Back

2 Trade and Industry Committee, Marketing UK plc-UKTI's 5 year strategy, Sixth Report of Session 2006-07, HC 557 & HC 161. Back

3 Mercosur's 'rules of origin' prevent non-members countries from exploiting the continuing differences in import tariffs between members, requiring certain proportions of products to be manufactured within Mercosur countries to benefit from tariff-free trading terms between them. Back

4 Q151 Back

5 2005 population/GDP (US$) data from World Bank, World Development Indicator database, 2006 Back

6 FCO, Brazil country profile: http://www.fco.gov.uk/servlet/Front?pagename=OpenMarket/Xcelerate/ShowPage&c=Page&cid=1007029394365&a=KCountryProfile&aid=1019744897089 Back

7 From Comunidad Andina; www.comunidadandina.org/endex.htm Back

8 "Mercosur 'must tackle inequality'", BBC News Online, 19 January 2007: news.bbc.co.uk/1/hi/world/americas/6278307.stm, and 'Mercosur frustrates extension of Chavez influence', Financial Times, 20 January 2007 Back

9 'Mercosur and Andean Community sign free trade pact', Inter Press Service, 19 October 2004, via bilaterals.org: http://www.bilaterals.org/article.php3?id_article=860). This followed agreements between Bolivia and Peru and Mercosur in 1996 and 2003. Back

10 Appendix 28 (UKTI). UKTI note that while as a former member Venezuela currently has preferential access to CAN as well as Mercosur countries, currently the "other Mercosur countries do not benefit from preferential access to the Andean Market." See, Appendix 26 (UKTI), paras 35 and 36. Back

11 'Chile Seeks To Strengthen Economic Ties with Mercosur', Latin America News Digest (via Factiva), 11 April 2007.UKTI told us that the 1996 Mercosur-Chile agreement included staged tariff reductions for over 90% of products from October 1996, with exceptions for sensitive products up to 2014. See Appendix 26 (UKTI) Back

12 See Appendix 26 (UKTI), C4-C8 Back