High-end Manufacturing

One of the most essential steps in transitioning from a middle-income country to a high-income country, as I have mentioned before, is the development of a competitive high-end manufacturing base. This means moving beyond the low-end basic assembly of products (think large-scale factories using an army of cheap labor) into more advanced, innovative product design and development. Once again, Japan and South Korea are useful examples in this regard. Both began their process of industrialization with low-end manufacturing, assembling basic products and exporting them to consumer markets in the West. But slowly, they developed innovative capacity and began to design and build their own high-end products, such as cars and electronics. While their brands were at first viewed with disdain and suspicion by Western consumers, companies such as Toyota, Samsung, Hyundai, Toshiba, Kia and Sony all became extremely successful at producing cutting-edge technology used the world over. The success of this high-end manufacturing catapulted Japan and Korea past their middle-income peers and into the ranks of the world’s wealthiest nations.

China is now trying to follow in the footsteps of its East Asian peers, investing huge amounts of money to build its own high-end manufacturing base. The country’s leaders are trying to shed their nation’s status as the global center of low-end manufacturing and instead develop indigenous brands that are known for quality and innovation. Brazil faces a similar challenge. The government has long been on a quest to produce “national champions”, local companies that are globally competitive in major fields.

For me, a simple but effective way to evaluate a country’s high-end manufacturing base is to look at its car production. Car manufacturing is a classic symbol of industrial societies. Due to the complexity of designing and mass producing quality automobiles, it is a very good indicator of a country’s innovative manufacturing capacity. All of the major competitive economies have at least one or two well-known car brands: Chrysler, GM and Ford in the U.S.; Jaguar and Rolls Royce in Britain; Renault, Citroen and Peugeot in France; Fiat in Italy; Volkswagen, BMW and Mercedes in Germany; Volvo and Saab in Sweden; Toyota, Honda and Nissan in Japan; and Hyundai and Kia in South Korea. (Caveat: some smaller wealthy economies do not have their own car brands, but are known for other national champions, especially in the area of electronics, such as Nokia in Finland and Research in Motion in Canada.) If a major emerging economy is unable to produce a single car brand, this is normally a strong indicator of the country’s underlying competitive weaknesses in manufacturing.

China’s growing success in car manufacturing suggests that it is quickly consolidating its high-end manufacturing capacity, a trend that should continue over the next several decades. Chinese brands such as Great Wall and Chery are already starting to penetrate foreign markets, and these cars are quickly becoming more commonplace here in Brazil. As with their Japanese and Korean counterparts, Chinese brands have been scoffed at by wealthy consumers skeptical of their quality. Over time, however, I suspect that this will change and Chinese cars will be just as common as Volkswagens or Fords on roads all over the world. This will be a clear indicator of China’s continuing development.

A quick look at the car industry in Brazil raises serious concerns about this country’s progress in developing high-end manufacturing capacity. Brazil is the world’s third largest consumer market for automobiles (after the U.S. and China), yet it does not have a single national brand. For many years, the government has tried to foster a national car industry in the way that it normally attempts to build national champions: imposing high tariffs on competitive imports and domestic content requirements that require foreign companies to set up factories within the country and develop supply chains with local industries. The result? Brazil is the most expensive major country in the world in which to purchase a car, as high production costs are passed on to consumers. And as of yet, there is still no sign of an emerging national car brand. As I mentioned in a previous column, the government has recently been increasing these tariffs and establishing quotas on car imports from Mexico to protect its domestic manufacturers and prevent further “deindustrialization”.

Despite the obvious failure of Brazil’s car industry, there are promising examples of Brazil’s high-end manufacturing capacity in other fields. Embraer, a former state enterprise, is a leader in the global aerospace market, becoming one of the world’s largest airplane manufacturers and competing successfully with international brands such as Boeing (U.S.), Airbus (Europe), and Bombardier (Canada). Embraer’s jets are famous all over the world for their quality, and chances are high that anyone who flies regularly has sat in an airplane designed and manufactured in Brazil. Marcopolo, a bus manufacturer, has had equally impressive success. In addition to dominating the large national market, it has expanded its operations all over the world and produces buses across Latin America, South Africa and India.

The success of Embraer and Marcopolo provides optimism regarding Brazil’s future. If the country can produce globally competitive jets and buses, it is surely capable of developing the high-end manufacturing capacity that will enable it to become a major economic power internationally. In addition to these manufacturers, the country is on the cutting edge of other global technologies, such as deep-sea oil drilling and biofuels. The question therefore becomes how Brazil can deepen and broaden these competitive advantages and build more national champions.

There is, of course, no straightforward answer to this question. It is easy to lambast Brazil for its damaging, ineffective protectionism. There are many examples of failure aside from the car industry. The government has been trying to take advantage of its growing offshore oil production to produce new national champions in related fields such as shipbuilding, using domestic content requirements that force oil companies to purchase locally and prop up nascent industries. So far, however, the only effect of this policy has been to dramatically slow down oil production. Brazilian shipbuilders have been unable to meet demand, and as international partners such as Samsung begin to pull out and Petrobras cancels contracts due to production delays, it is becoming clear that the government’s policies are backfiring.

Yet China, Japan and South Korea all imposed highly protectionist policies for many years as they set about building their own national champions. Opening up the country to more free trade and international competition would be good for consumers and for the economy as a whole, but while it would certainly force Brazilian industry to become more competitive in general, there is no guarantee that such a move would improve the country’s high-end manufacturing capacity. Mexico has embraced free trade in order to develop its economy with very successful results, but it, too, has yet to produce a national car brand. Neither protecting the economy nor opening it up is sufficient to become a high-income country.

What Brazil truly needs to develop its innovative capacity is to both shrink its government in areas where it is strangling domestic industry and to expand it in areas where it can serve as a useful partner for promoting productive investment. Shrinking the government will involve reducing red tape through public administration reform, tax reform and labor reform. Expanding the government will involve massive increases in investment, requiring more financing and better execution to improve infrastructure, build a skilled labor force, and promote research and development. It will also require the government to be more proactive in supporting start-up industries (the Chilean government, for example, offers seed funding for promising entrepreneurs and has a very favorable visa regime to attract potential innovators) as well as providing smart subsidies and favorable policies for certain strategic industries (the U.S. and Chinese governments, for example, have done this for renewable energy firms and other key sectors).

So far, there are both positive and negative signs. Major reforms have not been forthcoming, and investment is still far below the necessary levels. But the government has made some first steps in the right direction, reducing taxes on electricity and other sectors, simplifying some bureaucratic procedures, and announcing new investments in infrastructure and education. As I have mentioned before, the most promising new program is Ms. Rousseff’s Science Without Borders initiative, which aims to send up to 100,000 Brazilian students per year to study science and engineering in the industries and universities of the developed world. This is clearly the government’s boldest attempt to build the indigenous knowledge necessary to develop future high-end manufacturing capacity. We will have to stay tuned to see if the government is able to implement other big initiatives to move the country forward on this front.