While Brazil’s economic performance in the past decade has made it one of the leading targets of foreign investment in the world, its success has relied heavily—even excessively—on commodity exports, mostly destined for China. Exports have grown to $256 billion, up from $118 billion in 2005, and now account for 14 percent of GDP (compared to 6 percent in the 1990s).

Mineral, agricultural and other primary products constitute more than 50 percent of Brazil’s total exports. But it was not always that way. Exports of manufactured goods were once Brazil’s cash cow, commanding a higher value than primary and semi-manufactured goods combined. But as its agriculture sector grew, Brazil became one of the world’s leading exporters of soy, sugar, meat, coffee, tobacco, and orange juice. Over the past seven years, the value of commodity exports has quadrupled.

Should Brazil’s new dependence on commodities be a reason for concern? The growth that was fueled by commodity export success has improved Brazil’s financial health, and certainly helped the nation weather the 2008–2009 global financial crisis. Yet heavy reliance on commodities has created significant challenges that threaten the economy’s medium- and long-term prospects.

For starters, favorable commodity prices may be short-lived. The 2000s were an atypical decade with regard to consistently high prices, largely due to China’s emergence as a global economic power. Brazilian exports to China grew at roughly four times the rate of total exports between 2000 and 2010. Chinese imports of soy, for example, represent over 40 percent of Brazil’s exports, while Chinese imports of iron constitute over a third of the total exports in the sector. Oil, pulp and paper, and meat are also substantial exports to China, representing from 5 percent to 10 percent of Brazil’s exports of these products.

Commodity prices tend to be quite volatile. Economies tied to them become so, too: when prices are high, the economy booms. But when they fall, the contraction can be severe. And there are already signs of contraction in China.

As Chinese growth rates have begun to slow and global commodity prices start to fall globally, so have the volume and value of Brazilian exports to China. Depending on how severe China’s slowdown is—and whether other nations step in to fill the void—Brazil’s overemphasis on commodities could prove dangerous not just to the country’s short-term fiscal health, but also to its long-term prospects for economic stability and development.

The risks of commodity dependence go beyond the possibility of lost export revenues. While Brazil’s economy has benefited from the good fortune of Chinese consumption, manufacturing has paid the price. Manufacturing exports, and particularly high-tech exports, are crucial to sustainable, equitable development. On this front, Brazil is losing ground to other developing countries, most of all to China.

Chinese manufactured goods are increasingly displacing Brazilian ones. Kevin Gallagher and Roberto Porzecanski estimate in The Dragon in the Room that by 2006, 91 percent of Brazil’s manufacturing exports to the world were already under threat from Chinese competition, meaning either that Brazilian exports were falling while China’s were rising—or that Chinese exports were rising at a faster rate.1

At the same time, the commodity boom put constant upward pressure on the real, which has already appreciated roughly 10 percent in 2012 and over 40 percent since 2010. Appreciation has further hurt Brazilian manufacturing as imports have increased dramatically. Between 2003 and 2011, the coefficient of import penetration doubled from roughly 10 percent to over 20 percent. As a result, Brazilian manufacturing has lost ground in both global and domestic markets.

Commodity success over the past decade has also reduced the pressure for much-needed structural and institutional investments and reforms, including increased investments in infrastructure, research and development (R&D), and education, as well as reforms to the tax and pension systems. But deeper structural issues could make Brazil vulnerable should commodity prices drop. Beyond the value of the real, the low quality of labor and the scarcity of skilled labor have contributed to rising unit labor costs and low labor productivity.

Weaknesses in Brazil’s labor market reflect pitfalls in the education system, where low funding for primary and secondary schools and poor teacher training and supervision are chronic problems. Even highly touted programs like Bolsa Família—which has helped reduce poverty and greatly increased school enrollment—cannot effectively address these structural issues. As a result, after 10 years of education reform, Brazil’s Programme for International Student Assessment (PISA) rankings have barely changed. Scores in reading, science and math fall well below global averages and trail Latin America’s leaders.

Brazil’s lack of progress in developing its knowledge economy is manifested in a number of indicators. The global share of high-tech manufacturing exports has barely changed from the 1990s to the 2000s, lagging behind the absolute levels in countries such as South Korea, Philippines, Malaysia, or Mexico; and it is particularly weak compared to China. Similarly, public spending on R&D has been stagnant during 2000s. At roughly 1 percent of GDP for both public and private expenditures, it falls well below spending levels in other emerging markets such as China, Russia or South Korea.

If commodity prices start to fall and the good times recede, will there be enough of a manufacturing sector to fill the void? Will Brazil’s labor market have the skills necessary to compete with other developing nations in alternative industries? Or will it be too late to catch up? With Chinese growth slowing, we may know the answer soon. But if historical experience and current trends are any indication, it will be difficult to break the cycle.

ENDNOTES:

1. Gallagher, Kevin P. and Roberto Porzecanski, The Dragon in the Room: China and the Future of Latin American Industrialization, Stanford University Press, 2010.

Any opinions expressed in this piece do not necessarily reflect those of Americas Quarterly or its publishers.