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The Manaus free trade zone
Brazil's industrial policy
Bungle in the jungle
Feb 17th 2000 | MANAUS, BRAZIL
From The Economist print edition
The creation of a huge low-tax, high-tech manufacturing zone in the Amazon has done more harm than good
WHY on earth did Brazil plonk its electronics industry 1,750km (1,100 miles) up the Amazon river, slap in the middle of the rainforest? The answer is older than the country itself. More pressing questions are: would any of the factories in Manaus, Amazonia's biggest city, survive the ending of the tax breaks that took them there�worth more than 3 billion reais ($1.7 billion) last year? And what effect has this generous policy had on the rest of Brazil's firms?
First, a potted history: under the 1494 Treaty of Tordesillas, an imaginary north-south line was drawn across an uncharted part of the globe, 370 leagues west of the Cape Verde Islands. Spain was to rule over anything to the west of the line, Portugal anything to the east. Soon afterwards, Portuguese pioneers stumbled upon a huge new landmass that spanned the line; they called it Brazil. Through a mixture of opportunism and might, the Portuguese eventually claimed most of Amazonia for their own. But the fear that somebody may try to grab it back became embedded in Brazilian military thinking. When the generals took over in the mid-1960s they decided that the territory had to be colonised by as many people and buildings as possible.
Hence the creation of a Zona Franca in 1967. In its various guises this low-tax zone, centred on Manaus, has been intended to persuade businesses to ignore the obvious inconvenience of being distant from raw materials, suppliers and customers. But the military objective of occupying territory soon became entangled with an economic one: Brazil wanted to reduce its heavy dependence on imported consumer goods, especially expensive electronic ones. Since other countries were promoting industrial parks in underdeveloped places, why not promote one there too?
The policy was at least a military success. Manaus grew rapidly, and now has a population of 1.2m. Much of Brazil's considerable output of televisions, videos, hi-fis and other manufactured goods, from shavers to motorbikes, is made there. But in economic terms, it has been an expensive disaster, say the critics. These include industrial lobby groups elsewhere in Brazil, who assert that many of the "manufacturers" in Manaus are actually screwdriver plants, assembling goods from components shipped in from abroad. The rest of Brazil's businesses bear the high taxes that pay for all this folly.
The admirably detailed figures that are published by Suframa, the government agency that runs the Zona Franca, show that the critics are exaggerating, but only a little. Local value-added (ie, sales less parts and materials bought from outside the region, as a proportion of revenues) was only 57% last year. The big devaluation of the real in early 1999 made things worse, by adding to the cost of imports. But local value-added had been slipping for years, with firms recently buying less than a quarter of their parts and materials from Amazonia and around half from foreign countries. The zone's sales have been slipping since 1996, and the number of jobs that it offers�the main reason for its existence, remember�has fallen well below the levels of the late 1980s (see chart).
Some big firms continue to invest in the region. Multibras, which is American-owned, spent $40m in 1998 on a new factory to make air-conditioners and microwave ovens. But it and other firms still locate many of their plants, usually without tax breaks, in southern Brazil, the country's industrial heartland, or in emerging manufacturing zones on the north-east coast. When they are made in Brazil, high-value components such as cathode-ray tubes for televisions and compressors for refrigerators tend to come from southern states such as Sao Paulo and Santa Catarina, where firms have situated most of their research and product-design facilities.
Up the creek
With a few exceptions, such as Honda's giant Manaus plant, which makes motorbikes from scratch, the Zona Franca has failed to get much beyond serving as an assembly line. In particular, it has not seen the clustering of firms and suppliers that is needed to create a self-sustaining industrial centre. Although devaluation boosted the zone's exports to a record $372m last year, its trade balance was $1.8 billion in the red. Suframa, and local politicians, talk of an export boom solving the Zona Franca's problems. But the Brazilian Development Bank (BNDES) seems less optimistic. It has called for mergers and capacity cuts among the zone's electronics firms, and revealed that three of them�Sharp, Gradiente and CCE�were in talks.
Although the zone's tax breaks are guaranteed in Brazil's constitution until 2013 (local politicians are lobbying for an extension to 2023), their relative advantages may be eroded rather sooner: Congress recently voted to continue a scheme that offers similar tax breaks to makers of information-technology products in all areas of Brazil. Does a product such as a hi-fi or a television qualify if it is equipped with an Internet browser to download songs and videos?
Nilton Sacenco, Suframa's deputy superintendent, says that new rules will distinguish between a computer with good speakers (tax breaks available all over Brazil) and a domestic appliance with added Internet access (tax breaks in Amazonia only). But another layer of rules is about the last thing that Brazilian industry needs. To minimise fiddles and allegations of screwdriver plants, Suframa already requires firms to submit detailed plans of exactly which manufacturing processes they will use in their Zona Franca plants. Factory bosses in Manaus privately complain that benefits from tax breaks are largely offset by the suffocating effects of Suframa's huge bureaucracy.
One result of the scheme is that Brazil's industry is scattered illogically over its territory, adding to the so-called "Brazil cost". Another is to limit industry's ability to adapt quickly. This is because any firm wanting to make changes to its manufacturing process needs first to seek approval. If it does not, it risks losing its tax breaks.
In Manaus, local politicians keen to keep the current regime argue that the presence of the factories has given people seeking to make a living an alternative to chopping down the rainforest. However, the policy's effect on Manaus itself has been malign. The recent downturn in the zone's output suggests that the region is vulnerable to sudden changes in fortunes�just as it was 90 years ago, when competition from South-East Asian plantations wiped out its rubber-tapping industry. Agriculture and tourism, two industries that are well-suited to Amazonia and are potentially big providers of jobs, have been largely ignored by the tax rules. Consider the absurdity of a city in the middle of the world's biggest tropical forest having to ship in a large proportion of its fruit and vegetables.
Mr Sacenco says that government agencies like his are beginning to learn from their mistakes, and are now encouraging more investment projects that take into account the region's natural advantages. But it would surely be better if Brazil first simplified and reduced the tax and regulatory burden on all businesses (congressmen, ministers and state governors continue to squabble over proposals to take a step towards this). If it did, improving the infrastructure and public services of the country's underdeveloped interior might really do some good.
Source: The Economist
CONTENT COPYRIGHT The Economist. THIS CONTENT IS INTENDED SOLELY FOR EDUCATIONAL PURPOSES.
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