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The political economy of Brazilian trade policy: domestic determinants, world and regional strategies

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THE POLITICAL ECONOMY OF BRAZILIAN TRADE POLICY: DOMESTIC
DETERMINANTS, WORLD AND REGIONAL STRATEGIES

by

Glauco Avelino Sampaio Oliveira

A Dissertation Presented to the
FACULTY OF THE GRADUATE SCHOOL
UNIVERSITY OF SOUTHERN CALIFORNIA
In Partial Fulfillment of the
Requirements for the Degree
DOCTOR OF PHILOSOPHY
(POLITICAL ECONOMY AND PUBLIC POLICY)

December 2009

Copyright 2009 Glauco Avelino Sampaio Oliveira

ii
Acknowledgments

Completing a dissertation is a lonely endeavor in many aspects. However, this task
relies on a whole network of people and institutions that allow one to achieve her/his best
work. I am fully aware that without the support of many, I would not have had the
wherewithal and motivation to conclude my PhD. I am deeply indebted to those that gave
me so much support along the way.
First, I want to thank my parents, José and Sonia, who always believed in my
ability to meet the challenge of completing this project. I am also indebted to Professor
Carol Wise, my academic advisor and committee chair, whose intellectual guidance and
personal commitment never wavered after almost three years of relentless effort in
writing this dissertation. I am deeply indebted to Professor Jeffrey Nugent, the co-chair
of my academic committee, whose patience and dedication in exchanging emails almost
on a weekly basis for more than a year allowed me to complete the empirical part of the
dissertation. These two distinguished scholars had a crucial and enduring influence in my
graduate studies and made it possible for me to overcome personal and academic
obstacles and to conclude this research project.
Professor Eduardo Viola, who guided me during my M. A. program at the
Universidade de Brasília, has remained a trusted friend and intellectual influence.
Without his strong encouragement, I would not have even considered applying for a
PhD. program at the University of Southern California.
I would like to thank my colleagues in the program in Political Economy and
Public Policy who shared the same experiences and challenges with me. I would like to
iii
thank my Brazilian friends at the University of Southern California, graduate students
like me. Their presence helped me overcome the lonely times while I was still living in
Los Angeles and their support in hosting me when I visited the city was invaluable.
The successful completion of this project also depended on several public
organizations. I am grateful for the institutional and financial support that I received from: the
Co-ordination for Training of Advanced Degree Personnel (Coordenação de Aperfeiçoamento de
Pessoal de Nível Superior - CAPES) from the Ministry of Education, which provided me with a
full scholarship to pursue studies abroad; the Ministry of Planning, Budget and Management
(MPO); and the Ministry of Finance (MF), especially, my colleagues and supervisors from the
Secretariat for International Affairs and from the Secretariat of Economic Monitoring, who
understood the importance of training staff, even when that put pressure on the daily schedule.
Finally, as a career civil servant, I would like to acknowledge the importance of the
institutional mechanisms that allowed me to pursue graduate studies abroad. I firmly believe that
the continuous training of civil servants contributes to a better public sector in Brazil, to the
benefit of its population, particularly the underprivileged, who are most in need for the public
services.

iv
Table of Contents

Acknowledgments ii

List of Tables vii

List of Figures viii

Abstract ix

Introduction 1
Section I - The Research Problem 1
Section II - The Brazilian Case 5
Section III - Literature Review 9
Multilateral and Regional Trade Integration 10
Trade liberalization, Structural Reform and the Role of Domestic Actors 12
Economic and Institutional Development 17
Locating the Brazilian Case in the Political Economy Literature 19
Section IV - Methodological Organization of the Dissertation 22
Objectives 22
Hypothesis and dependent variable 23
Plan of the Dissertation 24

Chapter 1 - Understanding Trade Policy in Brazil:
The Historical, Regional, and Domestic Context 28
Introduction 28
Section I - Methodological Foreword 29
Section II – The Origins of Latin America Protectionism and
the Import-substitution Industrialization (ISI) Years 34
The Tradition of Inward Looking and Managed Trade in Brazil and
Latin America 34
Trade Policy and Economic Development Strategy in Early ISI Years 47
Political Economy, Policy Ideas and the Administrative Organization
of the State 53
The State as Supporter of Exporting Activities and the Role of FDI 57
ISI and the Political Economy of Macro and Micro Inconsistencies 61
Section III - The Demise of ISI, Macroeconomic Imbalances and
Structural Reforms 64
Macroeconomic Imbalances and the Fallout from ISI 65
Democratization, the 1988 Constitution and its Effects on Economic Policy 72
Trade Policy, Macroeconomics and Structural Reforms 76
Section IV –Trade Liberalizantion and Integration - Political Economy and
Institutional-bureaucratic Determinants 87
The Political Economy of Trade and Industrial Policy in
Post-Stabilization Brazil 89
v
Trade Integration and Second Generation Reforms as Vehicle to Enhance
Competitiveness 94
Bureaucratic Politics and Ideological Inclinations toward Free Trade 99
Section V – Conclusion 103
Section VI - Statistical Annex 105

Chapter 2 - The International Political Economy and
Multilateral and Regional Trade Integration debates 111
Introduction 111
Section I - Methodological Foreword 112
Section II - The International Political Economy and the Openness Debate 114
Openness, Regionalism and Growth 124
New Growth Theory 131
The Examples of Mexico and Brazil 136
Section III - Multilateral and Regional Trade Integration 140
The Political Economy of Trade and the World Economy 140
Deeper Integration Issues: the New Trade Agenda 147
The Doha Round: State of the Art and the Brazilian Position 152
Global Imbalances: China’s surge as a New Source of Tensions in
the World Economy 157
Section IV - Conclusion 163
Section V – Statistical Annex 165

Chapter 3 - Brazilian Trade Policy and Asymmetrical Integration:
The EU-Mercosur Stalemate and a FTAA Thwarted 166
Introduction 166
Brazilian Trade Options in the Face of Global Challenges 166
Section I - Methodological Foreword 168
Section II. Brazil and the EU-Mercosur Negotiations 172
The Heart of the Matter 174
Explanations for the EU-Mercosur Stalemate –
The Bureaucratic Underpinnings of Brazilian Trade Policy 179
Section III. The FTAA: Brazil, the U.S., and the Political Economic Hurdles to
North-South Negotiations 182
Brazilian and U.S. Domestic Political Interests in the FTAA 185
Brazil and U.S. Trade Strategies 196
Section IV - Conclusion 206
Domestic Obstacles, International Crises and
Brazil’s Place in the World Economy 206

Chapter 4 - The Political Economy of Brazilian Trade Policy:
Domestic and International Determinants -
Empirical Testing and Data Investigation 211
Section I - Introduction 211
Section II - Methodological section. 215
vi
Theory 216
Hypotheses and Expected signals of variables. 232
Empirical strategy and model specification 250
Comments on the choice of estimation techniques 256
Discussion of Results 268
Section III - Brazilian trade balance structure and destination 1990-2005 281
Section IV - Conclusion 300
Section V - Methodological Annex 303
Data sources and methodology for construction of variables. 303
Section VI - Tables and Graphs 308

Conclusion 317
Specific issues 317
Prospects for the future 324

Bibliography 327

vii
List of Tables
Table 1: Latin America - Average Implicit Tariffs (percentage). Selected Economies,
1880 - 1928. 35
Table 2: Foreign Trade Revenues as a Share of Total Revenue of Central Government
(percentage). Selected Economies, 1880 - 1928. 35
Table 3: Phases of Growth by Major Region, 1820-1992 (Annual average percentage
growth rate). 43
Table 4: Per Capita Real GDP Growth in 11 Sample Countries, 1820-1992 (Anual
average compound growth rate). 44
Table 5: Brazil - Effective Protection, 1958-1967 (percentage). 105
Table 6: Brazil - Effective Protection, 1966-1985 (percentage). 106
Table 7: Brazil - Effective Tariffs by Sector, 1987-1993 (percentage). 107
Table 8: Brazil, Effective Tariffs by Sector, 1994-1999 (percentage). 108
Table 9: Glossary on Tariff Nomenclature. 109
Table 10: Selected Macroeconomic and Fiscal Statistics, 1991-2005. 110
Table 11: Export destination, Latin America and Caribbean 2003, percentage of
total exports. 165
Table 12: Brazilian Exports by Main Markets, 1997, 2004 and 2005. 199
Table 13: Effects of Explanatory Variables on Brazilian Trade Policies. 236
Table 14: Model 01 - Dependent variable Nominal Tariffs, 1988 - 2005. 264
Table 15: Model 02 - Dependent variable State Support share, 1988-2005. 265
Table 16: Model 03 - Dependent variable Nominal Tariffs, 1988-1999. 266
Table 17: Model 04 - Dependent variable State Support share, 1988-1999. 267
Table 18: Model 05 - Dependent variables - Nominal Tariff and State Support share,
1988-2005, with interaction terms 279
Table 19: Average and Variance in MFN tariffs, Harmonized Schedule, Selected
Countries (2005), continued. 287
Table 20: Variation in Trade Balance and in Terms of Trade per sector,
selected years. 298
Table 21: Brazilian effective tariffs, manufacturing sectors (percentage). 308
Table 22: Summary statistics (all variables). 308
Table 23: Correlation Matrix (variables used in Models 1 and 2). 309
Table 24: Co-linearity diagnosis (variables used in Models 1 and 2). 309
viii
List of Figures

Figure 1: Gross Savings as Percentage of GDP.Source: World Bank Development
Indicators 2006. 44
Figure 2: Consumer Price Index in Brazil, 1970-2005. 67
Figure 3: Openness (X+M/GDP), 1962-2005. 85
Figure 4: External Sector. 86
Figure 5: Real and Nominal Exchange Rate, 1994-2005
1
.
86
Figure 6: Real GDP per capita selected Latin American economies. 120
Figure 7: Real GDP per capita selected Asian economies. 120
Figure 8: Real GDP per capita G-7 economies. 121
Figure 9: Productivity and trade protection. 139
Figure 10 - Median Nominal Tariff for selected countries, 2005. 310
Figure 11: Brazil, nominal and effective tariffs, 2007 (percentage). 311
Figure 12: Effective tariffs, 1986-2000 (percentage). 312
Figure 13: Nominal tariffs, 1986-2005 - Sectors (percentage). 313
Figure 14: BNDES Disbursements, 1986-2005 (constant US$ millions). 314
Figure 15: Trade balance by category of products and market destinations, 1990-2005
(constant US$ billions). 315
Figure 16: Trade balance by category of products and market destinations, 1990-2005
(constant US$ billions). 316

ix
Abstract
This dissertation discusses the political and economic forces, both external and
domestic, that have shaped Brazilian trade policy in the 1990s and 2000s. Marked by
concurrent multilateral and regional trade negotiations, the country has simultaneously
embraced orthodoxy and liberalization of the past, while also falling back on
protectionist practices. For instance, after implementing steep unilateral tariff cuts in
the late 1980s and early 1990s, trade policy has subsequently undergone only
piecemeal change; in fact, “industrial subsidies” were maintained and even reinforced
in the period 1988-2005. I analyze how the domestic institutional framework shaped
Brazil’s global strategy, swaying policymakers to opt for a regional integration
initiative (Mercosur) and a rigid negotiating position in the multilateral sphere (World
Trade Organization). At the same time, Brazil shirked its commitments with developed
countries in the context of the Free Trade Area of the Americas and the European
Union-Mercosur negotiations.
The methodological approach taken here is an interdisciplinary one which draws
on economics, international relations, and political science. I begin with a historical-
comparative narrative concerning the choice of development models (eg. import-
substitution industrialization), the nature of domestic economic institutions and
bureaucracies, and the interaction of both with powerful interest groups as determinants
of trade policy. Secondly, I explore the interaction between global forces, and Brazil’s
policy responses. I then conduct an econometric analysis using panel data which cover
ten industrial sectors over seventeen years, my goal being to explain two trade policy
variables – tariffs and subsidized loans. By applying the assumptions of neoclassical
x
trade theory (Heckscher-Ohlin and Ricardo-Viner), as well as those of the new growth
theories to the Brazilian case, my results show that collective action and factor
endowment variables explain patterns of trade protection/support in the country’s trade
policy over time. Finally, I discuss contemporary Brazilian trade policy decisions using
descriptive data

1
Introduction
Section I - The Research Problem
The purpose of this dissertation is to explain the contradictory political and
economic forces that have shaped Brazilian trade policy, with an emphasis on both
external and domestic influences. It will focus on Brazil’s trade strategy vis-à-vis world
trade, which has encompassed concurrent multilateral and regional integration processes.
My fundamental aim is to explain the ways in which trade tariffs have been gradually
liberalized in Brazil since the 1990s, while subsidies in some product lines are still the
norm. This dichotomous trend has evolved against the backdrop of a predominantly
mercantilist and protectionist discourse that has prevailed over this time period. Through
an analysis of ten manufacturing sectors that I conduct here, I argue that tariff
liberalization is largely a result of Brazil’s increasing adherence to multilateral
commitments made under the auspices of the 1994 Uruguay Round agreement and the
World Trade Organization (WTO), whereas the government’s maintenance of hefty trade
subsidies reflects the continued resistance of domestic producers to deeper levels of trade
integration. Taking the global context into account, throughout this dissertation I
emphasize that Brazilian trade policy preferences and negotiation strategies are a
function of the country’s domestic political-economy and institutional characteristics.
Concurrently with these multilateral and domestic forces, Brazilian trade strategy
has been shaped by the phenomenon known broadly as globalization, which has
propelled the flow of trade and investment among countries regardless of established
international rules and norms. These new trends have invoked additional agreements, for
2
example the General Agreement on Trade in Services (GATS), which was tacked on to
the 1994 Uruguay round agreement, spurring more encompassing rules that go beyond
tariff and border measures. Thus, in addition to traditional themes such as tariffs and
subsidies, contemporary trade agreements have sought to incorporate new themes, also
called deep integration issues. These new themes have dominated the kinds of North-
South negotiations that Brazil had engaged in recently, including the Mercosur-European
Union and Free Trade Area of the Americas (FTAA) negotiations. The stalling of both
these negotiations from the Brazilian angle, is a main source of concern in this
dissertation. Additionally, I explore how these contemporary North-South trade
negotiations have interacted with those underway at the multilateral level (WTO).
Finally, how the external trade policy agenda impacts on policies geared toward domestic
economic sectors and on the overall reform process of the 1990s is a point of concern
here.
What are the new trade themes and why have they become so important for a
developing country and emerging market economy such as Brazil? Broadly speaking, the
new trade themes involve regulations, rules, and standards, some of which pertain to
international legal norms, rather than trade in actual physical goods. Deep integration
issues encompass not only the flow of goods, but also the overall regulatory environment
for conducting business. For example, rules surrounding investment are included in the
category of new trade themes because these affect the decision of multinational
companies to establish overseas subsidiaries engaged in the production and trade of
goods and services. The same explanation holds for Intellectual Property Rights (IPRs):
the greater the protection for intellectual property, the more likely foreign investors will
3
transfer sensitive technologies to their overseas subsidiaries. These examples highlight
the differences between traditional trade issues, such as market access or tariffs, and the
new trade themes. Certainly, the traditional trade issues can also involve standards and
regulations, as in the case of Non-Tariff Barriers (NTBs). But for my purposes, the main
distinction is between negotiating over traditional physical goods and new trade-related
rules and regulations.
These new trade themes have important implications, not only for international
economic relations, but also for domestic economic structures and evolving institutional
frameworks within the emerging market countries. In fact, one major explanation for the
rapid proliferation of regional integration agreements (RIAs) in the 1990s is that they
facilitate the adoption of rules governing new trade issues by the developing countries.
Not surprisingly, the new trade themes have been taken up most vigorously in the context
of North-South international trade talks (e.g., NAFTA, Mercosur-EU, FTAA). Both in
the multilateral setting and within more recent regional integration arrangements,
developed countries have been pushing for more comprehensive rules around IPRs,
investment, and services in order to adequately protect property rights in such sectors as
telecommunication, software and pharmaceuticals. These areas are knowledge intensive
and require large investment costs in terms of R&D, labor force training and even sunken
infrastructure costs. As economic theory explains, risk-averse economic actors, when
making investment decisions in emerging markets, wish to minimize the possibility of
losses. From this it follows that the adoption of rules under trade integration agreements
by developing countries signals their willingness to respect those property rights that are
crucial for direct investment decisions.
4
In spite of the North-South divide and the clear comparative advantage of the
developed countries, deep integration issues raise vital questions concerning
technological externalities and economic productivity gains. In other words, in that they
shift domestic regulations toward more efficient, market-oriented economic and
institutional structures, new trade themes raise questions that affect both North and
South. Moreover, it is believed that economic and institutional evolution may be
enhanced with closer integration of a developing country into the world economy, as
recently discussed in the literature on economic regionalism and economic development.
Other aspects of RIAs, such as imperfect markets for competition, increasing returns to
scale, and the geographic clustering of industries are crucial to these trade themes. In a
world economy dominated by capital and knowledge-intensive sectors, the dynamic
features of localization of productive plants and intra-industry trade seem to provide a
major rationale for the growing interest in regionalism, which in turn has pushed new
trade themes to the top of the negotiating agenda.
Given the dynamic potential of these new trade issues, some sectors in the less
developed countries are clearly eager to exploit scale economies and enhance their levels
of international competitiveness. But other sectors in Latin America fear the
distributional and adjustment costs. This is especially true for Brazil, where those sectors
related to the new trade issues remain highly protected (capital intensive sectors such
electronics and the automobile industry). The next section summarizes some of the main
international and domestic influences on Brazilian trade policy.

5
Section II - The Brazilian Case
In the first half of the 2000s, Brazil was negotiating the creation and/or the
deepening of trade integration arrangements with a number of commercial partners,
including: regional negotiations for the FTAA; negotiations with the European countries
as part of the Mercosur-EU agreement; and, negotiations between Mercosur and other
Latin American Countries (Mexico, Chile) and with the Andean Community. With the
exception of the last agreement, these talks experienced delays and are currently stalled.
At the same time, Brazil has been active on the multilateral front at the World Trade
Organization (WTO). Historically, Brazil’s trade strategy has been to promote the
multilateral forum of the GATT/WTO as the best option for developing countries to
challenge the economic hegemony of the developed countries. The Labor Party
government, led by President Luiz Ignacio da Silva (“Lula”), has been most forthright in
pushing this line of Brazilian foreign economic policy, even more so than his
predecessors. Brazil’s more assertive stance has been especially apparent since the
launching of the Doha Development Round in 2001.
At the Doha/WTO meetings, Brazil and other similar developing economies
moved to form the G-20 group, its purpose being to present a joint proposal for the
liberalization of crucial markets (agriculture) and to protest the distorting consequences
of subsidies upheld by the developed countries. Within the G-20, Lula’s government has
pursued a bilateral trade rapprochement with India, Russia, China and South Africa, in a
move that indicates its renewed commitment to South-South integration. This shift has
been criticized by some as a “third world” bias in the Labor Party government’s foreign
policy. However, as I will show in the dissertation, an independent foreign economic
6
policy has been a long-standing concern of Brazilian diplomacy, notwithstanding the
incumbent government. Brazil’s emphasis on a multilateral and autonomous strategy is
understandable since its diversified portfolio of trade partners now renders the county a
truly “global trader.” See, for example, table 12 in chapter three, which shows the
breakdown of Brazil’s exports by region of destination from 1997 to 2005; by 2005, 22
percent went to the EU; 18 percent to the US; 14 percent to Mercosur, Chile and the
Andean Pact; and 12 percent to Asia.
1

Clearly, as regionalism has become an increasing tendency in the international
political economy, Brazil has joined step and actively sought membership in RIAs.
Curiously, prior to the debt crisis of the 1980s, Brazil rarely engaged in RIAs and instead
opted for a highly protectionist trade strategy that sought to exploit the considerable size
of its domestic market. In 1990, the Collor administration could no longer ignore the
failures of the country’s protectionist policies. Unilateral trade liberalization was
launched concurrently with the creation of Mercosur---a South-South RIA that formed a
common market between Brazil, Argentina, Uruguay and Paraguay. After an initial phase
of intra-regional boom within Mercosur, both in terms of volume and prices, this RIA fell
on hard times in the late 1990s. These difficulties were caused partly by external
macroeconomic shocks, such as the Asian and the Russian crises, but also by the
misaligned fiscal and macroeconomic policies of the Mercosur partners. Exchange rate
misalignment, in particular, has been a constant source of tension within Mercosur.

1
My point in this chapter is to depict Brazil is a global trader. In chapter four, I also discuss differences in
product content, market destination and technological intensity.
7
Although Mercosur continues to experience both political and technical
difficulties, it did signal an end to protectionist import-substitution-industrialization (ISI)
strategies in these countries. At the same time, some analysts are quick to point out that
Mercosur has upheld a number of trade exceptions that are more characteristic of the
past. To the extent that this is true, the discussion of new trade issues and future
integration options for Brazil is highly relevant. The enlargement of Mercosur, including
the possible joining of Venezuela and Bolivia, adds complexity to this problem, since the
former has adopted a bold confrontational discourse towards the U.S. On the other hand,
other Latin American Countries (Central America, Chile, Colombia, and Peru) have
opted for the negotiation of bilateral trade agreements with the U.S., showing how
polarized Western Hemisphere trade policy preferences are becoming.
The biggest challenge for Brazil to overcome will be the political and economic
issues intrinsic to integration with the more advanced economies. Obviously, the
prospect of joining a free-trade area with the biggest and most advanced economy in the
world---that of the United States---creates opportunities but also inevitable tensions
within business and governmental sectors in Brazil. The negotiations for an FTAA were
a prime example of the attempt to bridge this North-South divide. In line with this
endeavor, U.S. trade officials made it clear that the goals of the FTAA and in the bilateral
agreements should be the pursuit of a WTO-plus outcome involving issues of deep
integration. For many small Latin American nations with non-diversified economies, the
stakes for achieving a WTO-plus outcome are very high. Perhaps, the best strategy would
be to accept the injunctions of the new trade issues and foster new knowledge-based
sectors, while also seeking the best possible terms on market access and agricultural
8
trade. The North-South division of comparative advantage is taken as given: the North
sells high value-added goods and services, while the South sells agricultural, mineral and
other low value-added products.
2
Nonetheless, countries such as Brazil, Mexico and Argentina have considerable
industrial strength and even possess some important knowledge-intensive sectors. The
explosive growth of intra-industry trade and the importance of geographical location add
dynamic complexity to the formerly simple notion of the North selling high value-added
industrial goods and the South selling agricultural and low-skilled products. Thus, the
negotiation of RIAs linking North and South may raise difficult distributional issues, but
the benefits related to the transfer of technology, adoption of best practices, and the
prospects of heightened flows of foreign direct investment are also creating domestic
incentives and lobbies for liberalization.
Yet, Brazil and other Latin American countries have maintained trade and
industrial policies that are more aligned with the “interventionist,” state-led development
model. This policy choice benefits some special interest groups, but slows market
reforms, especially the so-called second generation reforms (SGR) which I elaborate on
below. I also discuss the connections and complementarities between market reforms and
deep integration issues, which were overlooked by Brazilian economic actors and
policymakers in the trade discussions of the first half of 2000s. Brazil’s reluctance to
tackle the discussion of deeper integration themes within the WTO, the FTAA and the

2
According to neo-classical trade theory, specialization, brought about by trade liberalization, enhances
world welfare despite inflicting distributive gains and losses within individual countries.
9
EU-Mercosur talks is a function of entrenched interests within the domestic political
economy, a theme which I discuss throughout this dissertation.
Although the Lula administration has committed to pursuing these new trade
issues at the WTO, with the breakdown of the Doha ministerial meetings, North-South
regional integration agreements could have perhaps been a more promising path for
deepening market reforms in Brazil and the rest of the region. Just as an RIA like
Mercosur was the first step toward locking in Brazil’s economic reforms, a North-South
RIA in the form of the FTAA or a Mercosur-EU agreement would seem the next logical
step for an emerging market country such as Brazil. However, this logical economic step
has been stalled by the political and ideological inclinations of those foreign policy
decision makers and special interest groups, who have held tightly to misperceptions
regarding the contemporary international economic order and remain locked in rent
seeking behavior. In this dissertation, I will examine those political economy forces that
have influenced such outcomes, using institutional-historical and statistical approaches.
The literature review in the next section will explore the main theories regarding
the political economy of multilateral and regional trade agreements, as well as long
standing themes in institutional and economic development, in order to locate the
Brazilian case in a proper comparative perspective.

Section III - Literature Review
In this section I review the most relevant political economy literature with regard
to:
1. Multilateral and regional trade integration, with a focus on the latter;
10
2. Trade liberalization, domestic reforms and the role that domestic actors play in this
process;
3. Economic and institutional development, including trade, technology and innovation
strategies.
Given the broad scope of these themes, my purpose here is to offer an overview
of the literature as it relates to the Brazilian case. Throughout the dissertation, I will
make use of the literature reviewed here and provide additional sources.
Multilateral and Regional Trade Integration
From the standpoint of the IR/IPE literature, Hegemonic Stability Theory (HST)
is perhaps a pertinent starting point for this. HST argues that the presence of a hegemonic
leader in the IPE is a necessary and sufficient condition for the establishment and
maintenance of a liberal economic order (Krasner 1976; Keohane 1997). This was the
basic structure of the IPE after World War II, when the Bretton-Woods institutions were
created under the auspices of US leadership and a liberal democratic ideology. One
possible explanation for regionalism, from the HST perspective, would be that a
declining hegemon undermines the liberal order and leaves weaker countries little choice
but to gather around the area of influence of a regional hegemon. At the same time, HST
tells us that the consequence of a declining hegemon for the international trade system
will be mounting protectionism on the international front, whereas preferential trade
agreements should abound (Bhagwati and Panagariya 1996).
Another point of view emerges from the liberal-functionalist literature within
IR/IPE. Here, countries co-exist in an anarchical international environment, and thus seek
forms of cooperation through international institutions so as to offset asymmetric
11
information and uncertainty within the international system (Keohane 1984). According
to the tenets of liberal-functionalism, the search for institutions holds whether or not the
international arena is dominated by a single hegemon and even in the case of a declining
one.
3
Thus, countries seek to establish multilateral, minilateral and bilateral institutional
mechanisms (Yarbrough and Yarbrough 1987), also called regimes (Ruggie 1982), to
guarantee a more stable international system. Since RIAs are minilateral initiatives, the
advent of regionalism in international trade can be understood on these grounds. Having
said this, and in light of the decreasing tariffs in Latin America since the early 1990s, it
seems clear that a decline in U.S. hegemony will not necessarily bring about
protectionism. But the rise of RIAs also demands further explanation.
According to traditional economic integration theory, trade creation and trade
diversion are the overriding effects of preferential trade agreements and customs unions
(Viner 1950, Johnson 1965).
4
RIAs are, therefore, second best alternatives, as unilateral
opening and/or liberalization via the multilateral trade system offer patently better
efficiency/welfare gains (Bhagwati and Panagariya, 1996). Yet, in line with a new wave
of research on RIAs, in the absence of trade diversion effects and discrimination against
third parties, RIAs may create the same level of efficiency and welfare (Krugman and
Obstfeld 2003; Feenstra 2004). This is due to the dynamic effects of deep integration
(Schiff and Winters 2003, chapter 2) and, from a international political economy point of

3
This strand of theory qualifies the use of power in different issue areas. For example, in the area of
continental trade the use of power by a hegemon has been posited as subtle, what Tulchin (2004), quoting
Joseph Nye, call “soft power.”
4
Trade creation occurs when two countries joining an RIA trade more than previously because there has
been a positive effect from the removal of tariffs, i.e. both countries are using their factors of production
more efficiently. Trade diversion results when two countries trade more due to the imposition of higher
tariffs on non-member countries; the latter could still provide more efficient goods were it not for the
application of tariffs related to the RIA.
12
view, the greater possibilities of engaging in constructive collective action at the regional
level (Wise 1998; Wise 1999).
The debate about the choice and consequences of the RIA route has become a
main theme in the IPE literature. Various analysts have asked: are RIAs complementary
to the multilateral system or are they a more subtle form of protectionism? Are they
building blocs or stumbling blocs to the multilateral order? Answers to these questions
do not come easily, as empirical analysis of RIAs makes many qualifications necessary.
In the early post World War II era, RIAs were security oriented and thus designed to
complement the multilateral trade rules embodied in the GATT, as exemplified in the
design of the European Community (Moravscik 1991). In the case of Latin America,
RIAs demonstrated a similar trend: a first phase of RIAs were mainly defensive attempts
to foster a development model based on import-substitution-industrialization (ISI) and
thus relied heavily on tariff walls and restrictions on FDI. More recently, RIAs were
launched under the aegis of open regionalism and as a response to external shocks in the
1980s and the need for deep structural adjustments (Edwards 1995; Haggard 1997;
Haggard 1998; Wise 1998; Wise 1999, IBD 2002).
Trade liberalization, Structural Reform and the Role of Domestic Actors
This recent upsurge of RIAs can thus be understood within the new context of
economic globalization and the domestic preferences of countries that adhere to this
trend. As trade liberalization and intra-industry production in Latin America have placed
a premium on increased economies of scale and the clustering of factor inputs (Schiff and
Winters 2003, chapter 5), policy preferences have changed (Mansfield and Milner 1999).
From the perspective of economic theory, the idea of clustering has been a key element
13
of growth and innovation since the works of Schumpeter (Schumpeter 2004; Day 1984).
From this standpoint, RIAs could be seen not as a failure of the multilateral system, but
rather as a direct consequence of the success of multilateralism and a way to guarantee its
survival (Ethier 1999, 2001; Baldwin 2006). As those with vested interests in the new
trade issues lobby governments to join an RIA (Milner 1997; Chase 2003), the expansion
of regionalism in Latin America can be understood in terms of the preferences of national
policymakers and those domestic interest groups engaged in global trade. In the case of
industries characterized by increasing returns to scale, for example, joining a free trade
area could lead to more dynamic outcomes because it increases the size of markets and
the rate of productivity growth.
The variations in trade policy among countries with different resources spawned a
literature on how factor endowments influence policy outcome. Known as endogenous
trade theories, these consider the political arena as a market where there exists a supply
and demand for protectionist policies. These theories can be used to understand structural
adjustment and trade liberalization in Latin America. Ronald Rogowski (1989), for
example, uses the Heckscher-Ohlin (H-O) model to explain how trade affects policy
outcomes and the political behavior of domestic actors. In short, those political actors
who own the scantily endowed factors of production will lobby against trade integration;
conversely, those who own abundant factors will support and benefit from trade. Free
trade decreases the welfare of the owners of the scarce factor and increases that of the
owners of abundant factors. Lobbying may occur along factor lines---capital vs. labor---
as in the application of the Stolper-Samuelson theorem; or it may manifest along industry
lines (e.g. import competing versus export oriented sectors) – which is the crux of the
14
Ricardo-Viner-Carnes hypotheses (Magee 1989). In another variation, Grossman and
Helpman (1994) depict an equilibrium structure of protection as a function of the state of
industrial organization (market power), trade dependency and the elasticity of import
demand or export supply. This approach means that trade policy may vary dramatically
with a change in government. The Grossman-Helpman (1994) model implies that
political capture gives rise to an unchanging or slowly changing equilibrium trade policy
(Noland 1997).
The broader context for the enactment of endogenous trade policies is that of a
two-level game in which the government needs to deal simultaneously with its domestic
constituencies and its international institutional commitments (Putnam 1988; Rosendorff
and Milner 2001). Some authors have found that endogenous trade policy can have
important implications for developing countries; for example, Grether, de Melo and
Olarreaga’s (2001) work on the Mexican case, and Chen and Feng’s (2000) research on
China. In short, earlier liberalization influences policy outcomes and the whole process
should be understood in a dynamic and complex framework. In the Mexican case, for
example, the owners of the scarce factor, capital, lobbied policymakers in favor of trade
liberalization because of their increasing engagement in intra-industry commerce and
cross-border production with the US (Pastor and Wise 1994); a first round of
liberalization in 1985-87 then set the stage for the country’s later entry into NAFTA.
However, bearing in mind the principal lines of endogenous trade theory, a closer look at
the relationship between business and governments in Latin America indicates a
significant variation in terms of trade policy preferences and strategies (Maxfield 2004;
Sáez 2005).
15
The literature on structural reform in Latin America sheds light on the changing
tastes of policymakers and interest groups with regard to the direction of economic
policy.

The literature on structural reforms in Latin America, also known as the
“Washington Consensus,” is extensive. Overall, such reforms included a macroeconomic
component in the search for monetary stability, fiscal balance and real exchange rate
adjustments; on the microeconomics side, the reforms were geared toward trade
openness/liberalization, privatization of state owned assets, and economic deregulation.
In short, stabilization and fiscal-macro reforms were easier to implement because the
future gains were more perceptible and the pain of adjustment was spread across the
entire population. Trade-regulatory reforms, on the other hand, involved more localized
distributive consequences that left small, but vocal, groups worse off. Thus, the logic of
collective action hindered the full implementation of such reforms.
5

The critical turning point was the deteriorated macroeconomic conditions that led
to the 1982 debt crisis, which in turn created a series of incentives and payoffs more
conducive to reform. In contrast to the political economic stalemate characteristic of the
pre-debt crisis era, some political actors finally agreed to bear the adjustment burden
associated with deep economic reform (Alesina and Drazen 1989). In the case of trade
liberalization, the policy shift stemmed not only from macroeconomic difficulties---high
inflation, fiscal deficits and overvalued exchange rates---but also from microeconomic
imbalances, including the declining terms of trade and lack of competitiveness of Latin
American goods on world markets (Rodrik 1994). Thus, after implementing unilateral

5
For a summary and overview of the content and preliminary outcomes of the Washington Consensus, see
Rodrik (1996) and Kuczynski and Williamson (2003). On the logic of collective action, and protection of
localized interests, see Olson (1967).
16
trade liberalization, countries quickly sought RIAs in order to “lock in” policy
modifications and to signal to international investors and financial institutions their
willingness to credibly commit to market friendly policies and institutions (Edwards
1995). In the Western Hemisphere, this trend can be observed in the case of NAFTA and
Mercosur. This example also applies to the smaller European countries that have more
recently sought membership in the EU.
The political economy literature has more recently turned its attention to the
importance of further reforms---the so-called Second Generation Reform (SGRs) agenda-
--in order to advance productivity gains and competitiveness, as well as to improve living
standards and human development (Navia and Velasco 2003; Sachs and Vial 2002;
Pastor and Wise 1999; IMF 1999). To the extent that SGRs include institutional and
human capital improvements, they may enhance innovation and technology absorption,
both of which are essential inputs for economic development.
6
In addition, SGRs are
related to the deep integration agenda, since RIAs have increasingly encompassed
institutional and regulatory improvements, such as rules governing investment. For
example, concerning a country’s ability to attract FDI, an RIA can help not only in the
crafting of the proper regulatory environment, but also in dissuading a given firm from
investing elsewhere (Blostrom and Kokko 1997). Although there are debates concerning
the direction of causality, the political economy literature has shown a high degree of

6
The literature on economic development has sought to explain differences in growth and development
among countries using non-traditional economic variables, such as the level of education of the population,
institutional design and the accumulation of social capital (Temple 1998; Fukuyama 2000; Easterly and
Levine 2001). Authors such as North (1990) and Pierson (2004) also emphasize the historical importance
of institutions (path dependence) in economic development (North 1990; Pierson 2004).
17
correlation between institutional improvements and integration into the world economy--
-which may or may not occur within an RIA framework.
7

Economic and Institutional Development
There is agreement that the simple removal of tariffs is insufficient to promote
growth and that other factors contribute to economic development, including differences
in the institutional framework and the actual content of trade policies (Rodrik 1993;
Rodriguez and Rodrik 1999; Baldwin 2003). Bardhan and Udry (1999, chapter 14), in a
literature review, report mixed results concerning the effect of trade on development and
they state that a certain level of protection, in some selected moments and sectors, may
be optimal for developing countries. On another note, Frankel and Romer (1999) argue
that, controlling for size and the geographical characteristics of countries, the impact of
trade opening on income is positive.
The degree of integration of a country into the world economy seems to be an
important source of economic development because it spurs dynamic changes throughout
the economy. New growth theories suggest that international knowledge spillovers can
occur as a result of trade in goods and FDI (Romer 1990, Grossman and Helpman 1995).
Coe, Helpman and Hoffmaister (1997); Greenaway, Morgan and Wright (2002) applied
these insights to the developing countries, observing that the growth of Total Factor
Productivity (TFP) in developing countries is positively related to the stock of R&D in
the industrial countries.

7
The consequences of closer integration into the world economy can vary depending on whether a country
or region pursues a unilateral, regional or multilateral framework. Integration under the auspices of an RIA,
for example, offers a different set of economic and policy incentives (Lawrence 1997; Schiff and Winters
2003, chapter 6).
18
Consider, for example, the case of intellectual property rights, one of the principal
themes of the deep integration agenda. There are multifaceted implications for the
protection of IPRs, FDI flows, the absorption of foreign R&D, and economic growth
(Gould and Gruben 1996; Maskus 2000; Smarzynska 2005). Overall, these studies
indicate the positive effects of IPR protection on FDI, foreign R&D absorption and
growth. Yet, Bardhan and Udry (1999, chapter 14) indicate mixed results; according to
them not granting foreign IPR may be optimal for developing countries in certain
moments. Diao, Roe and Yeldan (1999) verify that the positive effect of trade openness
in the absorption of foreign R&D stock will be greater if countries are able to process the
body of foreign knowledge according to their own characteristics, which opens the way
for the generation of domestic R&D. Similarly, Ocampo (2004) observes the importance
of linkages between inward and outward oriented sectors for TFP growth in Latin
America. Katz (2000) highlights the existence of national systems of innovation in the
recent experience of industrial policy and trade liberalization in Latin America and posits
these as necessary conditions for beneficial integration into the world economy. Finally,
Lederman and Maloney (2003; 2006) find that, although rates of return for R&D
investments are higher for developing countries, other institutional variables count in
R&D investment decisions as well. They suggest that countries with national innovation
systems and institutions may be better equipped to integrate into the world economy.
In brief, the literature seems to indicate that openness is a necessary but not
sufficient condition for economic development. Other policies and the institutional
background of the countries matter and play a crucial role. Due to the knowledge
intensive characteristics of the dominant sectors of the world economy, educational
19
investment, R&D policies and institutions are increasingly required to enhance the
benefits of trade integration. Otherwise, the absence of complementary policies may
reinforce the adjustment costs and the possible deleterious effects of sudden trade
liberalization on developing countries (Ocampo and Taylor 1998), not to mention the
differential adjustment burden that falls on small and medium-sized enterprises (Nugent
2002).
Locating the Brazilian Case in the Political Economy Literature
The literature that I have thus far reviewed seeks to present a rather generic view
of the possible effects of integration on the countries concerned, but what results can we
expect for an emerging market country such as Brazil? Recent studies suggest that there
has been TFP growth under unilateral trade liberalization and as a result of Brazil’s
membership in Mercosur (Ferreira and Rossi 2003; Lópes-Córdova and Mesquita
Moreira 2004). Other studies show that trade liberalization has reduced skill differential
earnings, improving the returns of unskilled in comparison to skill-intensive labor and
that tariff decreases have impacted more intensively in relative prices of skill-intensive
sectors (Gonzaga, Menezes Filho and Terra 2006).
Yet, further trade liberalization mechanisms, such as those envisaged with the
country’s participation in an RIA such as the FTAA remain hotly contested, while the
issue of trade policy has been regarded as more of a political than a technical matter.
Some Brazilian policy actors argue that deeper integration and trade liberalization could
increase the absorption of foreign R&D and spur growth, whereas others consider it a
threat to the country’s ability to carry out autonomous domestic development policies.
During the early 2000s, the Brazilian financial media exposed the cautious position of the
20
country’s team of trade negotiators toward the deep trade agenda under discussion in the
FTAA negotiations. According to these negotiators, such new trade themes should only
be discussed within the multilateral context of the WTO.
8
In brief, to many in Brazil,
particularly those nested in domestic policymaking circles, the new trade themes touted
by the FTAA and EU-Mercosur discussions boil down to the following: the attempt of
the developed countries to impose their policy preferences for a deep integration agenda
in new trade issues, where these countries clearly have comparative advantages, while
also conceding little in areas that matter most to developing countries such as Brazil (e.g.
market access, subsidies and, principally, agriculture).
From the standpoint of this dissertation, the findings from this literature review
will be applied, compared, and contrasted with the political economic dynamics that
underpin the prospects for Brazil’s foreign trade policy. First, I will locate Brazil’s
development process historically within a region where industrial development was
invariably carried out by a “developmental state” that relied on significant protectionism
(Evans 1995; Schneider 1999; Chang 1999; Wade 2004).
9
Despite more than a decade of
efforts at trade liberalization, managed trade and industrial policy still characterizes
Brazil’s regional integration strategy, as witnessed in its actions within Mercosur and in
the positions that Brazil espoused at the FTAA and EU-Mercosur negotiating tables
(Masi and Wise 2004; Wise 2004).

8
See, for example, Clóvis Rossi, “Brasil rejeita a ALCA teológica e ataca os EUA,” Jornal Folha de São
Paulo, October 1, 2003, p. B02.See also Clovis Rossi “Ceder na ALCA é hipotecar futuro, diz Amorim,”
Jornal Folha de São Paulo, February 15, 2004, p. B02. On the official position, Guimarães (2004),
Deputy-Minister for Foreign Affairs, also presents a skeptical view of the FTAA.
9
Historically, state intervention provided mixed results in terms of development, as reflected in the
different economic performance records of East Asia and Latin America. These differential outcomes are
the source of much unsettled debate in the literature concerning the efficacy of state versus market-oriented
approaches to development (Schwarz 2000).
21
Second, my assessment will provide evidence on the ways in which the
preferences of certain sectors of society and government have shaped Brazil’s trade
strategy (Fishlow 2004; Guilhon de Albuquerque 2003, 2006; Viola and Pio 2003). As
evidenced in the historically protectionist nature of Brazil’s foreign economic policy,
producers in the importing competing sectors have aligned with some segments of the
state bureaucracy in determining the role of the country in the international political
economy (Motta Veiga 2004). Of necessity, this longstanding status quo has gradually
given way to a more open trade strategy, although there is scant research on the inner
workings of this process. In this dissertation I intend to explain the differences within the
Brazilian government and society regarding deep integration vis-à-vis the FTAA and
EU-Mercosur, including the conflicting ideologies that have become embedded in the
negotiation process and the complex political economic cleavages at work.
Third, in pursuing these research questions I will rely on both qualitative and
quantitative methodologies, as well as on inter-disciplinary analysis. For example, in
addressing the role of ideas and policy preferences in shaping Brazilian foreign economic
policy, I will use a set of qualitative theories, as well as historical explanations. But I will
also attempt to quantify the degree of causation between such variables as domestic
tariffs, state subsidies, collective action, factor endowments and trade shares (exports and
imports) of industrial sectors and the possible consequences of all these variables for
policy outcome in the country.

22
Section IV - Methodological Organization of the Dissertation
Objectives
The main contribution of this study to the field lays in the application of
theoretical and empirical political economy tools to the Brazilian case study. Given the
political and economic relevance of Brazil in international economic relations, such a
case study promises to enrich the literature on emerging markets, trade integration, and
Latin American development. In carrying out an interdisciplinary study of this nature, a
main goal will be to strengthen the dialogue between such fields as political science,
international relations and economics.
My dissertation will seek to inform the controversial policy debate in Brazil over
the question of trade liberalization/integration. In this respect, the dissertation will also be
policy oriented, i.e., concerned with discussing current and relevant events intrinsic to the
policy-making process and the possible application of empirical results into actual
policies. Although Brazil has undertaken any number of trade negotiations, its decision to
join trade free trade areas or to commit toward deep integration issues has been stalled
due to political economy forces. This, in turn, has hampered potential gains, for example,
in terms of productivity or modernizing changes in the country’s institutional structure.
Unveiling the forces that have long perpetuated economic backwardness in Brazil, can
inform the negotiation strategy of the country and nudge it toward a more rational path.
In the end, although Brazil will be my main focus, the results of my study may be useful
for other developing countries seeking to reap the gains and mitigate the losses
associated with trade liberalization and deeper North-South integration.

23
Hypotheses and dependent variables
This dissertation will evolve around three clusters of theory described in the
previous literature review:
1) Endogenous trade policy and economic explanations for trade policy and
politics;
2) New growth theories of economic and institutional development;
3) Institutional-bureaucratic politics and ideas-ideology that can influence trade
policy outcomes.
The underlying working hypothesis of the dissertation is divided into two main
arguments:
1) International economic shocks/trends and the demise of domestic economic
models (ISI non sustainability) change the preferences of policymakers and
interest groups and hence open up the opportunity for (trade) policy reform.
2) However, entrenched domestic institutional/bureaucratic actors and
structures, as well as the ideological biases embedded therein, have prevailed
against further liberalization and therefore preserved some features of Brazil’s
traditional economic model.
In short, the dependent variable of the dissertation is Brazilian trade policy: how
it is endogenously determined by the institutional-historic characteristics of economic
policymaking and by domestic interest groups and how it is constrained and modified by
exogenous shocks emanating from the world economy.

24
Plan of the Dissertation
In chapter one, I depict the institutional-historical characteristics of trade policy
formation in Brazil and how these relate to a broader economic development strategy.
Chapter two discusses theoretical and empirical literature on trade
liberalization/openness and economic development and the debate about the efficacy of
multilateral versus regional trade negotiations. In chapter three, I discuss the North-South
regional agreements in which Brazil has been involved, focusing on the FTAA, but also
to the EU-Mercosur talks. Finally, in chapter four, I review stylized facts and quantitative
evidence about the foreign trade structure of Brazil and how factor content (labor,
capital), collective action variables and trade shares of industrial sectors may affect trade
policies. In the next paragraphs, I elaborate on the chapters.
In order to understand the current stance of Brazil in world trade negotiations, one
has to analyze the domestic characteristics of Brazilian foreign trade policy. In its
internal aspects, Brazilian trade policy must be understood not only a clash of interest
groups that aim to influence policy outcomes, but also as part of a particular institutional-
bureaucratic environment and a broad array of public policies geared toward economic
development. I begin by describing the main characteristics of import substitution
industrialization (ISI), and explain the policy changes that have occurred since the late
1980s. Although the last two decades of the twentieth century were characterized by the
deepening of economic globalization, international financial turmoil, and an ongoing
process of structural adjustment, Brazilian trade policy went scarcely unchanged.
Furthermore, the responsibility for formulating and negotiating international
commitments was kept under the domain of more conservative and even protectionist
25
sectors within the Brazilian state. Thus, these groups’ world views deeply influenced the
outcomes of trade and industrial policy and the negotiations in which the country is
engaged. The more pro-market and pro-liberalization groups within the Brazilian
government and civil society have still not staked out their claim in the realm of trade
policy. How these differing groups have interacted and impacted the government and
policy is my task in the first chapter.
The aim of chapter two is twofold: I provide a theoretical and empirical account
of Brazil’s trade liberalization/openness and economic development; and, I describe how
the standing theories apply to contemporary international economic relations. I depict the
current debate within the political economy literature on the pros and cons of trade
liberalization under multilateral and under regional scenarios. Neoclassical economic
theory prefers unilateral trade liberalization but in this debate opts for multilateralism,
arguing that this strategy is welfare- enhancing vis-à-vis regionalism (Krishna 1998,
Panagariya and Findlay 1996, Bhagwati and Panagariya, 1996). However, in a world
characterized by lobbies and large transaction costs, rarely is it the best outcome that
prevails. Furthermore, joining trade integration agreements raises apprehension among
state agents about losing policy discretion, particularly in agreements which are supposed
to be WTO-plus. Conversely, integration into the world economy is believed to launch
dynamic powerful forces inside countries, such as: economies of scale, R&D spillovers
and externalities, learning-by-doing, clustering of economic activities. Thus, some parts
of the literature contend that trade liberalization under regionalism promotes these
positive economic changes (Ethier 1998, Baldwin 2006). In short, this chapter aims to
apply the theoretical debate on multilateralism and regionalism vis-à-vis the current
26
world economic scenario, characterized by phenomena such as the stalemate of
multilateral negotiations, the increase of regional integration agreements and the upsurge
of China and India as powerful economic forces.
My task in chapter three is to describe and critically assess Brazil’s participation
in North-South agreements, including the FTAA and EU-Mercosur discussions. As the
FTAA was believed to have the most intense economic and political consequences for
Brazil, I present a more detailed account on that integration project. I also describe the
apparent contradiction of Mercosur for not opting for a trade agreement with the
European Union, as the EU sponsors a model of integration that goes beyond trade
issues, which is emulated by Mercosur in its attempt to create a common market and an
economic union. I contrast the differences between two models of regionalism which
entail different forms of economic governance – one the “Anglo-Saxon” market driven
regionalism, epitomized by the FTAA; and the other the regulated institutional order of
the EU based on supranational institutions. I close the chapter with a recapitulation of
Brazil’s cautious reforms and the resilience of domestic groups in shaping trade policy
outcomes.
Finally, chapter four offers a quantitative discussion. A first aim of this chapter is
to test some of the theories presented in previous chapters. Using panel data and
econometric methods, I examine the impact of variables related to trade participation,
industrial concentration and factor shares of ten industrial sectors on Brazilian trade
policy - my dependent variable in this empirical exercise. The two proxies for trade
policy are: the level of protection (Brazilian MFN tariffs) and state-support (subsidies)
offered to industrial sectors. Following endogenous trade policy models, I try to
27
determine the extent to which capital intensive sectors receive more protection (or
support) vis-à-vis labor and land related industrial sectors. Following new growth related
theories, I also test whether or not sectors with more intra-regional trade and
technological content have different policies. The data for the empirical tests are panel
corrected standard error (PCSE) and in testing the data I use seemingly unrelated
regression (SUR) models, my goal being to check for the possibility of endogenous
correlation between explanatory variables and the equation residuals. The second task in
this chapter is to analyze the destination and characteristics of Brazilian trade flows,
based on data (1990-2005) from the Economic Commission for Latin America and the
Caribbean (ECLAC). As I disentangle the structure and destination of flows, I argue that,
if Brazilian trade strategy is to increase the value-added intensity of exports, then
regional trade integration with the Western hemisphere is the more logical path to pursue.

28
Chapter 1 - Understanding Trade Policy in Brazil: The
Historical, Regional, and Domestic Context
Introduction
In order to understand the Brazilian position in trade negotiations, especially
regarding the new trade themes, the country’s commercial policy must be analyzed as part
of its broader development strategy. Moreover, an understanding of trade policy in Brazil
requires some background knowledge of the structural reform wave that swept Latin
America in the last two decades of the twentieth century. Therefore, this chapter will
discuss the essential elements of Brazilian trade policy, first, according to its historical,
institutional and bureaucratic determinants; second, as part of a broader economic
development trajectory; and third, in the context of structural reforms undertaken since the
early 1990s. Although I discuss how Brazil’s trade policies and politics relate to the
international economic setting, the focus of this chapter is on the domestic political
economy. The following chapters of the dissertation discuss the regional and multilateral
aspects of Brazilian trade policy.
The chapter begins with a short methodological explanation followed by a brief
account of the origins of Latin American protectionism and a more detailed description of
the underpinnings of import substitution industrialization (ISI) and how these related to
national economic development strategy in Brazil. I then turn to the structural reforms of
the late 1980s and early 1990s, with a focus on trade liberalization, macroeconomic
stabilization, de-regulation, privatization, and fiscal reforms. The chapter concludes with
an analysis of the political economy of foreign economic policymaking in Brazil, a
distinction between trade and financial bureaucracies/institutions, the role of social groups
29
and special interests, and how this domestic environment has shaped positions and
preferences concerning the integration of the country into the world economy.

Section I - Methodological Foreword
Theories of endogenous tariff formation posit that trade policy is a function of the
pressures that interest groups exert on policymakers. Lobbying can occur according to a
given country’s factors of production – the Heckscher-Ohlin (HO) hypothesis (Labor x
Land x Capital) – or along sectoral lines – the Ricardo-Viner (RV) hypothesis (import-
competing versus export-oriented sectors). The demand for protectionism is also a
function of inter-industry factor mobility; in the HO hypothesis the factors of production
are mobile whereas in RV factors are rigid. Hence, in the former, owners of different
factors tend to have opposing views regarding liberalization (capital versus labor), while
in the latter the effects of trade will pitt the owners of the same factor in different
industries/sectors, or even regions, against each other (Hiscox 2001). An example of the
latter case is the anti-liberalization bias among the owners of small mortgage institutions
(abundant factor – capital) in economically failing regions of the US, which part ways
with their financial counterparts in more capital abundant US regions and oppose trade
liberalization because it threatens to further their economic downturn in real estate assets
(Scheve and Slaughter 2001).
Endogenous trade policy models, with their roots in neoclassical economics and
public choice theory, can provide insightful albeit static explanations of trade politics.
That is, such models offer a “snapshot” of reality, rather than a dynamic, institutional-
historical explanation. A basic assumption of this dissertation is that in addition to factor
30
and sector determinants, trade policy is embedded in a set of domestic institutional-
historical variables that determine the way trade policy is carried out over time. Pierson
(2004), for example, notes the permanence of politics and policies through time as a
process of path dependency. While exogenous shocks can certainly alter this policy path,
in Brazil the long lasting characteristics of the Ministry of Foreign Affairs and the control
of foreign policy making by a career diplomatic corps have influenced trade policy more,
or at least as much, as contemporary political-electoral cleavages and business lobbies
(Guilhon de Albuquerque 2003, 2006; Lafer 2000; 2003).
Schamis (1999), in analyzing the politics of structural reform in contemporary
Latin America, draws upon a similar line of criticism. He argues that neoclassical models
treat liberalization as a public good, since market reforms will hurt some special interest
groups in the short run while ostensibly benefiting the majority in the long run. While
small interest groups will thus exert pressure to block such reforms, the more disperse
majority will not be able to organize in favor of welfare enhancing liberalization. Interest
groups protected by closed economic regimes are well positioned to hinder liberalization,
and hamper social welfare (Alesina and Drazen 1991). However, this collective action
problem does not consider that previously protected interest groups can adapt to new
economic circumstances, as has been the case in Latin America since the early 1990s.
Hence, as Schamis and others have argued, long lasting well-positioned groups can shift
assets to new promising sectors.
In this dissertation, I draw on these various approaches to analyze the Brazilian
case and show how enduring characteristics of domestic politics have been increasingly
affected by world economic conditions. The Brazilian story is one in which actors that
31
had previously been protected by an autarkic economic regime came to support trade
liberalization as long as they could perceive the benefits. Changing economic phenomena
such as globalization, regional integration and increasing intra-industry trade flows
offered new opportunities to these actors, as groups holding mobile assets were able to
shift from decaying to booming economic activities; liberalization did not hurt them as
much as it did the owners of rigid factors, such as labor. Although factor mobility will
tend to benefit incumbent powerful economic groups that will lobby for the continuing
benefits of trade liberalization, other long lasting political characteristics of the trade
policymaking apparatus may hinder further liberalization. In this dissertation I will
attempt to show that it has been the entrenched interests of those losing market shares
that have constituted the blocking position of Brazil in several trade talks, and
particularly the FTAA. Summing up, I believe this methodological view based on
domestic institutional variables is complementary, rather than conflicting, with
endogenous trade explanations.
Despite these entrenched characteristics of trade policymaking, it is undeniable
that Brazil and some other Latin American countries have gone through a substantial
change in economic development strategy during the last two decades of the twentieth
century. From an autarkic model characterized by heavy state intervention in economic
activities, Latin American countries have implemented laissez-faire reforms aimed at
enhancing market forces. Among measures such as macroeconomic adjustment, financial
sector restructuring, labor and welfare reforms, de-regulation of public utilities markets
and privatization of state owned enterprises (SOEs), trade liberalization is believed to be
of crucial importance because it contributes to macroeconomic stabilization in the short
32
run and fosters the competitiveness of domestic firms and productivity in the long run.
10

Generally speaking, these economic reforms happened in tandem with a shift from
authoritarian to democratic regimes. Democracy may offer greater opportunities for
special interests to push for protectionist policies, but it can also help to promote more
awareness about the positive effects of liberalization (Baker 2003). Thus, I will discuss
how new political economy cleavages in the post-democratization era have influenced
trade policymaking in Brazil.
Finally, an influential literature in comparative development points to the
importance of technocratic autonomy in carrying out development projects (Evans 1995,
Kohli 2004, Schneider 1999, Wade 1990). State “developmentalism” is part of the
Brazilian economic policymaking ethos; it was highly prominent during the import-
substitution industrialization (ISI) years (1950-1980) and continues to influence policy
orientation, even in the aftermath of structural reforms and neoliberal advice to the
contrary from international financial institutions. While the generation of structural
reforms in Brazil stemmed more from insulated technocratic decision-making, inspired
by the “Washington Consensus,” these reforms clashed with entrenched interests and
policymaking/institutional characteristics. The result has been a piecemeal approach to
reform.
To summarize, I will analyze the political economy of Brazilian trade policy
according to this broad set of questions:

10
According to this view, trade openness (X+M/GDP) is considered a crucial component of economic
growth and performance. Yet, as Rodrik (1996) notes, the benefits of a more export-oriented model were
not yet fully apparent in the beginning of the 1980s. Moreover, an outward orientation requires much more
than a simple strategy of laissez-faire (see Rodriguez and Rodrik, 1999; Ocampo 2004; Rodrik 2004).
33
1) Factor endowments and sectoral lines as policy determinants: What are the
political forces and groups that have historically shaped Brazilian trade policy? Do
the causal variables appear to cluster along factor explanations or along sectoral
lines? Have export-oriented interests prevailed over importing competing groups, and
if so, how?
2) Structural reforms and changes in policy preferences: What role has trade policy
played in the context of structural adjustment and economic turmoil of the last two
decades of the 20
th
century (macroeconomic disarray in the 1980s, stabilization in the
first half of the 1990s, and international financial crisis in the late 1990s)?
3) Institutional and bureaucratic characteristics: How have institutional and
bureaucratic components shaped the specifics of Brazilian trade policy reform? How
are the institutional and bureaucratic characteristics of Brazil’s commercial
bureaucracy related to other branches of foreign economic policy?
As I have spelled out in the literature review/introduction, this dissertation adopts
the following working hypothesis:
1) International economic shocks/trends and the demise of domestic economic
models change the preferences of policymakers and interest groups, hence,
opening up the opportunity for (trade) policy reform. However, 2) entrenched
domestic institutional/bureaucratic characteristics, as well as the ideological
biases embedded therein, are able to prevent further liberalization and therefore
preserve some features of the older and more traditional economic model.
In this chapter I focus on the domestic aspects of this working hypothesis. In
doing so, I apply the three questions above and probe the Brazilian policymaking process
34
and structural reform dynamics so as to elucidate on my dependent variable: Brazilian
trade policy.
Section II – The Origins of Latin America Protectionism and the
Import-substitution Industrialization (ISI) Years
The Tradition of Inward Looking and Managed Trade in Brazil and Latin America
Latin America is a region that has been historically characterized by high levels
of trade protectionism. During the nineteenth century, the explanation for high tariffs can
be found in the necessity of financing independent nation-states, which were recovering
from independence wars and social upheaval. Even after the consolidation of nation-state
structures in most countries, tariffs remained high by the end of the nineteenth century
and were combined with other restrictive non-tariff measures, such as licenses and
quantitative restraints. The heavy taxing of imports and exports reflected the ease of
collecting these revenues: production passed through few ports and did not require a
complex tax system or administrative apparatus. In Brazil, during the nineteenth century
and first decades of the twentieth century, the federal authorities generally set domestic
tariffs. However, sub-national (state) governments were mainly responsible for the
administration of national customs, with considerable differences emerging in terms of
administrative practices. Table 1 shows the average tariffs in selected periods in Latin
American countries; table 2 depicts the revenue from customs as part of the total
government revenues in selected Latin American countries during different periods.
35
Table 1: Latin America - Average Implicit Tariffs (percentage). Selected
Economies, 1880 - 1928.

Table 2: Foreign Trade Revenues as a Share of Total Revenue of Central
Government (percentage). Selected Economies, 1880 - 1928.

Despite the general view that local landowners engaged in agricultural exports
benefited from openness, this does not necessarily mean that Latin America as a whole
had laissez-faire policies during the late nineteenth and early twentieth centuries – the
golden era of Pax Britannica economic liberalism (Coatsworth and Williamson 2004).
Endogenous trade theory provides feasible explanations for the widespread use of tariffs
in Latin America: capital and labor, the main inputs for industrial goods, were scarce and
hence subject to higher levels of protection. Yet, tariffs were high across the board,
suggesting that institutional analysis can enrich our understanding of this period.
Argentina Chile Colombia Mexico
1880* 26.4 23.4 45.7 39.7
1900** 31.9 22.3 - 20.1
1913*** 20.8 20.0 46.0 20.1
1928 17.3 20.5 28.1 22.8
Notes:
*Argentina: 1881; Brazil: 1872-1873; Colombia: 1880-1881; Mexico: 1884-1885.
**Brazil 1901
***México 1912-1913
Source: Abreu (2004a)
Argentina Brazil Colombia
Imports Imports Imports Exports Total Imports Imports Exports Total
1880 61.7 53.8 35.9 3.5 39.4 70.2* - - 59.6
1900 55.9 54.4 31.9 29.6 61.5 68.7** 41.7 3.2 44.9
1913*** 57.0 49.6 37.1 22.6 59.7 76.4 43.8 2.9 46.7
1928 47.0 42.4 18.4 14.9 33.3 63.7 25.4 4.5 29.9
Notes: *Total "aduanas" 1880-1881
**Total "aduanas" 1897-1898
***For Mexico, 1910-1911
Source: Abreu (2004a)
Chile Mexico
36
Monetary and macroeconomic variables can also shed some light on the reasons
for high levels of protection. During the Pax Britannica era, the Brazilian currency was
pegged to the gold standard. The only fully convertible currency under this regime was
the British pound, meaning governments were willing to accumulate pounds.
Policymakers justified protectionist policies due to the balance of payment disequilibria
that were intrinsic to the gold standard, which often provoked the loss of international
reserves. Trade deficits were a major source of macroeconomic instability. The basic
idea: a pegged exchange rate imposes strict discipline on domestic monetary policy.
Money supply depends on foreign exchange reserves, which would finance domestic
credit. To maintain the peg, the monetary authorities must offset an increased demand for
foreign currency to purchase imports, otherwise, the exchange rate would suffer
pressures toward devaluation. If domestic demand outstrips the supply of local currency,
reserves become depleted and the monetary authority is no longer able to intervene in
currency markets. Summing up, high tariffs made sense under a pegged exchange rate
system because these facilitated the management of aggregate demand, albeit in a
mercantilist manner.
In Table 1, it is clear that Brazil had very high tariffs, even by Latin American
standards. High tariffs curbed domestic demand for imported manufactures, limited the
access to capital and intermediary goods used as inputs and hindered the full
development of many sectors. With production costs kept down due to the elastic supply
of labor and an abundance of land, and with generous subsidization from provincial
governments and national fiscal policy, landowners in Brazil worried little about the
overall level of tariffs or the higher input prices (Leff 1997). Despite the anti-export bias
37
of macroeconomic policy and the maintenance of high tariffs, landowners were able to
enrich themselves at the expense of society as a whole.
In terms of the management of its primary commodities, Brazil’s position as a
price-maker in the world coffee markets and its protectionist stance helped keep prices
for that commodity high. Economic theory holds that in a case such as this, net welfare
losses are smaller because production and consumption distortions are partly
compensated for by increased world prices. The price of protection was paid by world
consumers of coffee and by domestic consumers of Brazil’s imported manufactured
goods. Therefore, high tariffs in Brazil did not lead to the usual deterioration of export
sector income. In fact, many coffee growers diversified into the industrialist sector so as
to protect themselves against exchange rate instability and to reap lucrative rents in the
protected market for manufactures. This situation laid down the economic basis for ISI
policies in Brazil and provided the historical explanation for the country’s absence of an
explicit lobby for trade liberalization (Abreu 2004a).
Williamson and O’Rourke (1999) explain the alleged free trade era of the
nineteenth and early twentieth centuries by comparing the various positions of the
owners of the factors of production (land, labor and capital) in different regions. Thus,
land abundant Latin American countries would benefit from the liberalization of
agricultural goods, while land scarce Europe raised protective walls against staple
imports from the New World. Therefore, Latin American groups endowed with abundant
land would benefit and lobby for closer ties with the world economy, while the owners of
scarce factors - labor and capital - would veto trade liberalization and fight to keep tariffs
high. Indeed, the political economy literature has shown that in Brazil landowner groups
38
benefited from protectionist policies and oligarchies were able to influence the state
apparatus and to defend their interests: the policy of maintaining high governmental
stocks of coffee in order to prop up the price of that commodity in world markets
enriched landowners at the expense of the rest of society (Leff 1997).
But the historical record also suggests that trade policy is not just a function of
factor ownership, sectoral cleavages, and their equivalent lobbies. In the late nineteenth
century Brazilian policymakers engineered the institutional mechanisms, exerted policy
discretion over them, and followed their ideological impulses in crafting development
models. Policymakers and their constituents were no doubt aware of the intellectual
legacy of the American federalists, who defended trade control as a mechanism to
stimulate domestic industries. At the same time, several Brazilian intellectuals of the late
nineteenth and early twentieth centuries were inclined toward the liberal doctrine of
Adam Smith and argued the benefits of free trade. The Old Republic political coalition
(1889-1929), for example, was based on the liberal ideology of an export-oriented
oligarchy. Yet, this ideological commitment proved ephemeral, as tariffs were extremely
high and the overall economic policy was decidedly restrictive (Leff, 1997: 51). In fact,
the ideological basis of Brazil’s early Republican years was equally based on the
positivism of French sociologist Augusto Conte, who emphasized the need of a powerful
state role in guiding society.
11

11
The higher ranks within the Brazilian military were particularly keen on this ideology, and in fact used it
to justify the importance of the military in the country’s industrialization process in later decades (Fausto
1995).
39
Noticeably, Brazil’s superficial commitment toward liberalism early on can be
explained by deep-seated ideologies and institutional structures.
12
Protectionist policies
can be understood as part of a mercantilist tradition that saw international trade as closely
related to security issues, and justified not only to amass hard currency (bullion) and to
allow a primitive accumulation of capital, but also to buffer the country from foreign
threats (Viner 1948). In fact, hostility toward laissez faire and preferences for state
intervention in economic affairs date back to colonial times in Brazil: the plantation
system involved large sunken costs and economies of scale, requiring high outlays and
state support for initial investment. In the case of sugar, for example, the
commercialization of output was centralized in the hands of few traders directly tied to a
monopolist enterprise from Portugal (Companhia das Índias Ocidentais). In sum, in
Brazil’s colonial economy trade was monopolized in the hands of a few landowners,
intermediaries and the state.
In a sign of the institutional inertia that had set in, these restrictive characteristics
changed little after political independence from Portugal in 1822. According to one
eminent commentator (Faoro 1976), the main characteristic of the Portuguese-Brazilian
political-institutional system was patrimonialism, whereby political actors exerted
superiority over social actors and state institutions were used to dole out particular
privileges. The ability of the bureaucratic elites (estamento burocrático) to craft
economic and social policies according to their own intents rendered privileged access to
the ranks of public employment as one of the most cherished goals. In this respect, Brazil

12
The literature on the nature of colonial institutions in Brazil is extensive. See, for instance, Furtado
(1963), Prado Jr. (1953) and Faoro (1976). An excellent source in English is Maxwell (1973).
40
maintained several traits of its Portuguese heritage, including an institutional framework
that encompassed economic dirigisme and trade monopolies. After political
independence, and, especially, during the republican oligarchic agrarian order, from 1889
to 1929, politicians paid lip service to liberalism while free trade was restrained to
protect land owning interests, increase governmental revenues, and to appease incipient
industrial interests.
The more recent empirical research on development attributes laggard growth in
these countries of Spanish and Portuguese colonial heritage to the restrictions placed on
market exchange, the existence of state monopolies and the inward orientation of
economic institutions (Acemoglu, Johnson and Robinson 2001). Recent institutional
theory also points to the lack of economic development in Latin America as a function of
the excessive outward orientation of economies based on the plantation system. This
production model required high initial state investments and economies of scale, and
contributed to income concentration and the stalling of innovation in the domestic market
(Engerman and Sokollof, 1997). This literature highlights the deleterious consequences
of a monopolistic monoculture system for the development of domestic market
institutions. In contrast, the legacy of other European colonizers was the ability to create
domestic markets and engage in free trade in ways that fostered higher levels of
development.
Stemming from the original work of North (1990), research on institutional
economics provides important explanations for the dismal growth rates in Latin America
and Brazil. Ineffectual institutional frameworks during the nineteenth century also
explain the disparate economic performance of Latin America compared to North
41
America. Regarding Brazil, Summerhill (2000) and Haber (2000) note how a lack of
financial stability and insufficient capital markets has hindered long term investments
and the completion of crucial infrastructure projects. Weak property rights, law
enforcement and unclear investment rules explain the absence of medium and long term
public and private expenditures in roads, ports, and railroads. The cumbersome
application of French civil law codes in Brazil and the regulated nature of Brazil’s
newborn financial institutions hindered economic exchange. In a review of the political
economy of Latin American growth, Rodriguez (2003) stresses the infrastructure deficit
which, when combined with geographic limitations, hampered domestic and overseas
transactions and furthered an inward-looking economic model. Acemoglu et al (2001)
also argue that economic development was harmed by geographic characteristics, as
European colonizers could not adapt to tropical conditions and therefore, were not able to
establish market-enhancing institutions.
In summary, despite the export of primary goods, Latin America was not able to
fully reap the benefits of free trade and to reach the same income levels as European
offshoots or those developing countries with an Anglo-Saxon heritage. The data help to
clarify this debate. Table 3 from Maddison (2000) depicts GDP growth rates by region
and shows that from 1820 to 1913 – the golden era of Pax Britannica liberalism – Latin
America’s growth rates were smaller than those of the European offshoots. Table 4
presents GDP growth per capita of selected Latin American countries and Anglo-
European offshoots. The tables show that Latin America performed much better on GDP
growth during the 1913-1973 interlude, which comprised part of the ISI era. The
substantial growth of the sub-continent during the core ISI years (1930-1973),
42
particularly in Brazil and Mexico, may explain the reticence of policymakers and sectors
of society to surrender that model. It is also noticeable that, after 1973 Latin America’s
per capita growth slows when compared not only to the European offshoots, but also to
other regions of the world (except for Africa and Eastern Europe). Some countries even
experienced negative GDP growth per capita (Argentina, Peru, Venezuela). According to
Table 10 in the statistical annex to this chapter, the GNP growth rate of Brazil in the
1990s after the embracement of the Washington Consensus and structural reforms,
averaged a meager 2.6 percent from 1991 to 1999.
Rodriguez (2003) emphasizes the positive correlation between the investment rate
and economic growth, and both neo-classical and endogenous growth models defend this
causality running from investment to growth. A drop in investment, compounded by
Brazil and Latin America’s low savings rates, seem to partly explain the structural
slowdown that beset the region in the last decades of the twentieth century (Figure 1).
43
Table 3: Phases of Growth by Major Region, 1820-1992 (Annual average
percentage growth rate).

1820-70 1870-1913 1913-50 1950-73 1973-92 1820-1992
1.7 2.1 1.4 4.7 2.2 2.2
4.3 3.9 2.8 4 2.4 3.6
1 1.5 1.3 6.3 3.1 2.1
1.6 2.4 1.6 4.7 -0.4 2
1.5 3.3 3.4 5.3 2.8 3
Asian 0.2 1.1 1 6 5.1 1.9
Africa 0.4 1.1 3 4.4 2.8 1.9
World 1 2.1 1.9 4.9 3 2.2
0.7 0.7 0.5 0.8 0.3 0.6
2.8 2.1 1.2 1.5 1 1.9
0.3 0.4 0.9 1.4 1.4 0.8
0.9 1.3 0.4 1.2 0.7 0.9
1.3 1.8 1.9 2.7 2.3 1.8
Asian 0.1 0.6 0.9 2.1 1.9 0.9
Africa 0.3 0.7 1.9 2.4 2.9 1.3
World 0.3 0.8 0.9 1.9 1.8 1
1 1.3 0.9 3.9 1.8 1.5
1.4 1.8 1.6 2.4 1.4 1.7
0.6 1.1 0.4 4.9 1.7 1.4
0.7 1 1.2 3.5 -1.1 1.1
0.2 1.5 1.5 2.5 0.5 1.1
Asian 0.1 0.6 0.1 3.8 3.2 1
Africa 0.1 0.4 1 2 -0.1 0.6
World 0.6 1.3 0.9 2.9 1.2 1.2
Source: Madison (2000).
GDP per Capita
Western Europe
Western Offshoots
Southern Europe
Eastern Europe
Latin America
Population
Western Europe
Western Offshoots
Southern Europe
Eastern Europe
Latin America
GDP
Western Europe
Western Offshoots
Southern Europe
Eastern Europe
Latin America
44
Table 4: Per Capita Real GDP Growth in 11 Sample Countries, 1820-1992 (Annual
average compound growth rate).

Figure 1: Gross Saving as Percentage of GDP.
Source: World Bank Development Indicators 2006.
1820-70 1870-1913 1913-50 1950-73 1973-92 1820-1992
Australia 1.8 0.9 0.7 2.4 1.4 1.4
Canada 1.2 2.2 1.4 2.9 1.5 1.8
n.a. 1.2 1.3 1.7 0.5 1.2
USA 1.3 1.8 1.6 2.4 1.4 1.7
1.4 1.5 1.3 2.4 1.2
Latin American countries
Argentina n.a. 2.5 0.7 2.1 -0.2 1.3
Brazil 0.2 0.3 1.9 3.8 0.9 1.4
Chile n.a. n.a. 1 1.2 1.9 1.4
Colombia n.a. n.a. 1.4 2.3 1.9 1.9
Mexico -0.1 1.7 1 3.1 1.1 1.4
Peru n.a. n.a. 2.1 2.5 -1.7 1
n.a. n.a. 5.3 1.6 -0.8 2
n.a. 1.5 1.9 2.4 0.4
Source: Madison (2000).
Average
Venezuela
Average
Western Offshoots
New Zealand
24,28 24,14
34,57
23,41
24,17
34,22
22,24
20,28
0,00
29,57
18,70
15,32
18,73
29,06
24,23
15,78
18,83
21,21 20,94 21,71
18,78 19,48
16,08
32,76
21,91
22,14
24,23
19,30
22,45
29,31
0
5
10
15
20
25
30
35
40
Brazil High
income
High
income:
OECD
High
income:
non-OECD
East Asia &
Pacific
Latin
America &
Caribbean
Middle East
& North
Africa
South Asia Sub-
Saharan
Africa
World
1960-1980 1981-2004 1960-2004
45
Trade policies are best understood within a given country’s broader institutional
context. In the case of Brazil, high trade tariffs are just one component of the overly
regulated and restrained characteristic of domestic economic institutions. The political
economic cleavages that continue to characterize Brazil’s trade policy reflect the fact that
public institutions most often serve private interests, with patronage and clientelism
determining state intervention in economic and social life. In Brazil, due to the
magnitude of the state vis-à-vis private social actors, interest groups with strong ties to
the bureaucratic elite are able to obtain higher benefits at the expense of the rest of
society (Faoro 1976).
While these institutional characteristics go a long way toward explaining
protectionism and the inward orientation of the Brazilian economy in the first decades of
the twentieth century, the literature on modern political economy also emphasizes the
importance of international shocks in defining policy choice. Such shocks, for instance,
can have a crucial effect in shaping new development strategies and policy orientations
(Haggard and Webb 1994). Hence, the Wall Street crash of 1929, followed by the
depression of the 1930s, provoked a pronounced shift toward a more autonomous
development strategy in Latin America and Brazil. The origin of the term “export
pessimism” was motivated by a concrete international crisis. The abrupt decline in
international prices for the region’s main commodities (coffee, sugar, cocoa, rubber,
copper, guano) provoked a foreign debt default across the sub-continent. This
international shock caused a severe worsening in the terms of trade, a fiscal crisis in most
Latin American economies, and a total disruption of the regional trade system. New
groups (industrialists), struggling to make their voice heard, allied with reforming
46
politicians in defining a new ideological framework for economic policy characterized by
increasing levels of state intervention.
Thus, in the 1930s, the origins of the ISI strategy can be found in the new
perceptions of Latin American elites about the world order, and in the social status of
those groups that were now attaining political and economic power. Rogowski (1989)
affirms that during the 1930s, in many parts of Latin America, the coalition between
workers, industrialists, military actors, and displaced landowners resulted in an inward-
looking and autarkic development project. In Brazil, social upheavals that brought
President Getúlio Vargas to power in the 1930s reflected new tensions between export-
oriented agrarian oligarchies and these ascendant urban social groups, which supported
modernizing and autonomous policies.
Bearing in mind these apparent tensions between old and new economic and
social elites, it is important to offer a more nuanced picture of resulting economic
policies before and after the crash of 1929. Versiani (1980) provides an account of the
state-led attempts to foster industrialization and exports of manufactures before the
1930s, back in the first decade of the twentieth century. Furtado (1963) notes that the
policy to preserve the income of coffee growers, buying excess production to guarantee
minimal prices, was maintained and even reinforced after the world crash, in the
subsequent decades. Finally, Diaz-Alejandro (1984) affirms that activist countries – those
in which governments used counter-cyclical fiscal and monetary economic policies –
withstood the international crisis of the 1930s better than those that let to the market the
adjustment burden. He also sustains that the set of incentives and constraints – balance
of payments problems, lack of foreign currency, disrupted markets for agrarian exports
47
and lack of supply of imported industrialized goods - prompted the policy
experimentation and interventionism that begins to characterize Latin America in the
1930s and 1940s.
Summing up, although the relative economic backwardness of Latin America
during the first decades of the twentieth century has several complex explanations, based
on the domestic institutional framework, as I have briefly discussed here, the constraints
of the international system were considered by the new economic and political elites to
be the principal reason for delayed of development. In the 1940s and 1950s, the
structuralist school in Latin America began formalizing these assumptions about the
pitfalls of an export-oriented model. As they saw it, the outward model was responsible
for the severe concentration of domestic income, as these disparities were reinforced by
an over-reliance on primary goods and foreign consumer markets. They assumed a tight
connection between the landowning elite and the international markets. It was undeniable
that the rents from Latin American trade had accrued to just a few, however, instead of
tackling other regressive features of the outward model (e.g. extreme land concentration
derived from the monoculture system), a full-scale shift toward an autarkic orientation
seemed more expedient. The search for economic autonomy would influence the political
economy of Brazilian trade policy for decades to come.
Trade Policy and Economic Development Strategy in the Early ISI Years
Latin America’s import substituting industrialization (ISI) strategy comprised
more than just trade policy. It epitomized a shift toward a different economic
development strategy altogether and a political economic reorganization characterized by
direct state intervention in productive activities and social life. In Brazil, state dirigisme
48
and the construction of cooperative ties between workers and capitalists, mediated by
state institutions, had a long-standing effect on the political economy. Initially, however,
the ISI strategy was also spurred by pragmatic motivations and focused targets. The basic
idea was to build an industrial base to supply the domestic market in order to save
international reserves, ease the deleterious consequences of cyclical balance of payments
crises, promote capital accumulation. The project aimed at weaning Brazil’s dependence
on international markets for primary goods, characterized by periodic price and declining
terms of trade shocks. The ISI model was based on three pillars: macroeconomic policies
meant to keep exchange rates stable and overvalued; high tariffs to protect new
industries; and active industrial policy granting tax holidays and subsidies to industrial
producers (Cardoso and Hellwedge 1992,; Bruton 1998). Apart from the third item, these
measures were already a part of Brazilian foreign economic policy. What changed with
the rise of Vargas in the 1930s and was deepened in the following two decades was the
plethora of policy mechanisms now embraced by the state. Direct forms of intervention
took off with the creation of state owned enterprises (SOEs), which played an active part
in industrial promotion and infrastructure projects. Indirectly, this period saw the
proliferation of a thick web of regulations in economic life.
13

The new economic and social groups that had ascended to political power in the
1930s and in the post-World War II era were against the continued dependence of the
country on the export of primary goods (cocoa, coffee, rubber, sugar), and the import of
manufactures from the U.S. and Europe. Despite the lack of a laissez-faire orientation in

13
The theoretical assessment of ISI in this section is based on Cardoso and Hellwegde (1992), Bruton
(1998), Hirschman (1968), Edwards (1995), Ardnt (2000) and Krueger (1994).
49
commodity exports, in the wake of the Great Depression Latin American elites were
nevertheless disenchanted with the perceived liberal order and export oriented growth.
Thus, in addition to the focus on stabilizing the balance of payments from wild swings in
demand and prices on raw material exports, the main policy objective of ISI was to build
a more efficient growth strategy based on higher levels of industrialization (Skidmore,
1975).
14

Certainly an incipient process of industrialization had been underway in Brazil
and Latin America since the end of the nineteenth century, particularly in light
manufactures and food processing (Versiani 1980). Constant balance of payment shocks
had precipitated this earlier trend toward industrialization and import substitution, since
landowners had started small-scale industrial ventures as a cushion against frequent
interruptions of supply in consumer goods (Furtado 1963). During World War II, this
natural acceleration was further reinforced by a disruption of in supply of consumer and
capital goods from the Northern countries. These phenomena provided a big push for
new industrial projects and substantial state intervention. The creation of a large-scale
state owned steel industry in Brazil dates from the early 1940s, with the foundation of the
National Steelmaker Company (CSN). Furthermore, Brazil became an exporter of light
consumer goods for northern markets, strained by the war effort. As a consequence,
Brazil accumulated foreign reserves during this period (Skidmore, 1975).

14
A quick methodological note: my emphasis on how trade policy should be viewed as part of a broad
strategy for economic development does not rule out an endogenous policy explanation. In fact, the owners
of scarce factors in Brazil – Capital, and to a lesser extent Labor – influenced the policy preference shift,
which soon would be translated into concrete actions to protect these factors of production.

50
Macroeconomic and structural imbalances, however, continued to plague
Brazilian policymakers, some of these being directly related to the ISI model. Inflation
accelerated due to mounting budget deficits and the political inability to expand the tax
basis to pay for sizeable governmental subsidies. In fact, in the 1940s and 1950s, despite
the new urban-based power coalition, landowners’ income continued to be protected by
the government’s policy of propping up coffee prices in world markets. An overvalued
domestic currency was used to tame inflation, despite its adverse effect on exports. In
turn, currency overvaluation instilled an anti-export bias as well as constant devaluation
pressures coming from export-oriented producers operating mainly in the agricultural
sector. A solution to this problem was the design of multiple exchange rate systems, a
policy that would last up to the 1960s. As the trade portfolio was still predominantly
composed of primary goods, the country was not able to generate a sufficient trade
surplus, which was essential for garnering the savings necessary to promote full-scale
development. It was evident that the shallow nature of industrialization would not solve
the country’s structural limitations and low investment capacity; hence, policymakers
believed that this process should be deepened. So as to promote the production of durable
consumer and capital goods in the domestic market, tariffs and other administrative
measures such as import licenses were used to limit domestic demand for imported
capital goods. Greater autonomy in the production of these goods would save hard
currency and ease balance of payment problems. With the purpose of intensifying
industrialization, the direct participation of SOEs in heavy industrial areas, infrastructure
and capital goods was ubiquitous from the 1950s to the 1970s (Abreu 1993).
51
In addition to direct state intervention, a restrictive regulatory framework in
infrastructure and public services markets was enacted. SOEs were granted monopolies,
subsidies and tax breaks. This period saw the creation of several state companies, for
instance, the state oil company (PETROBRAS) was founded in 1953 to tap into domestic
oil drilling. Soon it would expand it activities to refining, distribution and
commercialization. Later, during the 1960s and 1970s, other public services and
infrastructure related SOEs were established to operate in markets such as energy
generation and transmission (ELETROBRAS), communication and telephony
(TELEBRAS), railroad transportation (RFFSA), and shipbuilding (Lloyds do Brasil
S.A.). High entry costs and the restrictive regulatory framework protected these firms
from competition and guaranteed a captive market. As public service tariffs had great
influence on inflation, federal authorities persuaded SOEs to limit price increases and
imposed price caps and controls. These measures appeased urban consumers but had
deleterious consequences for the finances of these companies in the mid- and long term.
The omnipresence of SOEs is part of an ideology that assigned the state the
leading role in economic development. In fact, the creation of PETROBRAS was
surrounded by an ample national campaign whose motto was: “O petróleo é nosso” (The
oil is our property). Despite the highly ideological tone, the justification for the closed
regulatory framework and heavy state participation lay in the fact that infrastructure
activities such as mining, oil drilling, steel production, electricity generation, heavy
transportation provided key inputs for other economic activities. Since these are used by
several economic sectors, the proper supply of these activities creates positive spillovers
to the whole economy. In fact, infrastructure and capital goods might be considered
52
public goods, that is, they are non-rival and non-excludable. Finally, the imperfect
characteristic of these markets, involving high sunken costs and large economies of scale,
provided the justification for direct state intervention in order to correct a situation of
capital scarcity and information asymmetries. Therefore, the notion that these economic
activities should be mainly carried out by state monopolies became widely accepted.
It is worth noting, however, that a state led economic-development strategy was
not a point of consensus in Brazil even in the initial years of this endeavor. The policy
debate among liberal (monetarists), structural-developmentalist and nationalist views was
in fact a source of conflict between public opinion and the governmental ranks, often
provoking the dismissal of an incumbent minister within the government bureaucracy.
15

Most often, new appointees to the Ministry of Finance or, later on, at the Ministry of
Planning, espoused one of the two main economic orientations (liberal or structuralist)
and frequently attempted shifts in policy orientation. Most often, but not always, liberals
were tied to agrarian or financial interests, whereas the ascension of industrialists from
the state of São Paulo to governmental ranks was noticeable, shaping policies
accordingly.
Yet the restrictive inclination of Brazil’s economic institutions offered little
policy space for truly liberal economics. With the deepening of ISI, the heavy regulatory
framework and the increasing participation of the state in the economy,
“developmentalism” and nationalism became preeminent. Several bureaucracies
responsible for financing agriculture and often subject to blatant political patronage

15
Skidmore (1975: chapter 5) highlights these contentious domestic policy debates during the 1950s and
1960s, and they have continued up to the present as sources of tension amongst economic policy-making
elites in Brazil.
53
clearly espoused a developmentalist view. This conflicted with the more economically
liberal finance ministry, constantly hindering its attempts at fiscal adjustment. Therefore,
the weight of ideas became ingrained in the state institutions and the bureaucracy, quite
often mixed with fiscal irresponsibility and corruption.
Summing up, Brazilian economic nationalism and state developmentalism
translated into concrete policy reforms in the post-World War II period. ISI policies were
initiated in the 1930s and deepened in the 1950s and 1960s. Brazil’s economic growth
strategy during the second half of the twentieth century was characterized by sizable
direct state intervention in industrialization and infrastructure and by restrictive
regulatory rules in several economic activities. Albeit justifiable from a developmental
point of view, such strategies coddled powerful groups within labor and industry who
demanded to be subsidized by the state. Those political groups connected to finance –
particularly national capitalists - were best able to realize their policy preferences.
Meanwhile, even politically displaced groups, such as landowners, were also able to
influence the state apparatus and received compensatory measures, in the form of
subsidized credit for agriculture. In fact, as I have mentioned, the owners of land
continued to exert important political leverage in Brazilian politics. This also occurred
because, despite the big push for industrialization, primary goods continued to be
important elements of the Brazilian trade portfolio up to the 1960s.
Political Economy, Policy Ideas and the Administrative Organization of the State
During the dictatorship of Getulio Vargas (1930-1945) there was a full scale
administrative re-organization of the state apparatus (tax, fiscal, tariffs, public service)
towards the centralization of the federal executive, which seized these policy instruments
54
to carry out a nationalist strategy. For example, a reorganization of the customs and the
tax system was fully implemented within the Ministry of Finance (Skidmore, 1975).
Rudiments of planning, welfare and state reform policies were designed. Social policies,
for example, were enhanced with the creation of new Ministries (Labor, Education and
Health) and the establishment of the minimum wage in 1940. The state forged ties with
trade unions, in order to appease latent social (communist) movements, but also the new
industrial classes. A true corporatist state was designed in Brazil, intellectually
influenced by the Europeans. For example, new labor legislation in Brazil was based on
the Italian Carta del Lavoro.
Biersteker (1993) argues that during the twentieth century countries were inclined
toward three political economic models: Liberal, Corporatist and Communist. Post-
World War II Brazil was predominantly corporatist with a few sparks of liberalism. In a
similar vein, although from a liberal-pluralist theoretical orientation, Hall and Soskice
(2000) emphasize a “varieties of capitalism” approach in explaining the comparative
political economy of OECD countries. They distinguish two basic types of capitalisms:
“liberal market economies,” i.e. those characterized by pluralistic and decentralized
group interests acting in a market economy; and a “cooperative market economy,” in
which interests between groups are decided by “negotiation” and often mediated by the
state. This dichotomy can be often summarized in a “pluralistic” versus a “corporativist”
society; accordingly, differences in economic institutions determine policy outcomes.
16

16
Hall (2006) summarizes the main features discussed by the literature on “varieties of capitalism.” One
feature is the size, strength, and diversity of labor organizations. A second is the organization of capital,
which includes patterns of financial intermediation, corporate governance, and inter-firm organization. A
third is industrial relations; the institutionalized relations between capital and labor that include procedures
for wage bargaining, education, and training. These three features concern institutionalized processes in
55
The experience of ISI in developing countries may be regarded as an attempt to
create state capitalist institutions, under a nationalistic and developmentalist ideology,
aiming to spawn a consensus among interest groups toward economic development. In
order to carry on this process of economic development, crucial bureaucracies – often
regarded as “pockets of efficiency” - were created in the 1950s. A principal one was the
BNDES (National Bank for Economic and Social Development), founded in 1952 to
establish investment priorities, finance infrastructure and support ISI policies, not only in
consumer goods, but also in capital intensive and intermediary goods. Established under
a model of “bureaucratic insulation,” BNDES was detached from the old-fashioned
bureaucracies and congressional pressures. The BNDES was often autonomous even
from the finance ministry, whose monetarist stances often clashed with the spending
priorities of that institution (Nunes 1983; Martins 1985).
17

This leads to another important point on the comparative political economy of
development: state led strategies are more common under authoritarian rules and
consequently are characterized by a lack of transparency. Martins(1976) uses the concept
of “conservative modernization” to emphasize the detachment from societal actors, the
lack of transparency and the technocratic approach to economic policy-making. From

decision-making. Finally, scholars also distinguish between different degrees of government intervention
in specific policies such as regulation, industrial policy, and social policy.
17
The Brazilian state organization, particularly after the military coup of 1964, is characterized, by a
division in direct administration (e.g. Ministries in the central government) and indirect administration
(e.g. SOEs). Basically, the direct administration is responsible for policy formulation, while indirect
administration is more operational. In practice, however, several indirect administration branches are quite
autonomous for policy making. It is often believed that the indirect administration is less inclined to
clientelism and there is more room for technical decision, while political appointments characterize direct
administration. This might be true in the case of the BNDES, or later on, in the Central Bank, but several
bureaucracies within the indirect administration were characterized by political appointments. Conversely,
economic ministries have been inclined toward technical staff appointments (Nunes, 1983).
56
1945 to 1964, the democratic regime followed suit, developing projects carried out by
highly insulated technocratic groups. The BNDES was instrumental in using task force
groups to plan national strategies, directly connected to the Presidential cabinet, shielding
them against political pressures and conducting the process under strictly technical
grounds. This policy expedient underpinned the Presidency of Juscelino Kubitsheck
(1956-1960), during the first national plan of development (PND). The subsequent
military regime deepened the process of conservative modernization and technocracy.
During the Presidency of General Geisel the second PND was launched and conducted
by skilled bureaucrats at the Secretariat for Planning (SEPLAN), along with the BNDES.
Summing up, authoritarian modernization was a hallmark of the Brazilian
industrialization experience, similar to other Latin American and East Asian countries
(Haggard 1990).
18

The establishment of semi-autonomous state institutions/actors to carry out
particular policies was part of the dynamic of state intervention and specialization. The
institutionalization of mechanisms of protection, such as quantitative restraints, licenses,
and high tariffs, provided an impetus to these autonomous entities. Brazilian state-owned
enterprises, such as CSN (steel maker) PETROBRAS (oil), ELETROBRAS (electric
energy generation) were forthright in influencing trade and investment policies toward
their own benefit. Quite surprisingly, their position sometimes was against protectionism
and import substitution. For example, state steel makers, eager to acquire imported and
better quality machinery, often exerted pressure for more flexible rules on the import of

18
Yet, authoritarian mechanisms did not hamper economic actors from lobbying. Interest intermediation
was exerted directly upon the BNDES, which, possessing financial and administrative autonomy, was able
to filter these demands according to their policy objectives.
57
capital goods. ISI financing programs carried out by the BNDES, aimed at acquiring
autonomy in capital goods production, were implemented at the expense of these SOEs.
But most often, SOEs were comfortable with monopolies and the subsidies granted by
the federal government.
The State as Supporter of Exporting Activities and the Role of FDI
According to Martins (1985), ISI should also be understood as the process of
capitalist expansion and the integration of Brazil into the international economy, whereby
the state supported economic actors – both private and public– in new ventures involving
foreign markets. After the 1964 military intervention, this statist trend deepened
significantly. New mechanisms of state financing were designed, including a tax on
industrial goods (the IPI) and a tax on services (the ICMS), both regressively applied to
several stages of production. The issuing of public bonds in domestic financial markets
also increased during this period. The enlargement of the Brazilian state happened
concurrently with a period of liquidity in international financial markets in the late 1960s
and early 1970s, when financial resources, due the deposit of oil producing countries into
European banks, were made available. Brazil, along with the other larger Latin American
countries borrowed, widely to finance huge infrastructure outlays and development
projects.
Several SOEs, which had full-fledged administrative autonomy, took advantage
of this trend, and in fact the expansion of SOEs in Brazil was part of this boom in
international capital flows. As a consequence, there was a mushrooming of SOE
subsidiaries and the diversification of productive activities. For example, PETROBRAS
created subsidiaries to tap into chemical and fertilizer markets, which had huge domestic
58
demand. This supply of foreign credit allowed SOES to implement a vertical integration
strategy. CSN, the state owned steel maker, for instance, expanded into to
complementary activities establishing subsidiaries in transport (railroads) and trading, but
also pulp, paper and reforestation industries. Some SOEs also established service-
oriented companies, such as insurance. The restrictive regulatory framework of the
country kept markets captive, as high barriers to entry hindered competition, SOEs
charged monopoly prices whenever possible. Therefore, this logic of business expansion
reinforced the highly regulated nature of Brazil’s economic institutions.
Export promoting policies should be understood within this context of state-led
capitalist expansion, which characterized the late ISI years in the 1960s and 1970s
(Baumann and Moreira, 1987). Despite the so-called inward orientation of the ISI model
in Latin America, Brazilian policymakers were forthright in seeking out external
markets, so as to acquire hard currency and tackle balance of payment problems, but also
for microeconomic reasons. Export promotion, by creating economies of scale and
supplying to more sophisticated markets, provided an outlet for manufactured and value
added products and increased the productivity and competitiveness of domestic
companies. It was a highly desired aim of policymakers to increase the participation of
manufactured and value added goods in the trade portfolio of the country because, having
higher income elasticity, they are less susceptible to price swings and unfavorable terms
of trade. In fact, governmental authorities created a myriad of incentives to help Brazilian
products climb up in the knowledge ladder and reach more demanding and specialized
markets. The aircraft and weapons industry is a successful example of an alliance
between SOEs, private companies and governmental institutes in the quest to enter more
59
specialized international markets (Goldstein 2002). Durable consumer goods, such as the
auto industry and appliances, also benefited from export financing.
In the administrative/institutional realm, in addition to the preeminent role of
BNDES in promoting several manufacturing sectors, the federal government established
CACEX (Foreign Trade Chamber) in 1953. Initially conceived as a chapter of the Bank
of Brazil, this entity acquired considerable administrative autonomy, in the distribution
of sizable foreign trade subsidies in the 1960s. The CACEX is another clear example of
bureaucratic insulation and a pocket of efficiency, where technical skilled staff had full
discretion to provide export incentives such as duty drawbacks and tax exceptions.
CACEX also managed BEFIEX (Special Fiscal Benefits for Exports) a program in which
firms negotiated incentive packages in exchange for long-term export commitments.
Finally, CACEX also granted import tariff and tax exemptions (IPI and ICMS) for capital
goods, components and raw material imports, even when these inputs were purchased by
an interested company in the domestic market. Thus, CACEX had full discretion to
bypass the “Law of Similars”, a milestone of Brazilian ISI policy that banned imports
whenever a domestic substitute was available (Shapiro 1997). With this policy primacy,
CACEX often clashed with other bureaucratic interests: the BNDES and other agencies
that regulated industrial policies and the establishment of import quotas, such as the
Council for Industrial Development (CDI) and the Council for Tariff Policy (CPA), both
created in 1969 and under the realm of the Ministry of Industry and Commerce (Motta
Veiga 1998).
Foreign direct investment (FDI), alone or in joint ventures with SOEs or national
private capital, was part of this process to enhance large-scale industrialization and
60
export promotion. The role of FDI is somewhat contradictory with the initial spirit of ISI,
since the ideology of industrialization is enmeshed with an appeal for autonomy, security
and nationalism. This policy inclination would change in the 1960s and 1970s, when FDI
was pragmatically welcomed to promote the autonomist project. Foreign automakers, for
instance, were keen to apply for the subsidies and exporting incentives granted by the
Brazilian government. This presence of FDI, however, was predominant in manufactures
and consumer goods, while public services and infrastructure activities were kept closed
and under state control. In technological areas – such as electronic goods and information
technology (IT) – the approach toward FDI was mixed. Brazil attempted to create
domestic capacity during the 1970s - a national hardware industry for example. Severe
regulations, such as quotas and import licenses, as well as BNDES subsidies were
applied. FDI was welcomed in this field, in joint ventures with national capital; however,
it was tied to performance requirements and the transfer of technology. Overall, policies
for the technology sector were also restrictive and ruled by ideological biases and
government planning (Adler 1984, Bastos 1995).
Summing up, multinational companies (MNCs) largely benefited from tax
holidays, subsidies and state financing aimed at enhancing industrial capacity and the
increased manufactures in Brazil’s trade portfolio. The FDI strategy initially
complemented the sizable and protected Brazilian domestic market. Later on, MNCs
joined forces with private and state owned Brazilian companies to develop an export
orientated industrial sector. At times, MNCs lobbied for a less restrictive approach
regarding intermediary and capital goods imports, as some consumer goods depend on
inputs such as steel, and limited competition augmented production costs. Automakers
61
were among the groups that complained about licenses, quotas, and the mechanism of
national similarity as a way of protecting domestic producers of capital goods. Most
often, though, MNCs were comfortable with domestic protection, and transferred to the
consumer and to the final product the burden of expensive production inputs.
ISI and the Political Economy of Macro and Micro Inconsistencies
It is indisputable that Brazil and Latin America experienced high rates of growth
during the ISI years (tables 3 and 4). Saving rates in Brazil and Latin America, however,
were considerably lower than international standards even during the late ISI years
(Figure 1). From a macroeconomic angle, state intervention was not sufficient to launch a
sustainable process of development, since it deferred aggregate saving. Furthermore, the
rigidity of economic institutions hindered the business environment, even though, from a
microeconomic aspect, many economists and political scientists acknowledge the
benefits of state-led industrialization (e.g. the process of learning-by-doing and
technological upgrading) (Wade 2004, Chang 1999, Hausmann and Rodrik 2003).
Nevertheless, in contrast to the East Asian ISI experience, which was also characterized
by state intervention, trade protection and economic regulation, Brazil and other Latin
American countries took much longer to liberalize imports and fiscal profligacy
undermined the macroeconomics soundness of the model. In brief, lagging productivity
and balance of payments problems soon became apparent.
Despite the incentives to spur value-added activities, the hindrance on capital and
intermediary goods imports caused a burden on Brazilian industry. Furthermore, tariffs
and regulatory barriers-to-entry kept domestic markets captive to private and state owned
firms in several sectors, decreasing incentives for productivity boosting investments. The
62
level of tariffs from that period shows that capital and intermediary goods experienced
high protection, reflecting the capacity of owners of capital goods to lobby for protection.
SOEs were also instrumental in pushing for their own interests. Tables 5 and 6 in the
statistical annex portray the level of effective protection during classic ISI years.
ISI policies spawned mechanisms to deal with balance of payment pressures,
including quotas and import licenses, export subsidization and multiple exchange rate
systems. Economic theory shows that tariffs on imports and subsidies on exports are
equivalent to exchange rate devaluation. Under the tariff-subsidy-license alternative,
there are incentives for smuggling imports, over-invoicing exports and so on, which do
not arise in the presence of a uniform exchange rate (Abreu 2004a). Trade regulations
created (negative) incentives and inefficiencies, over-protecting domestic industries,
increasing red tape and decreasing domestic welfare. According to critics, trade
regulations epitomize the rent-seeking characteristic of the ISI experience in Latin
America (Krueger, 1990).
Albert Hirschman (1968), in an assessment of the political economy of import
substitution in Latin America, acknowledges the alleged flaws of that economic model:
(1) Import substituting industrialization is apt to got “stuck” after its first success, due
to “exhaustion of easy import substitution opportunities”; it leaves the economy with
a few relative high-cost industrial establishments and with a far more vulnerable
balance of payments since imports consist now of semi-finished materials, spare parts
and machinery indispensably required for maintaining and increasing production and
employment.

(2) Import substituting industrialization is affected by seemingly congenital inability
to move into export markets

According to Hirschman, the solution for the first setback would be to adopt
backward linkages, that is, to encourage investment and productive capacity in heavy
63
industry sectors that supply inputs and capital goods to downstream industries. For
instance, it was not sufficient to build refrigerators and stoves; it was also necessary to
acquire productive capacity in steel production and energy generation, to guarantee basic
inputs and to build the machines used to produce consumer goods.
As discussed, Brazilian policymakers, either instinctively or as readers of
economic literature, followed policies to correct the problems spelled out by Hirschman.
The process of import substituting industrialization in Brazil, in different times, had two
clear concerns: First, to create backward linkages with huge governmental outlays in
basic industries and infrastructure projects in the post-World War II era. Second, by the
late 1960s and early 1970s Brazilian officials recognized the necessity to reach out to
overseas markets; hence, they established policy mechanisms to support exports,
particularly in value added goods and durable consumer goods, such as automobiles.
The strategy of state intervention worked for a while, as many countries,
principally those with large domestic markets, were able to build a considerable
industrial base. But the lack of competition undermined the microeconomic logic of the
model, and macroeconomic instability (overvalued exchange rates, fiscal deficits and
high inflation) worsened the picture. The policy inconsistency problem would be
magnified by the fiscal constraints of the 1980s and the propensity of vested interests to
lobby successfully. Despite some successful industrialization results, balance of
payments problems continued and worsened during the 1980s. Severe macroeconomic
imbalances, such as rampant inflation and budget deficits were exacerbated by external
shocks, such as the second oil crisis in 1979 and the drying up of international liquidity
due to US interest rate hikes in 1980. Depressed commodity prices in world markets and
64
high domestic demand for consumer goods put constant pressure on domestic reserves,
worsening capital accumulation. State debt skyrocketed and ISI started to run out of
steam in the late 1970s.
In sum, ISI should be understood in a context of political economy coalitions –the
urban middle classes, industrial workers, national and foreign industrialists, state owned
enterprises – that were able to influence political outcomes and policy orientations. These
policy orientations were embedded in state interventionism ideologies that influenced
policymakers and economic actors over the years, in a path dependency fashion that
seemed to lock politics in place (Pierson 2000). In spite of domestic and foreign shocks,
Brazil’s contemporary trade policy reflects these deep-seated political, economic and
institutional vestiges of ISI. The regulatory and institutional demands of modern trade
negotiations such as Doha and the FTAA, e.g. rules of investment, services, intellectual
property rights, government procurement, clash with this long-standing restrictive
framework and political economic cleavages in Brazil. External macroeconomic shocks,
reinforced by the domestic structure, also undermined attempts at modernization. In the
next section I examine the more recent structural reforms that have been undertaken in
Brazil, which have revamped the situation in some respects, but barely scraped the
surface in many others.
Section III - The Demise of ISI, Macroeconomic Imbalances and
Structural Reforms
The macroeconomic imbalances of the 1980s and the imperatives of structural
adjustment in the late 1980s and 1990s are crucial for understanding public policies
implemented during this period in Brazil. The political institutions of the country
65
significantly affect policymaking and policy outcomes; hence, the re-democratization
after 1985 and the Constitution enacted in 1988 also played a crucial role. Thus,
economic and trade policies should be considered as a function of a new domestic
political equilibrium that allow voice to new groups. Additionally, policies have also
been influenced by international trends, namely the liberalizing orientation of the
Washington Consensus.
19
However, the country followed the agenda in a piecemeal and
pragmatic approach, meaning that the commitment toward market reforms was only
partial and aimed at correcting short-run fiscal problems (Pinheiro et al 2004). In short,
contradictory forces have affected recent foreign economic policy in Brazil: the long
lasting nationalistic-developmentalist tradition conflicts with state-retrenchment and
market oriented reforms, prompted by the forces of economic globalization. The policy
preferences of various administrations have been influenced by these conflicting
worldviews since the economic collapse of the 1980s. Although reforms have been
adopted – more wholeheartedly under the government of Collor (1990-1992) or more
cautiously as with the current government of Lula da Silva (2002 - present) – long
standing policy characteristics continued to conflict in several areas, such as trade policy.
Trade policy should be understood in this political economy equilibrium in which
perennial and changing framework interact.
Macroeconomic Imbalances and the Fallout from ISI
The macroeconomic problems of Brazil had both foreign and domestic causes.
On the external front, they were triggered by the sharp increase in US interest rates in

19
The literature on structural reforms in Latin America – also known as the Washington Consensus - is
extensive. For a summary and review after ten years of launching the project, see Kuczynski and
Williamson (2003).
66
response to the second OPEC oil shock in 1979. Both events were highly detrimental to
net oil consuming countries like Brazil, which faced a dramatic problem of declining
terms of trade. This, in turn, prompted a policy of gradual currency devaluations that
provoked spiraling inflation rates. Public and private external debt skyrocketed, and the
huge state debt driven by fiscal profligacy and the blatant use of seignorage aggravated
spiraling inflation rates (figure 2). Added to the currency devaluations, hyperinflation
and recession ensued – prompting a classic scenario of stagflation. After 1982, the
decade was characterized by failed heterodox stabilization programs and a decline in the
public sector’s fiscal position. In short, balance of payment problems limited growth and
were a main characteristic of the 1980s. Along with severe fiscal constraints and chronic
financial crises, these decimated the Brazilian public sector and seriously undermined
public investment capacity. Public sector savings shrank by 6-8 percent of GDP from
1970-1977, and then dwindled harshly to negative rates in 1985 (Abreu 2004c).

67
Figure 2: Consumer Price Index in Brazil, 1970-2005.

Observation: in December 1993, inflation reached 2,490.99 percent
Source: Brazilian Central Bank and Economic research foundation/University of São Paulo -FIPE/USP.

The effects of these macroeconomic imbalances on trade and industrial policies
were numerous and complex. As ISI policies were based on a series of regulations,
quotas, tariffs, tax breaks and export incentives to support domestic production against
foreign competition, thus, the troubled situation of the public accounts provoked
financial strain and doubts about the feasibility of continuing these high levels of state
support. Albeit potentially justifiable in other contexts, the fiscal constraints and growing
skepticism about their social return rendered these transfers subject to criticism from
various sectors within the economic bureaucracy (Shapiro 1997). The industrial and trade
policy bureaucracies were especially harmed by the credit drought. Nevertheless,
CACEX was not extinguished until 1990, while the Council for Industrial Development
(CDI) and the Council for Tariff Policy (CPA) were closed shortly before. Thus, despite
18 21 17 14
33 29 38 41 40
67
85 91 95
228
68
367
892
459
1.650
941
23
10 5 -2 9 4 7 10 8 7 5
1.639 1.636
1.129
164 179
-100
0
100
200
300
400
500
600
700
800
900
1000
1100
1200
1300
1400
1500
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1700
1800
1970
1971
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1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
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1996
1997
1998
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2001
2002
2003
2004
2005
68
the prolonged crisis of the 1980s, industrial supporting policies and bureaucracies, in a
sort of inertia, were not removed right away.
Notwithstanding the mounting fiscal constraints, over the 1980s, 3-4 percent of
GDP were still transferred annually to the private exporting sector in the form
government spending or non-collected revenue (Baumman and Moreira 1987; Shapiro
1997). It is important to note that the total value of exports incentives relative to export
did fall after 1982. But the still high incentives of the early 1980s, along with the
currency devaluations, were attempts to make up for the dramatic deterioration in
Brazil’s terms of trade. In 1983, exports minus imports were almost 40 percent lower
than the 1970-72 average. A trade deficit of almost US$ 3 billion in 1980 was moderately
reversed in 1981 and 1982 because exports increased rapidly, but import contraction and
controls played a major role in response to foreign exchange devaluation.
20
The total
value of incentives to exports as a percentage of GDP began to fall only towards the end
of the 1980s with the phase out of subsidy lines. Public and private external debt also
increased sharply: from 1980 to 1986, Brazil saw its stock of foreign debt double from
US$ 64.3 billion to US$ 111.2 billion. As an example of the country’s long history of
socializing private losses, a significant part of this foreign debt was indexed to the US
dollar. In the late 1970s, those borrowers holding debt in foreign currency were allowed
to hedge their foreign exchange risks by making deposits in the central bank, in a context
in which the premium between official and black market exchange rates exceeded 100
percent. In short, Brazil’s foreign debt became the responsibility of the Federal
government (Abreu 2004c; Abreu and Werneck 2005).

20
The numbers in this paragraph come from Abreu 2004c and Abreu and Werneck 2005.
69
This example confirms the ability of private groups to extract concessions from
the Brazilian state up until the very end of the ISI model. The bureaucratic insulation,
initially designed to promote politically neutral and efficient public policies, reinforced
these predatory tendencies due to the intrinsic lack of accountability. Thus, it is important
to acknowledge that, in addition to the macroeconomic and fiscal constraints, governance
problems greatly undermined public policies in Brazil. This institutional frailty was
expressed in the poor performance of the insulated state agencies responsible for trade,
which became increasingly controlled by private interests. Hence, bureaucratic insulation
contributed to the declining management capacity and ineffectiveness of trade policy,
which became a field day for clientelist politics. According to Fritsch and Franco (1993),
export incentives were indeed important to neutralize the anti-export bias in an
environment of high effective protection, but the macroeconomic situation and the lack
of co-ordination between bureaucracies turned outcomes frustrating and by the late 1980s
the share of imports plus exports over GDP in the Brazilian economy kept at same levels
of the early 1960s, around 12 percent (figure 3).
Besides, due to macroeconomic disarray and a public investment freeze, SOEs in
the industrial and public utilities sectors were seriously undermined in their ability to
expand production and provide services. Yet, SOEs’ markets were still held captive by
high barriers to entry in the way of tariffs and infrastructure regulations. Price controls on
public utilities, as part of the attempted heterodox adjustment plans, also compromised
the financial soundness of domestic firms. The consequence was a decline in productivity
and in the quality of services delivered to the population.
70
Despite the apparent failure of the interventionist strategy, the policy debate in
the late 1980s was still biased toward the necessity of increasing state investment in order
to restore economic growth and to address the blatant levels of social disparity. The
presidency of José Sarney (1985-1989), the first democratic administration since 1964,
implemented economic packages meant to re-start economic growth. The Cruzado Plan,
for example, used price controls and fiscal measures to support the productive sectors
and to foster aggregate demand. However, these heterodox macroeconomic measures
failed to curb inflation or rationalize fiscal policy; public investments and social transfer
mechanisms could still not be properly financed.
Amongst these signals of macroeconomic and fiscal disorder, new trade themes
like investment and services were brought to center stage by the US when the Uruguay
Round of the GATT was launched in 1986. Notwithstanding domestic competitiveness
problems, the “national-developmentalist” orientation still prevailed in the domestic
debate: hence the relationship between intellectual property rights (IPRs) protection and
national technological and industrial policies became a stronghold for Brazilian foreign
economic policy in the late 1980s. In the domestic realm the Special Secretariat for
Informatics (SEI), established in 1979 to formulate and implement national information
technology policies, was able to set up regulations and high tariffs to avoid international
competition. The country then stiffened its position regarding IPR protection in the
multilateral negotiations of the GATT (Odell 1987). In the 1970s, Brazil attempted to
build a domestic hardware industry that relied heavily on copycatting, reverse
engineering and technological adaptation at the expense of international patents. The
technology policy also protected multinational companies (MNC), such as IBM, which
71
established joint ventures with Brazilian companies and thus kept a sizable domestic
market at bay.
21
Despite technological progress in some areas, such as bank automation,
Brazil was not able to establish competitive domestic industries in hardware due to price
differentials between foreign competitors. The state owned company COBRA S.A, for
instance, which attempted to develop a Brazilian desktop, epitomized this failed attempt.
Notwithstanding the better performance in software, Brazil also made some confusing
protectionist moves in this field, as in 1987 when SEI denied Microsoft the licensing of
the MS-DOS software due to the existence of a domestic substitute.
Ultimately, the SEI was also shut down, as Brazil engaged in negotiations over
IPRs in the Uruguay Round. As a consequence of this international agreement in 1994,
the country enacted less restrictive and more internationally harmonized IPR legislation
in 1996. But this squabble exemplifies the die-hard influence of the national-
developmentalist approach in trade and domestic industrial policies, despite pressure
from international and domestic actors that called for liberalization. The maintenance of
stiff regulations in a dynamic market such as IT exemplifies the rigidity of domestic
policymaking, despite the fiscal deterioration and poor governance capability of the
public sector and lack of competitiveness of the private sector.
22
IPR continued to be a

21
The technological subsidization effort in Brazil dates back to the late 1960s, when the BNDES
established financing lines aimed at improving the technological capability of domestic companies
(FUNTEC) and the acquisition of domestic equipments and machinery (FINAME). Even a new subsidiary
SOE was founded (FINEP) to tap into R&D public financing (Bastos 1995).
22
On the other hand, R&D subsidizing has public goods characteristics and creates spillover effects to
other economic sectors. Brazilian policymakers were understandably attempting to create an environment
for technological innovation similar to that cultivated by the East Asian countries (Korea, Taiwan).
Meanwhile, in Brazil, there was a tendency toward excessive government financing in picking winners
(supply driven policies) and a lack of contact between public research institutes and the private sector.
Besides, high barriers to entry, limited national learning ability and created an additional roadblock for
technological upgrading (Bastos 1995; Oliveira 2005).
72
controversial issue in multilateral and regional trade negotiations during the 1990s and
2000s, with Brazilian negotiators always referring to the necessity of preserving domestic
policy autonomy.
Democratization, the 1988 Constitution and its Effects on Economic Policy
According to the literature on institutions and economic growth, democratic
political regimes create strains on public finances and thus impose a toll on development
performance (Campos and Nugent 1999, Weyland 2002, Wise 2003). After 1985, the
democratization process in Brazil clearly increased the pressure on the state budget. This
impetus was symbolized by a social-democratic Constitution, enacted in 1988, which
earmarked several transfers meant to benefit broad social groups. Revenue earmarking is
an instrument to deal with the volatility in tax collections and ensure continuity in public
policies, particularly during periods of fiscal constraint. For instance, the new
Constitution established a minimum level of expenses that had to be upheld for health,
education and social security as a percentage of the annual budget. The Constitution also
increased labor benefits and transferred federal funds directly to states and
municipalities.
In addition to the redistributive mandate, the Constitution had extensive impact
on economic life since it attempted to reinforce a nationalistic order, one in which the
Brazilian state and private national groups would be the main executors of economic
development. International investments, for example, were restricted in infrastructure
(mining, energy, telecommunications, media, transport), or prohibited, as in health and
social insurance. Policymakers’ rationale for limiting foreign investments and increasing
direct state participation in key economic sectors again relies on the assumption that
73
there were market failures, such as asymmetric information and externalities, provoking
under provision by private actors and justifying their strategic management by the state.
Besides, some these sectors were also natural monopoles characterized by high barriers
to entry (Baumol et al. 1987). This national provision of public goods may have
preserved national economic interests, but not in a constructive manner: high regulatory
barriers to entry were reaffirmed, inhibiting investment capacity, creating monopoly
power and, hence, driving prices up and services/goods provision down.
Albeit a symbol of the democratization process after 20 years of military rule, the
1988 Constitution attempted to create a welfare state by decree. The Constitutional
debate overlooked the fiscal situation of the Brazilian public sector during the debt crisis
of the 1980s, regarding it as a momentary setback rather than a structural problem.
Additionally, Brazilian policymakers and legislators grossly overlooked the dynamics of
economic globalization of the late 20th century, which were already challenging the
financing capacity of national governments and spreading new ground-breaking
technologies in public administration and network industries. Wise (2003) remarks that
the policy debate in Latin America in the last decades of the 20th century has been
characterized by a polarization between state-versus-market approaches – pure
interventionism versus free-market fundamentalism. The Brazilian Constitution
epitomizes this trend. A more appropriate discussion would distinguish between an
interventionist versus a regulatory state and would look for ways to use public policy to
facilitate market failure corrections. However, this discussion was absent from the 1988
Constitution, and it would take a couple of more years until it was seriously incorporated
into the policy debate in Brazil.
74
From a political economy point of view, several lobbies blocked the economic
laissez-faire approach during the Constitutional debate. The overriding bias was that
SOEs or public institutions should be the main providers of public utilities, infrastructure
and transport services, agriculture and health care financing, R&D activities and so on.
Capital goods, durable and non-durable consumer goods’ production was left in the
hands of private domestic capital and international companies already positioned in the
domestic market. In sum, the Constitution approved an economic order characterized by
dirigisme, which would greatly influence the Brazilian trade negotiating position in the
late 1990s, not only in the discussion of market access and tariffs, but also in issues such
as services, investments and IPR – all of which have close connection with domestic
economic institutions and regulations.
Concerning the bolstering of democratic and pluralistic rights, it is auspicious that
the Constitution enhanced social and political participation after twenty years of military
rule. However, it perpetrated severe imbalances that have taken a toll on economic
policymaking and public governance. The Federal Executive had its legislative power
greatly enhanced by the mechanisms of provisional measures,
23
although this power is
still constrained and checked by the Congress, the Judiciary, public prosecutors and the
bureaucracy. Despite this precedence of the Executive, the political capital expended to
bypass some Constitutional guarantees, for instance, to enact reforming legislation,
revealed the weaknesses of the political system. This trend became evident with the
mushrooming of corruption scandals. The Constitution also re-established a tendency

23
The provisional measures (medidas provisórias) are legislative decrees proposed by the Executive and
were passed to speed up the structural reform process. For a contemporary account of the institutional
characteristics of Brazilian democracy see Caroll and Shugart (2006), particularly on the concept of hyper-
representation; for the effects of democratization on policymaking see Alston et al (2006).
75
toward decentralization in the delivery of social policy (health and education) and it
earmarked funds for these policies. While a much-esteemed objective, de-centralization
created fiscal constraints for the Federal Executive, which transferred resources to states
and municipalities, but policy delivery continued to be problematic. Subsequent
amendments to the Constitution in the early 1990s fostered the institutionalization of
macroeconomic and fiscal equilibrium and established the dominant role of the
Executive in economic policymaking. Unfortunately, several sectoral policies, such as
social policies, continued to be driven by clientelism.
Alston et al (2006) affirm that the policymaking process in post-Constitution
Brazil can be separated into four broad categories: “stable but adaptable”
(macroeconomic and fiscal), pork (localized interests of congressmen), “hardwired”
(mandatory constitutional transfers, principally in health and education) and residual
(policies with a more ideological tone, such as land reform and wealth distribution).
According to the authors, the post-Constitution political equilibrium allowed the Federal
Executive to trade pork and residual policies for macroeconomic stability and fiscal
adjustments, while hardwired policies were kept stable. This new political equilibrium
was crucial for macroeconomic balance since it granted autonomy to the Federal
Executive in economic policymaking. Conversely, it improved societal leverage because
sectoral policies were discussed openly in the Congress. However, in the highly
burdensome negotiating process between the Executive and the Congress, special interest
groups were forthright in logrolling and approving their particularistic agenda, creating
inefficiencies and incentives for corruption.
76
To sum up, in spite of democratic and pluralistic inclinations and the social
transfer commitments, Brazil ratified a Constitution that constrained the investment
capacity of the economy and set the basis for an unbalanced fiscal federalism, in which
the states had no incentive or means to establish and provide public goods. Brazil ended
the 1980s not only with another move toward developmentalism but also with a set of
political institutions that had a mixed effect on economic efficiency.
Trade Policy, Macroeconomics and Structural Reforms
The regulatory nature of Brazil’s Constitution would soon be at odds with the
new hemispheric thrust toward state retrenchment and pro-market reforms that took off
in the early 1990s. Structural adjustment policies under the banner of the Washington
Consensus (WC) became a constant in the discourse of Latin American policy makers at
this time. On the macro front, these policies promoted monetary stability, fiscal balance
and real exchange rate adjustments; the microeconomic aspects of WC reforms embraced
trade openness/liberalization, the privatization of state owned companies, and
deregulation of the economy. Brazil, like other Latin American economies, used
unilateral tariff slashing to stimulate competition with foreign goods and to curb inflation
which, by the end of the 1980s, was running in the three digit range (see figure 2 above).
The early trade liberalization measures were launched under President José
Sarney (1985-89), the first civilian president after 20 years of military rule. Following a
highly polarized election in 1990, the administration of President Fernando Collor
enhanced the pro-reform and market orientation of Brazil’s economic policy, continuing
to lower tariffs and deepen the process of privatizing state companies. Political scandals
provoked the impeachment of Collor in 1992, substituted by President Itamar Franco
77
who, despite coming from a national-developmentalist tradition maintained some
reforms, particularly, the unilateral tariff cuts.
It is important to stress that these domestic trade reforms were taken unilaterally,
despite the Uruguay Round negotiations the country was involved in at the time at the
General Agreements on Tariffs and Trade (GATT) (1986-1994). During the 1980s, in a
context of severe macroeconomic imbalances, policy advice coming from the multilateral
institutions, the IMF and the World Bank includes, recommended cutting tariffs and
subsidies. Abreu (1998) remarks that the bad economic situation in the mid-1980s
undermined Brazil´s negotiating position before and during the Uruguay Round. In the
next sections, I will discuss the issue of concurrent domestic reforms and international
commitments at the GATT/WTO.
The new Constitution reinforced the prominent role of the federal executive in
negotiating trade agreements, which then needed to be ratified by the lower chamber of
congress and by the senate. Other social and political actors within civil society could
work through the congress in order to input their policy preferences. However, trade
negotiation and industrial policy making were still highly insulated in the Ministry of
Foreign Relations (Itamaraty) and in the Ministry of Industry and Commerce. The
economic ministries (Finance and Planning) played a marginal role in trade issues.
Hence, direct lobbies around the federal executive continued to exert pressure for
protection, or at least, to receive compensation for the pain of economic liberalization
(e.g. export subsidies and tax exceptions). During the Sarney presidency, for example,
there were some attempts to institutionalize the sectoral chambers that represented
industrial and trade policy interested groups, although this effort failed because of a
78
continued macroeconomic instability (Diniz 2000). It was still all too apparent that the
process of trade liberalization in Brazil would be carried out in a piecemeal format and
that industrial groups would hang on tenaciously to their demands for protection.
Despite Brazil’s gradualist stance, it played a leadership role in the launching of
Mercosur in 1990, a customs union initially negotiated between Brazil, Argentina,
Paraguay and Uruguay. Mercosur’s subsequent establishment of a Common External
Tariff (CET), covering almost 90 percent of goods in the internal market, was an
important steep toward fostering trade liberalization and consolidating domestic
structural reforms. It also symbolized a new approach to trade policymaking, one where
member governments used trade liberalization as an anchor for macroeconomic stability
and with the long run intention of improving domestic competitiveness.
As Edwards (1995) has noted, arrangements such as Mercosur marked a shift in
the region, from closed economies, high tariffs, heavy state intervention in productive
activities, and overvalued real exchange rates. The initial results of unilateral trade
liberalization were impressive, as an upsurge of regional trade integration projects
followed. This included the revamping of earlier regional trade schemes in the Central
American and Andean blocs, and the 1994 implementation of the North American Free
Trade Agreement (NAFTA). This regional integration trend was both a consequence of
unilateral trade liberalization and the overall need for structural adjustment; these, in
turn, were logical responses to the debt shocks of the early 1980s and of the outright
collapse of an interventionist development model.
As a customs union, Mercosur set a single tariff for all members, which averaged
12 percent by 1995. The Common External Tariff (CET) also granted temporary tariff
79
exceptions for certain industrial sectors (e.g. automobiles and information
technology/electronics), allowing them time to restructure and catch up with international
practices and productivity trends. The automotive regime, for instance, established a
sectoral agreement between Brazilian and Argentine automakers in 1996, which was
initially scheduled to end in 2006. This initial deadline was modified (extend till 2011),
as the automotive sector in Mercosur has become a contentious aspect of the customs
union. As endogenous trade policy asserts, those sectors temporarily exempted from the
average CET possess less comparative advantage vis-à-vis foreign competitors
(Olarreaga and Soloaga 1998). In short, the continued exceptions to the CET and the
automobile regime are examples of managed trade policy and vestiges of earlier
protectionism that continue to characterize Brazil and the southern countries in the 1990s
(Leipziger et al 1997).
Even so, the first half of the 1990s did see a complete revamping of Brazilian
trade policy, including the ending of old export subsidy programs (BEFIEX), and
creation of new GATT-friendly instruments (PROEX).
24
The business chambers also
underwent a bureaucratic overhaul that established CAMEX (Inter-ministerial Chamber
of External Trade) in 1995 (Motta Veiga 1998). These institutional innovations, although
important, have still not provided Brazil with the adequate tools to craft a coherent
negotiation strategy, or to properly address the new trade themes within multilateral and
regional venues. This lack of policy co-ordination became apparent with the collapse of
both the FTAA and the Doha negotiations, as the pro-market and liberalizing contingent

24
PROEX (Program for Export Financing), initially managed by the BNDES, absorbed some of the old
financial lines for capital good exports, but was mainly targeted at interest rate equalization.
80
within some sectors of the bureaucracy clashed with the traditional state led and
regulated agenda within others.
25

Trade policy would also be deeply influenced by the macroeconomic adjustments
after the 1994 Plan Real. This plan, although successful in taming inflation, soon
reinforced the lack of consensus among different bureaucracies concerning trade
liberalization, also echoed within civil society. During the two administrations of
President Fernando Henrique Cardoso (1995-2002), the debate was clearly between the
developmentalists, influenced by powerful industrialists in the state of São Paulo and
their entrenched allies within the Ministry of Industry and Trade, and the Ministry of
Foreign Affairs, to a certain degree, and the monetarists, pro-market sectors from the
Ministry of Finance and the Central Bank. The latter faction had broken with tradition
and wanted tighter monetary and fiscal policy in line with the Washington Consensus,
despite alleged deleterious effects of such policies on the productive sector (Abreu and
Werneck 2005).
The Plan Real, launched in 1994, had elements of both heterodox and orthodox
policy, but overall it adopted a more monetarist approach, pegging the new currency
(Real) to the US dollar. Unilateral tariff cuts were also made to force domestic goods to
compete more forcefully with foreign goods, and to combat inflation. Tariff reforms
provoked a steeper decrease in the rates of effective protection in several industries and
economic sectors (see tables 7 and 8 in the statistical annex). In short, average tariffs
decreased from 32.2 percent in the early 1990s to 12.1 percent in 1995 (Pinheiro et al.

25
As a customs union, Mercosur members should have a single negotiation strategy in multilateral and
regional trade talks, but countries have not agreed on joint positions on several issues and, principally,
exogenous shocks adversely affected the negotiations.
81
2004: table 01). At the same time, meanwhile, several capital-intensive sectors continued
to have above average effective rates of protection (Abreu and Werneck 2005).
In addition to this strategy of macroeconomic stabilization in the 1990s, Brazil
pursued a microeconomic agenda based on privatizing, deregulating and liberalizing the
domestic economy. The launching of the Brazilian national privatization program in
1990 was a major step forward. The selling of steel companies, such as Usiminas in 1991
and Vale do Rio Doce in 1995, were critical landmarks in this process – symbolizing the
initial surrender of the Brazilian industrial state. Privatization has passed through several
distinct phases, beginning with the industrial sector, and then the public utility
companies. According to the official position (Brazilian Ministry of Finance 2002),
privatization has been part of broader reform strategy aimed at generating a fiscal surplus
and establishing a sound basis for fiscal revenues in the long run. Additionally,
privatization contributed to the better quality and reduced prices for products and
services, and it attracted foreign direct investment (FDI), which helped to finance the
chronic current account deficits of the 1990s (figure 4 below). Governmental regulatory
agencies were created to monitor the efficiency of these de-regulated markets. Total
proceeds from privatization, comprising sales proceeds and debt transferred, accumulated
US$ 105 billions in 2002. (Ministry of Finance 2002: table 09)
Regardless of these accomplishments, the economic policies embraced during this
period were far from the simple orthodox blueprint of the WC. Generally speaking, state
intervention in economic affairs continued, but emphasis was now placed on managerial
skills rather than the state’s entrepreneurial position (Giambiagi and Moreira 2000;
Ministry of Finance 2002). In fact, a more contemporary debate about the tasks and role
82
of the state in economic development was finally initiated in the mid 1990s. During this
period, several Constitutional amendments were enacted to allow for more market
friendly legislation and private participation in the provision of infrastructure. Yet, neo-
liberalism, privatization, and so are expressions that still grate on the political lexicon in
Brazil, even within more right wing and conservative circles.
Therefore, despite the so-called shift in the role of the state in Brazil, Pinheiro et
al. (2004) stress that structural policy reforms were pragmatic and aimed at resolving
urgent monetary and fiscal problems. In other words, policymakers did not commit
wholeheartedly to the pro-market agenda. Across Latin America, the bundling of
economic reforms was common in this period, but the lack of a more modern and
complementary institutional environment was apparent. Hence, the macroeconomic
agenda progressed at a much faster pace, while microeconomic and institutional reforms
lagged behind. Finally, it is worth noting that social spending, – on health, education,
pensions and welfare programs – albeit riddled with imperfections, is a sizable part of the
Brazilian budget, even superior to similar emerging market countries. Reforms in these
sectors have been also problematic. Pension reform, made urgent by a spendthrift public
pension system, was constantly defeated by the Congress during the Cardoso presidency.
Although Brazil’s social safety net is thick, the country is attempting to overhaul its
welfare and labor legislation in order to improve formal employment and establish a
sounder basis for economic growth. Social and labor reforms are imperative for
improving the economic competitiveness of the country in world markets, but they entail
complex political economy trade-offs and cleavages. Therefore, a cautious and piecemeal
83
reformist approach was reassured with the election of the Labor Party government led by
Luis Inácio “Lula” da Silva in 2002.
Overall, the policy agendas of both Cardoso and Lula have been similar. Both
were based on a social democratic platform that promised to tackle inflation and the
disarray in public finances and governance; and, although a deeper commitment toward
economic liberalism was evident under both, official discourse downplayed the WC
influence. Gradualism prevailed, but the bundling of reforms meant that delays in one
issue area would damage other policy objectives. For instance, delays in administrative
and bureaucratic reform hindered the building up of more effective regulatory agencies.
Administrative and bureaucratic reforms were also slowed by the use of patronage
appointments to please political allies in the congress. The federal executive took
responsibility for advancing the reformist agenda in the congress, but it had to finesse the
opposition each step of the way. Several amendments to the Constitution were necessary
in order to allow the privatization of public utilities sectors, and the federal executive was
forced to rely on provisional measures and strictly technical terms based on dire fiscal
necessity. As a baseline for comparison, other Latin America countries adopted the
neoliberal agenda more deeply in the 1990s, such as Argentina and Bolivia (Wise and
Roett 2002; Wise 2003).
Additionally, Brazil maintained a system of incentives and subsidies aimed at
compensating sectors badly affected by adjustments. As Schamis (1999) argues, the
reforms were carried out in order to allow owners of capital to relocate to other more
promising sectors. The privatization of state assets in the telecommunications and energy
sectors, for instance, was partially financed by BNDES. During the second half of the
84
1990s, the federal government also assumed a series of financial liabilities from bankrupt
banks, such as the state owned Bank of São Paulo (Banespa), the private owned
Economico, and a massive bail out for the domestic banking sector (PROER). Although
these measures were considered important stepping-stones towards a more robust
domestic banking sector, and justified by the turmoil and international financial crises of
Mexico (1994) and East Asia (1997), the Brazilian state was criticized at home for
transferring income to economic privileged sectors.
In brief, Brazil’s macroeconomic record during the 1990s and early 2000s was far
from negligible. It was able to launch a sweeping monetary adjustment and curb
skyrocketing inflation in 1994. Later on, Brazil committed to a targeted inflation policy
and to Central Bank independence, signaling a more credible commitment to monetary
stability. After a period of pegging the exchange rate, which helped tame inflation, Brazil
adopted a floating currency regime in 1999 (figure 5). It has also been steadily
increasing the participation of exports and imports in GDP, which hit 25 percent in 2004
(figure 3). More recently, Brazil also shifted the composition of its public debt,
decreasing short-term liabilities issued in foreign currency and stretching maturities.
Together, these measures have led to current account surpluses and Brazil’s closer
integration into the world economy, and they have decreased the country’s exposure to
international financial shocks.
Brazil is also more credibly devoted to maintaining a fiscal balance, as reflected
in the passage of a Fiscal Responsibility Law in 1998 to lock in a governmental
commitment toward balanced public finances over the long run. Yet, despite these
accomplishments, Brazil’s real GDP per capita growth, averaging 2.1 percent from 1987-
85
1997 and 2.4 percent from 1996-2006 (IMF 2005), has been far from impressive and
lower than the ISI years. Brazil’s trade opening and the joining of integration agreements
with more advanced economies – both at the multilateral and regional levels – have thus
been postponed. For many groups inside the country, this remains a highly contentious
issue, as the low growth records in an era of trade opening have fueled suspicion toward
further liberalizing measures.
Figure 3: Openness (X+M/GDP), 1962-2005.

Source: Central Bank of Brazil.
5
10
15
20
25
30
dez/62
dez/64
dez/66
dez/68
dez/70
dez/72
dez/74
dez/76
dez/78
dez/80
dez/82
dez/84
dez/86
dez/88
dez/90
dez/92
dez/94
dez/96
dez/98
dez/00
dez/02
dez/04
%
1984 - Exchange rate
devaluation provoked GDP
fall
Jun 94 - Real Plan
nominal exchange
rate peg
Nov 99 -
Devaluation
crisis boosts
exports
competitivene
86
Figure 4: External Sector.

Sources: Central Bank and Ministry of Development Industry and Trade of Brazil

Figure 5: Real and Nominal Exchange Rate, 1994-2005
1
.
Sources: Central Bank of Brazil and Federal Reserve Bank of Saint Louis
1
Monthly averages. Price Deflators: Brazil (IPCA), US (CPI)
10.580
13.299
10.466
-1.283 -753
2.650
13.125
24.825
33.666
44.780
-3.466
-5.599 -6.753 -6.624
15.239
11.738
4.177
-7.637
-23.215
-1.407
6.109
-278
-1.811
-18.384
-23.502
-30.452 -33.416
-25.335
-24.224
14.228
-60.000
-40.000
-20.000
0
20.000
40.000
60.000
80.000
100.000
120.000
140.000
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
US$ millions
Trade balance
Exports
Imports
Current account
0,0
0,5
1,0
1,5
2,0
2,5
3,0
3,5
4,0
jun-94
dez-94
jun-95
dez-95
jun-96
dez-96
jun-97
dez-97
jun-98
dez-98
jun-99
dez-99
jun-00
dez-00
jun-01
dez-01
jun-02
dez-02
jun-03
dez-03
jun-04
dez-04
jun-05
dez-05
0
50
100
150
200
250
300
350
400
Real Exchange Rate
Nominal Exchange Rate
(R$/US$) * 100
Brazilian Currency Crisis
87
Section IV –Trade Liberalization and Integration– Political Economy
and Institutional-bureaucratic Determinants
The political economy literature poses a key question: if reforms are beneficial
for all, then why are they delayed for so long? The same rationale could be applied to
trade liberalization and integration into world economy: if economic theory and data
sustain that these are beneficial for the majority, do they still raise eyebrows in a country
like Brazil? Obviously, the answer to this question is a highly complex one. The logic
of collective action partially explains this political economy stalemate, as these small
groups most affected by reform have a higher capacity for mobilization and are able to
obstruct reforms that would benefit the majority (Olson 1967). External and internal
shocks can also play an important role, as with the 1980s debt crisis in shifting the
delicate political economic support for ISI, and thus quickening its collapse. Increasing
integration in the world economy was a consequence of the changing the role of state
after the 1980s, when Latin American countries finally faced their macroeconomic
problems and embraced a more outward economic model. Yet, even after the success of
some structural reforms, localized interests continue to exert pressures for protection. In
Brazil, for example, state-bureaucratic actors have emerged as intervening variables, and
continue to influence policy outcomes quite autonomously, including the push for
managed trade policies. In short, owing to institutional inertia, favored groups continue
to reap rents and policymakers still argue for a “developmentalist” state, albeit on a
smaller scale and with a different discourse. In other words, despite the impressive
changes that the region has undergone in the last 15 years, some traits of the past remain.
88
In Brazil, rather than a deep commitment toward liberalism, trade reform was a
pragmatic response of policymaking elites to a harsh macroeconomic situation. Just like
the 1930s, when state interventionism was a logical response to the disrupted world
markets, the adoption of free market was a reaction to the drying up of fiscal resources
and skyrocketing inflation, ensued by the debt crisis of the early 1980s. As Pio (1997)
remarks, the decisions were taken by policymaking elites, which some ideological
penchant toward free-markets ideas, though, he also makes clear that the decision-
making process preserved some characteristics of the “technocratic model” of the
authoritarian regime. More specifically, after democratizing in 1985, and the Constitution
of 1989, public policies happened to be influenced by the popular demands of
redistribution. However, stabilization policies were carried out by the technocratic ranks
at the Executive in a rapid and rather discretionary way, maintaining the pattern of the
authoritarian era. Trade policy, in particular, was conducted in order to advance a
macroeconomic stabilization agenda and it was facilitated by the insulated characteristics
of the bureaucracies.
Despite the domestic economic difficulties and the urgency to gain better market
access via international negotiations, some policymaking groups – specifically within the
diplomatic ranks - maintained blocking strategies on some issue areas at the
GATT/Uruguay Round negotiations. In spite of resistance in the Ministry of Foreign
Affairs, the position of the Ministry of Finance prevailed and Brazil was the first
developing country, for instance, to sign the Code on Subsidies agreeing to freeze and
phase out these GATT-illegal subsidies. Abreu (1998) and Lima (1986) emphasize the
impact of the economic situation of the country in the negotiations of the Uruguay
89
Round. This trend will be reinforced during the late 1980s and early 1990s, as the
pragmatic response will prevail. As Abreu (1998) points out:
There is no doubt that the Brazilian bargaining position was weakened by
the country’s growing financial vulnerability since the end of the 1970’s.
But it is also clear that the economic stagnation which started in 1981 and
was to last until well into the 1990’s, following a long period of high
growth with protection which had started in the end of last century,
stimulated a re-examination of the net advantages of the continued
adoption of an import substitution model. It became also increasingly clear
that an industrial development strategy based on “picking the winners”
was generating substantial friction with suppliers, especially the US,
without significant benefits in a situation of increasing loss of credibility
related to the persistent macroeconomic disequilibria, especially high
inflation. The bargaining power of developing countries was also
undermined by the end of the bipolar world with the collapse of the Soviet
Union.

After the conclusion of the Uruguay round and the creation of the WTO in 1994,
however, the commitment of the Brazilian government with further trade liberalization
was conditioned by the headway in the multilateral order, which did not happen. Hence,
Brazil refused to commit toward further integration with developed countries, both at the
multilateral and at regional negotiations. As I described in the former section, structural
adjustment has followed a gradual approach. As result, the extent of further liberalization
and the role of state in the 2000s is a contentious issue. Trade integration with the
advanced countries is embedded in this debate. This section analyzes the different
positions on trade policy on the domestic front in Brazil, and discusses how second-
generation reforms fit into this policy debate.
The Political Economy of Trade and Industrial Policy in Post-Stabilization Brazil
According to the neoliberal political economy critique, the sudden realization of
the benefits of a market economy was triggered by the failures of ISI; enlightened
90
policymakers are then prodded to undertake structural adjustments (Krueger 1974). This
assumption has been modified by Alesina and Drazen (1991), who argue that
postponement of adjustment becomes a war of attrition in which societal and political
actors are unwilling to bear the costs of stabilization. Instead, deficits, inflation, and
balance of payments crises eventually force socioeconomic groups to take responsibility
in solving the problem. Once the payoff of benefits is realized, the stalemate is broken
and reforms are undertaken. This model is more related to macroeconomics issues.
Stabilization reforms positively impact the whole population, as the costs of spiraling
inflation far outweigh the benefits to any one economic faction.
Concerning trade policy, while the aggregated gains of liberalization are
considered to be positive, the localized pain for particular economic sectors or industries
makes it more difficult to break with protectionist policies. Yet, trade reform can also be
launched in a process of macroeconomic adjustment, as the political cost-benefit ratio of
protection declines dramatically in a context of stabilization (Rodrik 1994). Trade
liberalization, when implemented along with monetary reform, can help break inflation
inertia. In Brazil, support for monetary stabilization under the Real Plan far outweighed
the opposition from any displaced groups, in contrast with the mixed opinions expressed
about privatization and pension reform, for instance. Thus, these other policy reforms
required compensatory measures. With trade liberalization, the unilateral slashing of
tariffs created strains on several localized industrial groups, who later demanded special
treatment in the application of the CET under Mercosur. Other reforms, such as
91
privatization and de-regulation, albeit beneficial for consumers, are not well accepted due
to politicized opinions in Brazil about the role of the state in the economy.
26

In a later assessment, Rodrik (1996) argues for the need to distinguish between
the financial/budgetary/monetary side of structural reforms (macroeconomic policies)
and the trade liberalization/deregulation/privatization side (microeconomic policies). He
argues that East Asian success was characterized by conservative orthodox management
of the macroeconomy, yet greater innovation and flexibility at the microeconomic level,
particularly in the realm of industrial and export promotion, but also with policies aimed
at enhancing human capital, such as labor training and education. Policy makers in Brazil
tend to attribute East Asian success to efficient state intervention in industrial,
educational and technological policies, and the selective promotion of foreign trade,
rather than the straightforward application of neoliberal precepts. Yet, Brazil’s
effectiveness in pursuing similar industrial and trade policies during the 1990s was
hindered by the lack of governmental coordination, faltering infrastructure, a burdensome
tax system and a heavy regulatory environment.
According to sectors of the Brazilian bureaucracy and society, further trade
liberalization within multilateral and or regional agreements may hamper policymakers’
ability to carry out active industrial and trade interventions. The rationale for postponing
deeper integration is not only Brazil’s low capacity to compete with developed country
products, but the alleged inability to carry out domestic policies as well. These same
sectors, meanwhile, seem to overlook that trade agreements were important for locking in

26
Baker (2003) notes that trade liberalization is often regarded by the electorate as more beneficial than
privatization, which ranks less favorable in opinion polls, but neither is as popular as macroeconomic
stabilization. Also see Latinobarometro (2005).
92
reforms and increased policy effectiveness in countries such as Chile, which has signed
bilateral agreements with the US and the European Union, and in Spain and Portugal
(Viola 2006; Santiso 2006). In Brazil, even labor-intensive industries, such as apparel
and textiles, are suspicious about further integration along the lines of an FTAA or the
EU-Mercosur agreement. The rapid rise of China in world trade adds more complexity to
these fears: industrialists face stiff competition from Chinese products not only in third
countries, but also inside Latin American markets. Furthermore, both foreign and
domestic business sectors complain about the high Custo Brasil (Brazilian costs) of
investing, and this includes everything from poor infrastructure to an overwhelming tax
and regulatory environment.
In order to offset some of these costs, Brazil has engaged since the mid-2000s in
a more pro-active industrial policy, launching an Industrial, Technological, External
Trade and Policy Programs, combined with complementary legislation and measures to
increase the access to credit and tax breaks for firms engaging in R&D. These are
revamped policy measures aimed at boosting the international competitiveness of
domestic industries. Although it is too early to gauge the effects of these policies, it
seems that the country is now seeking to emulate something closer to the East-Asian
development model. The sound performance of exports, including higher value-added
goods, in the past five years is testimony to this “East Asian” tendency.
The combined effects of trade liberalization and active industrial policies are one
of the most contentious points in the international economic relations literature.
Neoclassical economists are suspicious of industrial policies aimed at increasing a
country’s competitiveness, such as export promotion, while political economists most
93
often argue in favor of such policies. In his study of the cases of Brazil and Korea during
the 1960s and 1970s, Rodrik (1993) argues that both countries succeeded in
implementing export and industrial promotion policies and creating relatively modern
and competitive industrial sectors. These active industrial policies promoted welfare
gains domestically, but losses on a world basis. In contrast to the East-Asian experience,
however, Brazil’s industrial and trade promotion policies privileged some sophisticated
goods with high governmental intervention and subsides, for example, weapons and
aircraft exported to the Middle-Eastern markets.
Industrial policies were also combined with trade promotion in traditional goods
and commodities, such as iron ore shipped to Japan. In the Brazilian case, state
intervention was more expensive since it was targeted at scale-intensive activities and
sought to exploit remote economic areas of the country, for example, iron mines in the
Amazonian region. Land scarce and labor abundant countries such as Korea decided
early on to establish labor-intensive industries (apparel, simple electronics, and clothing)
that required less costly state action.
27
The differences between the two industrial models
became evident by the end of the 1980s, when a cash-strapped Brazilian state could no
longer promote industries and low levels of public investment reinforced the lack of
structural competitiveness. Despite its diversification of trade partners during the post-
war period,

Brazil decreased its share in world trade from 2.2 percent in 1945 to 0.87
percent in 2000 (Abreu 2001).

27
Auty (1995, 2001) critiques the Brazilian strategy and contrasts it with the more successful Korean
experience.

94
Trade Integration and Second Generation Reforms as Vehicles to Enhance
Competitiveness
28

The launching of Mercosur in 1990 marked a change in Brazil’s foreign
economic policy, one that sought to exploit the proximity of neighbors as a logical outlet
for Brazilian industrial exports. Additionally, Mercosur was regarded as a vehicle for the
modernization of the country’s industrial structure. Although trade promotion and
industrial policies of the 1960s and 1970s had been successful in diversifying markets
and creating economies of scale in some sectors, these failed to generate positive
externalities in the highly regulated and distorted domestic market. Trade integration
based on liberalization, it seemed, could foster greater export dynamism, not only in
high-end sophisticated products, such as aircraft, but also in more mundane consumer
goods, such as refrigerators and home appliances.
This scenario departed considerably from the historical experience of trade
integration in Latin America, which was regarded as a mechanism to implement ISI
strategies: eliminating trade and investment barriers among member countries while
maintaining protection against third parties; and, relying on state planning and direct
intervention, including the regulation and limitation of FDI (IABD 2002). In short, the
“Old Regionalism” yielded low competition, weak economies of scale, poor
infrastructure, a lack of private investments (domestic and foreign), all of which actually
undermined the early integration schemes of the Andean Community, the Central
American Common Market (CACM), the Caribbean Community (CARICOM) and the

28
This section briefly introduces the debate about regionalism as it relates to Brazil’s industrial
competitiveness. In following chapters, I review the current debate about multilateralism and regionalism
and how Brazil fits into it.
95
Latin American Integration Association (ALADI). Although a champion of ISI policies,
Brazil was not an active participant in these early integration schemes on the continent.
Due to the huge size of its internal market and to the country’s rich natural endowments
in land and labor, Brazil opted for a more autonomous and autarkic development
strategy.
Quite differently from this previous experience, Latin American regional
integration of the 1990s is based on the liberalization of trade and investment. The North
American Free Trade Agreement (NAFTA) is the main example of this trend, and to a
lesser extent, so is the Mercosur bloc. In the context of this “new regionalism,” trade and
investment are regarded as complementary and welcoming of FDI (Bouzas 2000). In
view of this, MNCs have played an important role in Mercosur. In sectors such as
automotives, foreign companies have been forthright in pushing for special treatment in
terms of tax breaks and exceptions from average tariffs (peaks of protection), and in turn
have committed to modernize the manufacturing process and the final product. Again, it
is important to note that industrial policies, in spite of a “less interventionist” discourse,
have remained an active part of Brazilian trade strategy within the Mercosur bloc.
Realizing that state restructuring, principally in terms of fiscal balance and better
prepared government bureaucracies, were part of the successful Asian experience and
could be complementary to active industrial and export promotion policies, the most
successful trade reformers in Latin America are also those that have advanced structural
reforms. The example of Chile stands out, as the country followed a “competitive trade
strategy” in which state institutions played a key role in promoting its inclusion in world
trade, devising a set of active and efficient policies. Those policies aimed to improve
96
human capital and were targeted mainly toward small and medium companies (Wise
1999). Drawing on the work of Pastor and Wise (1999), SGRs in Latin America can be
understood in the following terms: 1) market completing measures to bring liberalization
initiatives undertaken in the first phase of reforms to full realization; 2) equity-oriented
programs crafted to ameliorate the region’s income gap; 3) and institution building
initiatives aimed at “good governance.”
29
Broadly speaking, SGRs can bolster trade-led
development by encouraging a modern institutional and regulatory environment so
crucial for a technology driven world economy.
Not surprisingly, the challenges intrinsic to the SGR agenda coincide with those
that have arisen within multilateral and regional trade talks. In the case of the FTAA, this
involved negotiating with the most knowledge-endowed country in the world, the United
States. This having failed, Brazil still faces serious questions as to how its trade and
industrial strategy can be made more competitive in the context of regional integration.
First, it is now clear that the competitiveness of a country derives not only from low
average tariffs, but also from a set of institutional advances that make it attractive to
business (Vial and Sachs 2001; World Development Report 2005; World Economic
Forum 2006). In this regard, and notwithstanding the apparent “open regionalism"
approach of Mercosur, the latter has been insufficient for locking in a credible
commitment and hence delivering positive spillovers to the domestic economy. Despite
progress in terms of increased trade and productivity gains (Lópes-Cordova and
Mesquita Moreira 2004), Mercosur’s South-South integration model was not able to raise

29
Navia and Velasco (2002) also note the potentially positive impacts on competitiveness when a country
pursues the SGR agenda.
97
the bar in terms of modernizing the regulatory and institutional environment of its
members. Quite to the contrary, in the face of severe macroeconomics imbalances like
the Brazilian devaluation of 1999 and the Argentinean meltdown in 2001/2002, the
bitterness of internal disputes (e.g. anti-dumping complaints within the bloc) undermined
the internal business environment. In spite of Mercosur’s possible enlargement, the
competitiveness and business environment scores of Brazil and Argentina continue to be
weak (World Bank 2005; World Development Report 2005; World Competitiveness
Report 2006).
Second, the emergence of China and India as world-class players has quickly
raised the stakes for Brazil and shed doubt on the competitive strengths of its industries
and services. The boom in commodity prices from 2004-2008 restored growth to Latin
America, and Brazil continues to benefit from the huge demand coming from China
(CEPAL 2005: chapter 02). But as Ocampo (2004) has observed, it is doubtful that an
export-oriented model driven by commodities can sustain advances in productivity and
promote the necessary backward and forward linkages to the non-tradable sector of the
economy. To the extent that the trade negotiations sought to incorporate those regulatory
measures that could help to attract badly needed FDI and to advance domestic reforms,
this would seemingly be a welcome opportunity. However, actors in Brazil poorly
understand these new trade issues, be it within the WTO, the FTAA, or the EU-Mercosur
negotiations. This is problematic since the initial launching of Mercosur was due to an
extensive debate regarding the need for Brazil’s competitive international insertion and
the locking in of first generation reforms (FGRs).
98
FGRs were prompted by the long overdue perception of the drawbacks of high
inflation and the low quality of consumer goods. By the early 1990s these
macroeconomic imbalances were finally impacting electoral outcomes. As evidence,
Karen Remmer (2003) showed a positive correlation between incumbent votes in
presidential elections and macroeconomic performance. Yet the failure to introduce
SGRs did not register the same electoral impact, nor did this seem to cause the same
distress in citizens’ daily life. Nevertheless, the deleterious consequences are evident
over the long run. For example, in telecommunications and information technology,
despite a steady increase in Brazil’s rates of Internet connection, the educated population
that has access to this service is ignorant of the fact that the upsurge in this technology
was due to a relatively clear and modern regulatory reform prompted by the privatization
process (OECD 2005).
In terms of political leadership, there is a crucial difference between the process
of implementing FGRs and SGRs in Brazil. Political responsibility for the
implementation of FGRs was carried out with the leadership of the economic ministries
and the executive, using the fast-forwarding reliance on provisional measures. Whereas
the political implementation of SGRs is tightly connected to the new trade agenda, and
depends on several ministries – some of them politically weaker or characterized by
logrolling, such as the Ministry of Science and Technology, and the main infrastructure
Ministries (of Transport, of Energy and of Telecommunications). Reforms in the
institutional framework also require more consultation with the congress and a long-term
negotiation process with civil society and key economic actors. In some sectoral
ministries, trade integration is but a small part of an overburdened congressional political
99
agenda that gets crowded out by the unending battles over how to reform the country’s
regulatory framework.
Finally, the Ministry of Foreign Affairs (MRE), which could logically take the
lead with the reform agenda, takes a very cautious approach on such issues. More
recently, in the Lula government, MRE assumed a more rigid negotiating tone
concerning the inclusion of regulatory themes in hemispheric trade talks. Brazil, as a
global trader with exports divided between several different partners (table 12, chapter
3), has greater interest in making headway within the multilateral trade system. Its
commercial diplomacy has thus stressed that the new trade themes should be discussed
primarily at the WTO. As the multilateral trade discussions of the Doha round are now
stalled, these issues will not be resolved in the short run. In the next section I elaborate
on the various positions within the Brazilian bureaucracy regarding free trade.
Bureaucratic Politics and Ideological Inclinations toward Free Trade
The bureaucratic politics model, in which competition among bureaucracies
determines foreign policy outcomes, can be useful for understanding Brazilian trade
policy and the position the country has adopted regarding RIAs with the advanced
economies.
30
Drezner (2000) expands on this approach by analyzing the interaction
between institutions and ideas in foreign policy, which is clearly relevant for
understanding the domestic political dynamics that have played out thus far with the
FTAA.
31
In terms of the interaction between bureaucracies and ideas in explaining trade
policy, Drezner (2000) notes that the weight of ideas in determining foreign economic

30
Allison and Halperin (1971).
31
The interaction between ideas and institutions was pioneered by Goldstein (1993) in analyzing American
institutions and trade policy.
100
policy outcomes will be limited unless those beliefs are carried out by individuals or
groups with political clout. Only when a system of beliefs supporting free trade is rooted
in domestic institutions with a political stake in implementing such a policy, can it be
brought to life.
32
For instance, if a given administration is committed to the idea of free
trade, as the Clinton and George W. Bush administrations appeared to be, then a
concerted effort will be made to leverage the necessary political instruments and reach
the desired objectives.
Within Brazil’s foreign economic policy apparatus any equivalent commitment to
free trade is incipient at best. If not exactly a competition between bureaucracies, there is
a noticeable informal system of specialization in the government’s international
organizations; in particular, financial/monetary affairs are distinct from the trade
policymaking apparatus in Brazil. This format was institutionalized over the last two
decades, due to the necessity of gaining monetary and fiscal stability to support the
country’s effort at structural adjustment. Those bureaucratic segments that deal with
macroeconomic/monetary policy were granted a good deal of autonomy and have been
insulated from the bureaucracy at large. The responsibility for macroeconomic and
international issues was concentrated in the upper advisory ranks of the Finance Ministry
and the Central Bank. These particular bureaucracies involve a considerable degree of
professionalism and institutionalization. Important technical appointments within them
are filled by professionally trained economists or by politicians who have economic
background.

32
Pastor and Wise (1994), 459-489.
101
On the trade side, however, this same degree of specialization and even
professionalism is much less evident. Currently, the responsibilities for international
trade policy are scattered across at least five different Ministries (Agriculture, Finance,
Foreign Affairs, Industry and International Trade and Planning and Budget). The degree
of expertise and institutional robustness of some of these bureaucracies has traditionally
been lower, particularly in the Ministries of Agriculture and Industry and International
Trade. These trade-related ministries have improved over the years but there remain
unfinished reforms that pertain to them in the way of administrative and public service
career tracks. In the current government, the Ministry of Industry’s status was
considerably enhanced vis-à-vis the Economic Ministry, as Lula’s more active industrial
policy seems to indicate.
Legally speaking, the economic ministries (Finance, Planning, Industry and
International Trade) should play a frontline role in the country’s trade talks. However,
the Ministry of Industry and International Trade has historically been a weaker and less
stable bureaucratic entity, dominated mainly by political appointees to manage subsides
for the private sector. As such, this ministry has been subject to lobbying from the
business community and plagued by a high turnover of staff, though recent
administrative reforms have partially changed this picture. The Ministry of Finance,
albeit more professional and institutionalized, has been marginally involved with Brazil’s
trade policy and negotiations, specializing in fiscal and macroeconomic affairs.
Conversely, it is the Ministry of Foreign Affairs (MRE), probably the most
traditional governmental bureaucracy in Brazil, which has taken the lead on trade policy.
Characterized by a rigid hierarchical career track based on merit and seniority, the
102
consequence of MRE’s stronger organizational coherence and institutionalization has
been its ability to dominate Brazil’s trade negotiations. MRE has an important stake and
autonomy in assessing how international trade agreements impact the domestic economy.
For example, the designation of Mercosur as one of Brazil’s top foreign policy priorities
had much to do with political preferences within MRE. In short, MRE has been
instrumental in setting the pace and defining the substance of trade policy formulation in
Brazil.
MRE is also the institutional locus for the generation of ideas about foreign
economic policy. The MRE position on commercial policy is directly related to its
worldview with respect to Brazil’s international status. Here, Brazilian foreign policy
intersects with the current trade strategy in the sense that the country seeks to carve out
its own autonomous space both globally and within the Western Hemisphere (Lafer
2003, chapter 04). There is, understandably, a constant effort to reinforce Brazil’s
autonomy from the U.S., a tension that has been consistently present in trade negotiations
at both the international and regional levels. Although some Brazilian administrations
may have preferred a closer alignment with the U.S. in various issue areas, in trade
summits the discourse and pursuit of autonomous positions has been unwavering.
The Chamber for External Trade (Camex), comprised of the five aforementioned
entities, plus the Ministry of Civil Affairs (Casa Civil), is the organization that
coordinates trade policy formulation and negotiations.
33
Yet, officially attached to the
Ministry of Industry and International Trade, Camex is hardly an autonomous player. It
does not formulate trade policy, but is rather a forum for policy debate and the legal

33
Camex was created by the decree n.
o
1386 of 1995, and modified by decree n.
o
4732 of 2003.
103
endorsement of decisions made elsewhere. One example of how decisions concerning
foreign trade are formulated elsewhere is the early 2006 enactment of legislation granting
Argentina the right to levy safeguard duties on Brazilian consumer goods (e.g. home
appliances), known as the Mechanism of Competitive Adjustment (MAC); aimed at
helping Argentinean industries regain competitiveness, this understandably generated
acrimonious responses from Brazilian businessmen. The decision, basically, followed the
political authority of MRE and underscored Brazil’s political commitment to Mercosur,
whilst the Ministry of Industry and Trade, more in line with businessmen interests,
simply acquiesced. Moreover, because Camex basically rules on tariff and anti-dumping
issues (trade in goods), it has little understanding of the deeper integration agenda that
encompass domestic institutional and regulatory matters. As a relatively new
bureaucracy, Camex might evolve into a more autonomous and effective decision-
making entity. As for now, it has little command over those trade negotiations in which
Brazil is currently involved.
Section V – Conclusion
This chapter’s main assumption is that trade strategy is part of a broad set of
economic development policies and it has been deeply affected by Brazil’s domestic
institutional structures. As international trade talks have sought to advance a more
audacious trade integration agenda that includes investment, services, IPR, labor and
environmental issues, these new issues were rebuffed by domestic sectors with stiff
ideological biases regarding foreign economic policy. The realization of a deeper
integration agenda will depend on the ability of free traders inside Brazil, including
sectors with strong ties to the executive, to link the reduction of inefficiencies in the
104
domestic economy to further integration into the world economy. It is obvious, though,
that trade policy and its formulation within regional integration agreements will not
resolve all of Brazil’s problems of economic governance. But trade opening can correct
certain failures and make citizens and economic actors more aware of the possible gains
from efficient reforms.
This chapter attempted to put Brazil’s trade policy in historical perspective, starting
with the economic development agenda of the old ISI years and up through the ongoing
effort at structural reforms. I have argued that the domestic environment is a determinant
for the manner in which Brazil integrated into the world economy. This chapter adopted
a descriptive approach based on an historical-institutional explanation, one in which
state-led interests emerges as the main explanatory variable for trade policy. In chapter
four I will look at specific industrial sectors in order to gauge possible variations, based
on “endogenous trade policy” assumptions of factor of production use by sectors as a
determinant of policy choice. The following chapters analyze Brazilian trade policy
from the standpoint of multilateralism and regionalism and specify how the country has
sought to position itself in the international political economy.
105
Section VI - Statistical Annex
Table 5: Brazil - Effective Protection, 1958-1967 (percentage).

1958 1963 1966 1967* 1967**
n.a. n.a. n.a. n.a. n.a.
Vegetable products -47 -15 -13 -14 -14
Animal products 24 12 16 18 -
106 183 108 63 48
Mining products -5 34 24 13 9
Non-metallic minerals 73 34 72 45 48
Metallurgy 61 130 63 35 33
Machinery 22 124 30 32 31
Electrical equipment 83 68 112 67 57
Transport equipment 82 169 103 84 81
Lumber and wood 138 147 120 81 44
Furniture 221 176 251 90 92
Paper 86 367 91 43 42
Rubber 139 169 158 126 182
Leather 248 221 174 127 84
Chemicals 56 405 56 29 20
Pharmaceutical products 17 146 1 10 10
Perfumery 279 60 281 121 74
Plastics 281 453 332 133 117
Textiles 239 298 232 162 88
Apparel and footwear 264 481 321 107 154
Food products 502 677 423 252 71
Beverages 171 243 183 104 76
Tobacco products 273 469 299 114 79
Printing and publishing 139 305 142 4 8
Miscellaneous 88 175 95 47 45
Consumer goods 242 360 230 122 66
Intermediate goods 65 131 68 40 38
Capital goods 53 112 69 56 52
141.6 221.24 146.96 75.72 61.63
Variance 15,080 29,914 13,627 3,590 2,096
Notes: *1959 imput-output table; **1971 input-output table
Source: Abreu (2005) apud Fishlow (1975)
Effective tariff is the ratio between value added taken at
post protection prices and value added taken at world prices minus 1.
Agriculture
Manufactured products
Average all sectors
106
Table 6: Brazil - Effective Protection, 1966-1985 (percentage).

Jun-66 Apr-63 Nov-73 1980-1981 1985
n.a. n.a. 25 -8 -25
Vegetable products 35 8 n.a. n.a. n.a.
Animal products 164 17 n.a. n.a. n.a.
Mining products 25 13 14 -4 -11
254 117 47 44 43
Non-metallic minerals 86 39 46 -20 10
Metallurgy 58 36 35 34 53
Machinery 41 32 32 77 6
Electrical equipment 215 97 61 112 55
Transport equipment 151 75 34 -10 -4
Lumber and wood 45 25 68 12 39
Furniture 239 124 74 53 53
Paper 118 59 50 -19 44
Rubber 136 116 66 -21 43
Leather 117 85 81 14 29
Chemicals 59 42 19 86 63
Pharmaceutical products 39 35 17 116 118
Perfumery 8,490 3,670 46 92 26
Plastics 183 58 41 28 189
Textiles 379 162 118 37 112
Apparel and footwear 337 142 29 47 231
Food products 87 40 83 26 46
Beverages 447 173 114 -1 -2
Tobacco products 313 124 83 6 -80
Printing and publishing 142 67 30 32 -5
Miscellaneous 128 72 37 172 97
Consumer goods n.a. n.a. 67 36 40
Intermediate goods n.a. n.a. 36 42 46
Capital goods n.a. n.a. n.a. 60 15
492 217 53 40 50
Variance 2,789,912 519,707 826 2,486 4,412
Source: Abreu (2005) apud Bergsman (1970); Tyler (1976) p.244; Braga,
Santiago and Ferro (1988); World Bank (1983, 1990), passim.
Effective tariff is the ratio between value added taken at
post protection prices and value added taken at world prices minus 1.
Agriculture
Manufactured products
Average all sectors
107
Table 7: Brazil - Effective Tariffs by Sector, 1987-1993 (percentage).

Sector 1987 1988 1989 1990 1991 1992 1993
45.8 14.8 2.2 3 2.7 2.3 1.9
16.9 15 4.6 6.3 2.3 0 -0.5
8.3 -2.9 -5.4 -3.4 -4 -4 -5
81.7 46.2 39.5 38.8 22.6 13.2 12.2
30.9 36.3 18.6 15.8 13 9 8.4
34.4 28 13.4 12.8 9 6 8.4
88.4 59.2 44 41.5 31.3 22.1 21.7
47.5 50.2 44 41.5 31.5 22.1 21.7
88.5 61.6 55.6 61.5 50.6 32.1 24.8
55.4 51.2 42.5 44.2 41.4 27.6 23.5
308.1 201.3 244.3 351.1 198.3 93.5 76.5
73.3 43.9 45.1 44.6 36.3 24.9 21.3
53.1 28.9 29.1 29.4 17 9.5 9.8
65.5 30.1 23 22.6 11.1 8 8.2
122.4 58.5 67.1 70.2 49.8 26 16.9
72.7 30.9 26.6 25.2 18.6 14.6 12.6
62.9 70 42.3 38.5 26.8 15.7 12.7
12.3 44.9 33.9 29.4 21.5 14.9 16.4
91.7 51.8 39.8 35.8 23 14.8 13.6
31.4 72.1 49.5 50.7 41.4 24.2 20.2
123.1 83.9 85.7 49.2 50.9 31.4 21.3
Apparel 117.2 94.3 95.5 67 63.1 36.6 23.7
Footwear 96.9 39.8 38.5 28.8 25.6 16.5 15
73.7 36.2 30.2 30.6 20.9 15.3 12.8
121.6 86 79.7 80.6 64.1 19.1 16.1
43.6 29.6 20.3 19.4 15.8 9.8 9.9
74.1 41.6 34.8 35 29.8 22.9 21.7
Sugar 83.3 24.8 22.2 23.9 18.8 20.6 21.3
82.3 24.1 19.5 20.7 5.2 7.6 8
118.9 98.5 94.2 94.5 82.8 36.5 25.3
64.8 64 58.2 58.9 47.7 27.9 19.1
77.1 52.1 46.5 47.7 34.8 20.3 16.7
67.8 46.8 38.8 37 28.6 17.7 15.2
77.1 52.1 46.4 47.4 34.5 20 16.8
53.4 36.3 44.1 60.1 36.2 16.9 13.3
Variance 2,899 1,340 1,980 3,673 1,330 291 180
Simple average
Standard deviation
Source: Kume, Piani and Souza (2000).
Effective tariff is the ratio between value added taken at
post protection prices and value added taken at world prices minus 1.
Dairy industry
Vegetable oil products
Other food products
Other industries
Simple average
Average weighted by value added
Pharmaceutical and perfumery products
Plastic products
Textiles products
Coffee industry
Processing and vegetable products
Meatpacking
Wood products and furniture
Cellulose, paper and printing
Rubber products
Chemicals elements
Oil refining
Chemical products
Other metallurgical products
Machinery and tractors
Electrical equipment
Electronic equipment
Automobiles, trucks and buses
Parts, components and other vehicles
Agricultural products
Mining products
Oil and Coal Extraction
Non-metallic minerals
Steel products
Non-ferrous metallurgy
108
Table 8: Brazil, Effective Tariffs by Sector, 1994-1999 (percentage).

Sector 1994 1995 1996 1997 1998 1999
Agricultural products 2.4 7.6 7.4 9.9 9.9 9.8
Mining products -0.1 0.1 1.3 4.4 4.2 4.1
Oil and Coal Extraction -4.9 -2.4 -1.8 -2.2 -2.2 -2.2
Non-metallic minerals 10.5 11.5 11.9 15.5 15.4 15.3
Steel products 8.8 9.1 11.2 14.3 14.2 14.3
Non-ferrous metallurgy 7.5 9.2 8.8 11.8 11.9 12
Other metallurgical products 19.7 22 21.5 24.7 24.8 24.8
Machinery and tractors 22.4 18 16.7 18.6 18.6 17.5
Electrical equipment 25.8 31.3 22.7 25 24.5 23.8
Electronic equipment 21.7 21.5 16.4 18.5 17.9 16.8
Automobiles, trucks and buses 27.7 113.8 217.5 177 129.2 89.1
Parts, components and other vehicles 21.8 21.8 18.4 20.8 20.5 19.5
Wood products and furniture 10 11.6 11.9 15.1 15.1 15.2
Cellulose, paper and printing 8.1 9.7 10.4 14.7 14.7 14.8
Rubber products 15.2 14.9 14 16.3 16 16.1
Chemicals elements 8.7 6.9 5.4 18.3 24.2 23
Oil refining 7.1 3.4 4.3 5.6 5.7 5.7
Chemical products 9.2 9.2 9.1 12.5 12.5 12.3
Pharmaceutical and perfumery products 3 7.5 7.3 10 10 9.8
Plastic products 23.3 21.2 19.1 21.9 21.9 20.7
Textiles products 20.9 21.9 21.8 24.9 24.9 25
Apparel 24.5 23.6 23.1 26.1 26.1 26.1
Footwear 15.9 23.9 18.2 20.8 19.4 18.8
Coffee industry 10.1 10.2 12.4 15.4 15.4 16.1
Processing and vegetable products 17.5 16.4 17.8 20.9 20.8 20.8
Meatpacking 7.3 8.3 9.2 12.2 12.1 12.2
Dairy industry 24.8 18.6 19.9 22.1 24.4 23.3
Sugar 9.5 16.7 16.8 19.9 19.9 20
Vegetable oil products 8.5 8 8.3 11.6 12 12.7
Other food products 19.2 20.3 21.6 24.3 24.1 24.1
Other industries 16.9 15.3 15 17.9 17.9 16.9
Simple average 13.6 17.1 19.9 21.6 20.2 18.7
Average weighted by value added 12.3 10.4 14.3 16.6 16.2 15.4
Simple average 13.6 17.1 19.9 21.6 20.2 18.7
Standard deviation 8.3 19.4 36.9 29.3 21.1 14.5
Variance 70 381 1,387 875 455 214
Source: Kume, Piani and Souza (2000).
Effective tariff is the ratio between value added taken at
post protection prices and value added taken at world prices minus 1.
109
Table 9: Glossary on Tariff Nomenclature.

Many types of tariffs are mentioned in the literature, this glossary includes the relevant
definitions:
Ad valorem tariff corresponds to a percentage of the FOB (free on board) value of imports.
Specific tariff is a tariff based on payment of fixed nominal duties by physical unit of imports.
Average implicit tariff is the ratio between collected duties and values of imports.
Ad valorem equivalent of specific tariff is the ratio at the product level of aggregation
between specific duty and value of import
Average tariff is the legal MFN nominal tariff at the sector of economy-wide level of
aggregation, weighted, for example, by trade values of value added.
Effective tariff is the ratio between value added taken at post protection prices and value
added taken at world prices minus 1.
Implicit nominal protection corrects the implicit tariff in relation to the world price by taking
into account production subsidies
Source: Abreu (2004a)

Table 10: Selected Macroeconomic and Fiscal Statistics, 1991-2005.

110
111
Chapter 2 - The International Political Economy and
Multilateral and Regional Trade Integration debates

Introduction
In this chapter I will review the theoretical debates over the benefits of an outward
economic orientation (e.g. trade openness, investment friendliness) versus the more
protected state-led model, particularly as these have played out in the context of regional
integration schemes. In order to grasp the political economy underpinnings of the world
trade discussions, I will turn to the literature on trade liberalization and economic growth.
My purpose here is to look at an economic theory that identifies the benefits of
liberalization and the political constraints trade reformers face and to tie these to the
current stalemate at both the multilateral (WTO) and regional (e.g. FTAA) levels. In
doing so I briefly analyze the theoretical and empirical economic literature, such as “new
growth theory” and general equilibrium models, which predict, among other beneficial
effects, technology transfer and welfare gains from trade liberalization and I discuss the
extent to which such theories fit with actual trends in the world economic order. I discuss
how economic theory seems to indicate that integration into the world economy is
beneficial for countries, not only in terms of the flow of goods but also in the “deep trade
integration” disciplines, where world trade discussions have stalled. Finally, in the course
of this chapter, I introduce Brazil’s foreign trade policy and strategy, an issue that will be
expanded on in the next chapter when I elaborate on the North-South integration
negotiations in which the country was recently involved, attempting to locate the
explanations for the trade policy options in the international political economy.
112
The chapter is be divided into the following sections: [1] the next section offers a
methodological discussion and connects assumptions of this chapter with the broader
hypotheses of the dissertation; [2] a second section describes the openness x growth
debate, provides data and applies economic theories related to the broader international
political economy; [3] in section three I turn to an analytical description of
multilateralism versus regionalism and I locate these options in a discussion about the
world economy and globalization. In this part, I also discuss recent trends in international
economic relations, including the upsurge of China and India, the stalled WTO
negotiations, and Brazil’s role in these phenomena.

Section I - Methodological Foreword
Following the literature presented at the outset of the dissertation, this chapter
tackles three broad questions:
1) Trade liberalization versus managed/state led trade policy and the consequences for
economic growth: What are the so-called benefits of an outward oriented versus a more
protectionist model? Have countries with more open trade regimes (outward/export
oriented) grown faster than those that embraced a more autarkical strategy? Do free-
market trade policies spur better economic performance over time than managed/state led
policies?
2) Factor ownership and/or sectoral lines as determinants of policymaking and trade
negotiation positions in multilateral and regional venues: If unilateral trade liberalization
is optimal, as much as the literature contends, why have policymakers in both the in
developed and the developing countries experienced such fierce protectionist pressures
113
from domestic economic groups? Assuming that domestic political economy influences
trade negotiations, are there differences between the multilateral/WTO and regional
negotiations? If so, what accounts for them?
3) New theories of economic growth and institutional development in a regional and
multilateral trade integration context: Are regional integration schemes superior to
multilateral ones in terms of economic growth, productivity and institutional
development? In a regional integration setting, are North-South ties more welfare
producing than South-South integration projects?
As I have spelled out in the literature review/introduction, this dissertation
assumes three clusters of analytical tools:
1. Multilateral and regional trade integration, with a focus on the latter;
2. Trade liberalization, domestic reforms and the role that domestic actors play in
this process;
3. Economic and institutional development, including trade, technology and
innovation.
Against this backdrop, it is worth reiterating the broad hypotheses which underpin
this dissertation:
1) International economic shocks/trends and the demise of domestic economic
models shape the preferences of policymakers and interest groups, which opens
up the opportunity for (trade) policy reforms; however, 2) entrenched domestic
institutional/bureaucratic structures, as well as the ideological biases embedded
therein, can also slow trade liberalization and therefore preserve features of the
old economic model in the new era.
114
This chapter focuses on the international aspects of these hypotheses, including
such exogenous shocks as the 1980s debt crisis, the deepening of financial-economic
globalization, the advent of the Washington Consensus, the collapse of the Soviet Union,
the financial crises of the late 1990s and early 2000s, and the 9/11 terrorist attacks. Each
of these required a response from Brazilian policymakers and domestic groups, who
turned out to be quite divided. Whereas many domestic actors resisted giving up the
status quo and clung to the country’s long standing protectionist model, others perceived
the opportunities from liberalization and have embraced new realities. In this chapter, I
attempt to apply actor centered (firms, interest groups) and political economic theories to
a broader systemic/structural international political economy (IPE) framework. Here, I
attempt to merge economic models (e.g. new growth theory), based on rational choice
assumptions with a historical/systemic analysis of the international political economy.
My ultimate purpose is to locate the Brazilian case within this analytical framework and
to explain the role of path dependence and institutional inertia in producing conflicting
policy currents on the trade front.

Section II - The International Political Economy and the Openness
Debate
The question of whether integration into the world economy has positive
implications for economic development is one of the most recurrent issues in the political
economy field, dating back to the work of Adam Smith and David Ricardo. Economic
theory suggests that openness is conducive to growth due to potential efficiency gains
115
derived from the international division of labor and comparative advantages.
34
There is
an ongoing discussion in the empirical literature, especially with respect to the policy
orientation of developing countries, questioning if outward-oriented countries grow faster
(Baldwin 2003). This debate assumed ever more relevance after World War II when,
under the influence of the Bretton Woods liberal order, multilateral institutions were
established to promote free trade, representing a mechanism to encourage economic
development via the closer integration of the developing countries in the international
economic relations. Among these institutions the World Bank, the International Monetary
Fund (IMF) and the GATT (General Agreement on Tariffs and Trade) led this effort. In
the same period, any number of developed and developing countries in Western Europe,
Latin America and East Asia adopted state intervention and a regulated domestic
economic order. In Europe, countries maintained and expanded welfare state policies of
social protection. In the developing world, countries adopted import substitution
industrialization policies, aimed at shielding national firms from external competition to
nurture domestic industrial capacity. Both groups of countries have embraced a regulated
domestic political economy, emphasizing the role of state institutions in welfare
distribution and in carrying out industrial and infrastructure policies. The regulated
domestic policy approach has co-existed with the liberal international order since the
1950s.

1
The literature often interprets openness in terms of the share of exports plus imports in a country’s GDP
(X+M/GDP). Here, I consider openness to be not only trade in goods or the level of domestic tariffs, but
also the overall outward policy orientation of a country, including the degree of willingness to receive
foreign direct investment. I use the term trade liberalization interchangeably with openness, although they
may not be the same thing. Winters (2004), in a comprehensive literature review, makes this distinction,
positing that countries with high trade openness can also have substantial state intervention.
116
The rationale for the liberal international order began with the necessity of
providing domestic stability to the Western European countries, striving to recover from
the economic disruption of World War II. An overriding concern of Bretton Woods was
to foster financial and trade co-operation in order to avoid the economic instability that
was so ubiquitous during the 1930s. The Post World War II political economic order thus
evolved according to two economic models: market capitalism versus social capitalism.
The Soviet Union, of course, took the latter to the extreme and triggered the Cold War
and an international bipolar order with its insistence on a centrally planned communist
strategy. Thus, the Marshall Plan and U.S. support for the creation of the European
Economic Community must also be understood within this political-strategic context.
Ruggie (1982) affirms that, to provide international stability, embedded liberalism – a
system in which liberal international norms co-existed with domestic state
interventionism - was necessary to foster welfare states in U.S. allies and to deter the
“threat” of communist expansion.
Trade liberalization is considered to be a major cornerstone of the liberal order
and one meant to complement the monetary order. During the 1930s, countries promoted
beggar-thy-neighbor policies based on currency devaluations that artificially increased
the competitiveness of domestic goods, accumulated trade surpluses (gold reserves) and
guaranteed their own balance of payment stability. However, this mercantilist policy
promoted a race to the bottom that undermined the international financial order and it is
ultimately believed to be one of the causes of sluggish international economic
performance during that decade, even contributing for the scaling up of military tensions
117
prior to World War II. Protectionist trade policies were also at the core of this disruptive
model.
After World War II, U.S. and British policymakers argued that free trade would
provide stability and prosperity to all the involved countries. Therefore, the GATT’s new
liberal trade order was defined by two core principles: (1) reciprocity – countries should
lower tariffs in return for similar concessions; (2) most-favored nation (MFN) – a
principle that granted non-discrimination and equal treatment in trade relations among all
GATT members. Thus, in spite of the GATT’s technical-juridical language, the ultimate
aim of the trade order was to promote political stability (Spero and Hart 2003, chapter 3).
In other parts of the world, although the political-strategic logic was not as
apparent as it was in Europe, developing countries used the loopholes of the Bretton
Woods order to promote their interests. Brazil, for instance, used the GATT’s balance of
payment exceptions, i.e. “special and preferential” treatments, as a mechanism to nurture
domestic industrial firms (Abreu 1998, 2004a). In Latin America and East Asia during
late 1950s and 1960s, government subsidies and incentives sought to foster
industrialization in light consumer goods, such as appliances and apparel, and later in
durable consumer goods, such as automobiles. In a certain way, these industrial polices
were the catalyst for a state capitalist strategy that was embedded in nationalist
ideologies, but one that prevented communist threats.
35

These exceptions were consolidated in the Generalized System of Preferences
(GSP) of the GATT, negotiated during the Tokyo Round (1973-1979), which granted

35
See Schwartz (2000), Kohli (2003), and Wade (1990) for an elaboration of this particular form of state
capitalism within late industrializers.
118
preferential tariff treatment for developing country’s exports of manufactured and semi-
manufactured goods in order to promote their industrialization. The GSP agreement,
however, prompted several complaints from developed countries. It characterized the
latent tensions between North and South, as the newly industrializing countries (NICs)
started to tap into northern industrial markets, particularly in low-skilled labor intensive
industries formerly dominated by the developed countries. This conflicting picture grew
even more contentious in agricultural goods, where subsidies and policy incentives to
farmers in the developed countries, such as the Common Agricultural Policy (CAP) of
the European Economic Community, damaged the competitiveness of developing country
agricultural production. These tensions, nonetheless, did not hinder the successful tariff
reductions promoted by the GATT in the post World War II era. After the Kennedy round
(1962-1967), tariffs on dutiable, nonagricultural goods in the developed world were
slashed by about one-third compared to levels before the round. After cuts, tariffs stood at
an average of 9.9 percent in the U.S., 8.6 percent in the United Kingdom, and 10.3
percent in Japan. The overall decline in tariffs for the first five trade rounds was 73
percent; for the Kennedy round alone it was 35 percent (Spero and Hart 2003: 72). As a
consequence, from 1950 to 1992, merchandise exports as percent of GDP grew from 9.4
to 29.7 in Western Europe; from 3.0 to 8.9 in the U.S.; from 2.3 to 7.2 in Asia, and
remained stable in Latin America at 6.2 (Maddison 2000).
Developing countries also took advantage of booming trade in the post World
War era and several of them grew at fast rates during the post-world war period. The
graphs below compare the GDP per capita in PPP adjusted U.S. dollars (thousands) of
selected Asian and Latin American economies from 1950 to 2000, based on the Penn
119
World Trade data. While the Asian countries grew monotonically during this period, with
a dip but noticeable rebound in income after the 1997 financial crisis, Latin America only
maintained this same monotonic pace until 1980. Moreover, although the Latin American
countries started at a higher level of GDP per capita, they ended the period with lower per
capita income than some Asian countries.
36
Regarding China and India (figure 7), even
considering that the impressive growth of these countries in world markets is a
phenomenon of the last two decades, their relatively lower levels of income per capita
compared to other countries stands out in the graph. The vertical straight lines in figure 6
denote the 1980s, the so-called “lost decade” in Latin America, a period also
characterized by “structural reforms.” In figure 7, the vertical line depicts the year of the
“Asian crisis” (1997).

36
The graphs are based on the real-GDP-per-capita data from The Penn World Table (version 6.1),
compiled by Summers, Heston and Aten (2002), who adjust national income levels according to purchasing
power parity and thus overcome the complications caused by using foreign-currency exchange rates.
120
Figure 6: Real GDP per capita selected Latin American economies.

Source: Summers, Heston and Aten (2002)
Figure 7: Real GDP per capita selected Asian economies.
Source: Summers, Heston and Aten (2002)
1000
1500
2000
2500
3000
3500
4000
4500
5000
5500
6000
6500
7000
7500
8000
8500
9000
9500
10000
10500
11000
11500
12000
12500
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
Brazil Colombia Dominican Republic Ecuador Honduras Panama Paraguay Mexico Argentina
500
1500
2500
3500
4500
5500
6500
7500
8500
9500
10500
11500
12500
13500
14500
15500
16500
17500
18500
1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000
Indonesia Taiwan Malasya Thailand South Korea Philippines China India
121
Figure 8: Real GDP per capita G-7 economies.
Source: Summers, Heston and Aten (2002)

0
5000
10000
15000
20000
25000
30000
35000
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
Canada France Germany Italy Japan United Kingdon U.S.
122

Figure 8 above, also based on the Penn World data, shows the same pattern of
income per capita growth in selected OECD countries (G-7). Straight lines indicate
periods of recession: in the early and mid-1970s, as well as the early 1980s, they are
noticeable. These slumps provoked a turning point in the world economy, and this
obviously impacted the developing countries. Latin America, in particular, was severely
hit by the drought of international savings, also known as the external debt crisis of the
1980s. These recessions were caused by several world economy imbalances: in late the
1960s, the flourishing economic scenario raised inflationary trends; the oil price shocks
of the early 1970s, which contributed to price acceleration and the deterioration of the
fiscal position of oil-importing countries, also amplified the downturn. Such events
brought about slower rates of income growth, undermining the welfare state model build
since World War II in Europe. The Bretton Woods exchange rate system, led by a U.S.
dollar that was pegged to gold reserves, also suffered strains and was abandoned in 1971.
In the 1980s, orthodox macroeconomic (tight monetary policy, interest rate hikes,
floating exchange rates) and microeconomic (de-regulation, privatization, tariff cuts)
policies ensued. Increasingly, there was a perception that throughout the Western World
the managed/state led economic order had intrinsic flaws that could be only corrected
through staunch market discipline. The Reagan-Thatcher orthodox revolution in the early
1980s brought about an acceleration of market forces and unleashed further economic
globalization trends, particularly in the financial sector. Finally, the demise of the Soviet
Union in the late 1980’s and of the communist economic model symbolized the victory of
the free-market political economy over the state interventionist/inward oriented model.
123
The exogenous shocks influenced the policy orientation of many developing
countries around the world. In Latin America, structural adjustment, based on market
oriented policies and state retrenchment were carried out, as advised by the Washington
Consensus, which I discussed in chapter one. Thus, during the 1980s, Latin American
countries underwent a series of policy reforms, among them trade liberalization.
Against this backdrop of policy reform in the developing countries, the world
trade negotiations within the Uruguay Round (1986-1993) of the GATT continued to
promote a considerable drop in non-agricultural tariffs. During the Uruguay round a new
trend crystallized: commercial agreements started to address behind the border trade
related measures, for example, the liberalization of the domestic institutional framework
in which the economies of signatory countries operate. This trend continued with the
establishment of the World Trade Organization (WTO) in 1994. For example, among the
new WTO regimes were the agreement on Trade Related Investment Measures (TRIMS),
the Agreement on Subsides and Countervailing Measures (ASCM), an accord on Trade
Related Intellectual Property Rights (TRIPS), and the General Agreements on Services
(GATS).
In short, these “new” trade disciplines increasingly included not only measures to
facilitate the free flow of goods, but also issues pertaining to the institutional/regulatory
domestic environment, such as rules on foreign direct investment (FDI) and intellectual
property rights protection (IPR). From the standpoint of the South, much of the current
debate surrounding trade negotiations evolves around how international trade regimes
may limit the ability of developing countries to carry on autonomous domestic policies
and regulations. Brazil, along with India, Russia, and China, has been especially vocal in
124
expressing this concern. From the graphs above, there is hardly a trend relating to the
income convergence predicted by neoclassical economic growth theory. There are
successful growth “accelerations”, such as South Korea, Thailand in Asia, as well as
more meager performances in Latin America and linear pattern in developed countries.
Yet, the policy responses adopted across the board with varies degrees of depth
emphasize the importance of openness– understood in terms of outward orientation of
countries. The economic literature has been debating how openness translates in
economic growth. In the next sub-section, I explore the recent literature on the
trade/growth connection, and seek to bolster the discussion about openness for a country
like Brazil.
Openness, Regionalism and Growth
Modern neoclassical economic theory stresses the importance of openness as an
explanatory variable for economic growth. Openness increases foreign direct investment
(FDI) and improves the productivity of human and physical capital. Neoclassical
economics is based on the notion of utility-maximizing rational actors and the market
equilibrating forces of supply and demand. Thus, with free trade, rational actors within
countries optimize the production of goods with favorable factor endowments to sell to
the international market, spurring growth in the long-run. Furthermore, accordingly to
economic growth theory, knowledge accumulation – the crucial force for growth - is
encouraged by the free flow of goods and services. The principal neoclassical growth
model (Solow) also posits that economic development is a consequence of capital
accumulation due to high rates of investment and savings. Hence, FDI may contribute to
growth by offering an external source of savings and knowledge to a country. However,
125
whereas neoclassical growth models take production technology as exogenous, new
economic growth theories believe knowledge accumulation can be enhanced due to
proper use of policies, which foster R&D and education. As the rest of this section will
discuss, this feature is one of the main differences between neoclassical and new growth
theories. This theoretical debate goes to the heart of contemporary discussions about
globalization and the role for policy intervention in world trade agreements.
Much of the dispute about globalization and the effects of trade on domestic
economies depart from two main tenets within classical political economy (Buchanan and
Yoon 1999, 2000).
37
Neoclassical models derived from a Ricardian approach are based
on constant returns to scale and static considerations about factor endowments, and hold
that the distribution of the ownership of factors of production will determine the benefits
of free trade. Market equilibrium after trade opening is thus based on supply and demand
in a scenario of perfectly competitive markets. There are, therefore, losers and winners
when a country joins the world economy. Technological improvement, although possible
due to spillover effects, occurs as a consequence of factor accumulation (e.g. knowledge
capital) and the import of capital goods.
The Smithean perspective is based on imperfect market competition and increasing
returns to scale.
38
Accordingly market expansion after trade liberalization can bring about

37
Buchanan and Yoon (2000: 42-48).
38
The formulation of the Smithean perspective and the possibility of increasing returns are given by Euler’s
theorem. The theorem asserts that when a function, Y = F (K, L), relating the dependent variable, output
(Y) to two independent variables, factors of production capital (K) and labor (L), is homogenous of degree
one, the sum of the separate partial derivatives multiplied by the corresponding independent variables is
equal to the total value of the function or the dependent variable: e.g. Y = F
K
K + F
L
L. In the case of
constant returns, factors of production will marginally pay their shares, exhausting the total value of the
product. The exponents of the independent variables sum to unity. Under the Smithean perspective, profit-
seeking firms extend their scale of operation in order to take full advantage of increasing returns. When
aggregate demand is high, as in the expansion towards foreign markets, firms may reach scale advantages
126
potent redistributive effects due to dynamic specialization inside the economies, in a
manner that even those initially harmed can adapt and benefit from a new equilibrium
driven by new market forces. Besides, market expansion due to openness also allows for
greater levels of entry and exit, which may enhance the efficiency of economic actors and
allow for a Pareto superior market equilibrium. Finally, as far as technology is concerned,
the possibility of increasing returns to scale allows for the adoption of the latest evolving
technologies which may create dynamic productivity gains. Proper institutional rules and
governmental policies can enhance this market process, contributing to factor
accumulation (knowledge, capital), and innovation.
The discussion about the economic effects of regional integration agreements
(RIAs) relates to both of the abovementioned political economy models: the classical
approach clearly follows a Ricardian tradition and focuses on short-term effects about
trade creation and diversion; modern trade theory relates to the Smithean perspective,
positing that regional integration may trigger dynamic economic effects due to returns to
scale, the clustering of economic activities, and technological spillovers. Yet, both
traditions emphasize that, while in the short term some actors will lose, in the long run,
trade liberalization allows for a more efficient allocation of the factors of production.
Integration theory also stresses that these effects tend to be greater in a regional setting

while remaining small relative to the size of the product. In this competitive structure, an increase in the
number of efficiently operating firms, combined with non-efficient firms leaving the market, will enhance
overall productivity of the economy and will stimulate the adoption of new technologies. Mathematically,
the production function where x
1
,…, x
n
are factors of production (input bundles), t is their shares and k is
and scalar referring to the sum of their marginal prices:
f(tx
1
, …, tx
n
) = t
k
f(x
1
, …, x
n
) for all x
1
, …, x
n
and all t > 0 is homogenous of degree k >1,
meaning that when one doubles the factors of production, the output more than doubles and the sum of the
exponents of factors of production is more than unity (Buchanan and Yoon 1999; 2000).
127
because of deeper liberalization commitments, which in turn can foster greater
productivity and economic welfare gains. These productivity enhancing effects are also
amplified by the imperfect markets aspect of modern international trade, characterized by
intra-industry transactions and the vertical integration of firms.
39
Bardhan and Udry
(1999 chapter 05), for example, describe a model about the market enhancing effects of
trade openness: an upstream market characterized by imperfect competition and
increasing returns to scale, and a downstream market in which firms are price takers and
operate in a constant returns to scale environment. Trade liberalization and integration
with more advanced economies in the upstream market enhances domestic efficiency and
productivity in both upstream and downstream markets because markup prices for the
inputs in the downstream market tend fall after liberalization.
Despite theoretical justifications from different traditions of political economy,
the openness-growth relationship is empirically controversial and may be somewhat
unclear because of endogeneity and reverse causality. Historically, trade growth happens
in countries already experiencing modern economic growth; and developed countries
trade more with each other than with developing countries (Kravis 1970; Easterlin 1998,
41-42). Technological change is the crucial cause of economic growth, which must be
combined with institutional arrangements like property rights (e.g., intellectual property
rights) and enforcement of legal contracts to create incentives to foster markets. Rational
actors will then look for mechanisms to enhance comparative advantage (North 1990,
1993).

39
Baldwin and Venables (1995) provide a technical explanation of new trade theories and regional
economic integration. Krugman (1995) provides a technical review on international trade and imperfect
markets. For a brief but comprehensive review of the empirical literature on the economic effects of RIAs
see also: OECD (2001).
128
There is growing evidence in the empirical literature that the simple removal of
tariffs is insufficient to promote economic growth. Rodriguez and Rodrik (1999)
categorically dismiss the negative causal relation between trade barriers (tariff or non-
tariff) and economic growth. Rebutting a series of empirical works, they state that other
factors contribute to growth, including differences in macroeconomic policies and
domestic institutions, and suggest that the study of variations in trade policy may prove to
be a better avenue of analysis. Frankel and Romer (1999), however, defend the idea that
the link between trade and growth is somewhat tenuous, but exists. They argue that the
impact of trade on income growth depends on a country’s size and geographical
characteristics. Controlling for these factors, they affirm that trade has a positive impact
on income growth. Their results apply both to developed and developing countries. They
also minimize the impact of tariff removal and acknowledge that policies and institutions
are important channels influencing growth.
Overall, there have been a variety of empirical methodologies employed in the
literature, which may contribute to the divergent results obtained in terms of verifying the
trade-growth relationship. In light of this diversity, Greenaway et al (2001) criticize
different methodologies and employ lagged dependent variables to account for the
income growth effects of trade liberalization on developing countries. They find that the
impact of trade liberalization on income is illustrated with a J-shaped curve, with positive
but modest impacts on GDP per capita. Finally, a more recent paper by Wacziarg and
Welch (2003) follows up this question. First, they update a comprehensive cross-country
database on trade indicators, such as tariffs, non tariff barriers, and trade liberalization
dates for the 1990s; then, implementing new measurement strategies based on within-
129
country trade policy variation that allows them to correct some of the previous
inconsistencies in the literature, their results suggest that the effects of increased trade
liberalization within countries through time are positive, economically large and
statistically significant.
Conversely, while the literature on trade liberalization under regional integration
focuses on the welfare effects and direction of trade, much less attention has been
dedicated to the effect of RIAs on growth, especially at the empirical level. The
traditional literature usually uses dummy variables, which implies that the potential
growth effect of an RIA depends merely on a country signing it, and does not reflect
agreement or country characteristics. Berthelon (2003) fills this gap by introducing some
methodological innovations. He uses two variables: absolute RIA, which captures the
size of partners’ markets, and relative RIA, which reflects partners’ market size relative
to the size of the domestic market. The former variable captures the different effect of a
county joining, for example, the NAFTA versus Mercosur or the Andean Community.
The latter variable allows one to capture the different effect of, for instance, Czech
Republic or Ukraine joining the EU, or Argentina and Colombia signing free trade
agreements with the U.S. With these variables, the author finds strong evidence of RIAs
fostering growth, and the results are robust to different estimation techniques. The author
also considers whether the growth effects of RIAs depend on the country’s level of
development by differentiating between three kinds of RIAs: North-North (including only
developed countries); South-South (including only developing countries) and North-
South (including countries in both groups). The author finds sound support for the
positive growth effects of N-N agreements, but mixed results for N-S and S-S ones.
130
Of note, the broad literature discusses the impact of openness on income growth
rather than on income levels; therefore the distributional consequences of trade
liberalization, which can be severe, are seldom considered. This void is filled by a
growing literature on the welfare effects of trade liberalization. Quantitative research -
computable general equilibrium (CGE) models – has been estimating economic welfare
gains of trade liberalization under unilateral, multilateral and regional frameworks. The
Michigan Model of World Production and Trade, for example, which covers eighteen
economic sectors in twenty two countries/regions and incorporates aspects of trade with
imperfect competition in manufacturing and services, is one of these computational
analyses.
40
According to this research, trade liberalization has positive welfare effects for
the owners of abundant factors of production, which in developing countries such as
Brazil, is unskilled labor and land.
Regarding the effects of trade on income inequality, the World Development
Report “Equity and Development” (World Bank 2006, Chapter 9 and 10) offers a
comprehensive discussion about the effects of trade liberalization. This report emphasizes
the deleterious effects of agricultural subsidies/tariffs in the North, and stresses that the
phasing out of those protectionist instruments could quickly boost the income of poor
citizens in the developing countries. However, the World Bank report also acknowledges
that trade liberalization causes several modifications in products and labor markets, and

40
There are several studies that assess the possible quantitative gains of multilateral liberalization and use
the Michigan Model data set. See, for example, Drusilla K. Brown, A. V. Deardorff and Robert M. Stern,
“Computational Analysis of Multilateral Trade Liberalization in the Uruguay Round and Doha
Development Round”, RSIE Discussion Paper no. 489, Ann Arbor MI, School of Public Policy, University
of Michigan 2002. See also, Sandra Polaski. Winners and Losers: The Impact of the Doha Round on
Developing Countries, (Washington: Carnegie Endowment for International Peace 2006). The CGE models
also gauge the quantitative effects of multilateral vis-à-vis regional liberalization. When I discuss the
FTAA, I will mention one of these studies.
131
income growth depends on several other factors, such as the level of human capital or the
stability of the macroeconomic environment. In fact, the report mentions the possibility
of losers emerging from amongst the poorest households in several countries, particularly
because their agricultural goods would be displaced by more competitive sellers in both
domestic and international markets. Therefore, the report suggests it is worth looking at
the micro-level and at case studies to assess the impact of trade liberalization in poorer
countries.
Of course, there are plenty of doubters concerning the effects of trade
liberalization on poverty alleviation, income distribution and job creation (Oxfam 2002).
The Oxfam study just cited also discusses the allegedly negative impact of trade
liberalization on the environment, one of the main criticisms leveraged at trade
agreements since the negotiation of NAFTA in the early 1990s. In this dissertation I
assume trade liberalization is important for economic growth, principally due to the
dynamic forces it may trigger, including technological shifts, which can trigger more
efficient resource savings and uses of the factors of production. The following review of
new growth theories will further clarify the relationship between trade liberalization,
technological change and economic growth.
New Growth Theory
New growth theory—known also as endogenous growth theory— posits a causal
relationship between openness and growth; however, it acknowledges that the causes of
growth are complex, and conditioned by the accumulation of human capital. New growth
theory focuses on understanding the economic motivations the trigger technological
investments. Thus, in contrast to neoclassical economic models, new growth theory
132
considers technology to be an endogenous variable. R&D activities, carried out both by
private and public actors, are believed to increase the stock of ideas available in the
economy, some of which may promote innovation and technical progress, as well as
increased profits. Hence, R&D stimulates economic growth because it affects total factor
productivity (TFP)—new technologies promote more efficient methods of production
with a given amount of capital and labor.
41

New growth theory emphasizes the importance of human capital for R&D
activities and innovation. The accumulation of human capital stock facilitates not only
the creation of new ideas, but also the absorption of knowledge developed elsewhere.
Thus, this theory posits that long-run economic development is connected to the growth
of the number of people dedicated to research, which positively affects the growth of
ideas. The cost of innovation falls as human knowledge improves, due to increasing
returns to scale (Romer 1990).
42
Summing up, improvements in human capital, leading
to technical innovation, are responsible for economic growth in the long-run.

41
The functional form of these assumptions expressed in the Cobb-Douglas model, which adds human
capital to the Solow growth model:
Y(t) = K(t)
α
H
β
[A(t)L(t)]
1 - α - β
, (1)
where K is the stock of capital, L is labor, and A is the stock of ideas (e.g. knowledge); H is human capital,
which arises with the interaction between labor and the stock of ideas in a given society (Mankiw et. al.
1992).
42
The property of increasing returns to scale in a production function refers to the fact that the use of ideas
by one economic actor does not preclude their use by others (non-rivalry). However, some may charge
others for the use of their ideas (partial excludability). In the previously mentioned Cobb-Douglas
functional form, based on the textbook of Romer (2002: 100), the property of increasing returns to scale
can be applied to the variation of stock of ideas, thus the production function is given by:
Ǻ (t) = B[a
K
K(t)]
β
[a
L
L(t)
γ
] A(t)
θ
, (2)
θ > 0, β ≥ 0, γ ≥ 1 ,
where, Ǻ is variation in the stock of ideas across time, B is a shift parameter, K is the stock of capital, L is
the stock of labor, a
K
and a
L
is a fraction of capital and the labor force associated to the production of ideas
(e.g. knowledge intensive goods), β, γ and θ are coefficients (elasticities) associated with capital, labor and
133
Such theoretical findings have policy implications and justify the importance of
formal education and labor force training. However, definitive conclusions are still
unresolved in the literature. For instance in a textbook on economic growth, Jones (2000),
stresses that market forces out of the control of policymakers (e.g., population growth
rate) determine technological and long-run economic growth.
Furthermore, new growth theory posits that countries can improve the level of
R&D investment and innovation when increasing their degree of integration into the
world economy. This occurs because of international knowledge spillovers and positive
externalities resulting from trade in goods and foreign direct investment. Coe et al. (1997)
observe that the growth of TFP in developing countries is positively related to the stock
of R&D capital of industrial countries. Thus, the absorption of technology increases as a
country imports more sophisticated products—for instance, machinery and equipment
used in domestic production processes—or, as FDI increases, local firms enhance their
productivity by copying methods of production from foreign companies. Nonetheless,
this latter mechanism has drawbacks since foreign firms may limit the transfer of
technology in order to preserve a competitive edge. The absence of a qualified work force
in the receiving country may be another obstacle. In addition, companies may transfer
only a certain level of technology due to license restrictions. Proper institutions can
enhance this process: a minimal level of intellectual property rights protection (IPR), for
example, must be required, and the lack of it may hinder technology transfers (Narula
2003: 191-192).

knowledge, and A is the current stock of knowledge. This functional form may have constant, decreasing,
or increasing returns to scale. The interaction among researchers, fixed set-up costs, and so on may be
important enough in R&D that doubling capital and labor more than doubles output. Therefore, there are
increasing returns to scale, and the parameter θ is positive.
134
Along with the importance of openness, new growth theory acknowledges the
crucial role of domestic institutions. For instance, one of the logical linkages between
IPR protection and economic growth is that, by constructing an environment conducive
to technical innovations and to the accumulation of human knowledge, IPRs will
contribute to increased economic growth (Gould and Gruben 1996). Another point of
dispute regarding IPRs stems from the presence of both static and dynamic effects.
Generally speaking, in a static environment, IPRs are not welfare maximizing because,
after an innovation, the economic entrepreneur has a legal monopoly. Once the
innovation is made, however, spillover effects might spread over other sectors of the
economy. A temporary monopoly is justified because research activity requires large
sunken costs, such as building high-level human capital. The incentives for continuing
innovation will be greater if the results of new discoveries are protected by an extensive
system of IPR. In a dynamic setting, the patent is justifiable because society will be better
off when economic actors undergo risky activities, allowing knowledge to advance and
spread into other sectors (Narula 2003; Maskus 2000). IPR protection also has
asymmetric distributive effects on a global level: the efficient degree of protection might
not maximize every country’s welfare. Net importers of knowledge products may be
required to pay more royalties. Thus, the creation of domestic IPR systems, by itself, may
not guarantee economic growth. On the one hand, developed countries advocate that IPRs
should be granted indiscriminately so that market forces would suffice to spur
technological innovations. On the other hand, developing countries argue that
indiscriminately granting IPRs may hinder domestic R&D, and they are doubtful that
135
private multinational companies will transfer up-to-date technologies and support
domestic learning.
Under the assumptions of new growth theory, lower access to external R&D due
to inadequate institutional settings is usually associated with lower productivity growth
rates (Schiff and Wang 2006). Since externalities and knowledge spillovers are inevitably
international, the global economic integration of a developing country may contribute to
its economic growth. Diao et al. (1999) verify that trade openness impacts the absorption
of foreign R&D stock: the effect is greater if countries are able to process this body of
foreign knowledge effectively. This last point relates to the issue of domestic R&D
capability. According to this assumption, Lederman and Maloney (2003, 2006) examine
patterns of R&D investment and development, verifying that although rates of return for
R&D investments are higher for developing countries; other institutional variables count
in R&D investment decisions. Albeit returns may be smaller, the evidence implies that
developed countries have more investments in R&D. This suggests that countries with
national innovation institutions may be better equipped to integrate into the world
economy. In their case study of Mexico, they posit that trade integration in a RIA was not
enough to spur domestic R&D performance. Thus, it seems that trade
integration/openness is a necessary but not a sufficient condition for technological
innovation, which require other policies and adequate institutions.
Summing up, based on new growth theory assumptions, the more policy-oriented
literature suggests that trade openness and FDI are important channels to allow spillover
and growth in productivity (Schiff and Wang 2006, Schiff et al 2002). The more
theoretical literature also supports the technological spillovers hypothesis: Diao et al.
136
(1999) and Coe et al. (1997) verify that more open countries experience an increase in
both foreign and domestic stock of R&D.
This theoretical and empirical debate has serious trade policy and trade
negotiation implications, as the new trade agenda comprises sectors intensive in
technology, such as communication services, and disciplines that may affect domestic
R&D policies. Along these lines, the protection of IPRs has been one of the most
contentious issues of contemporary trade discussions and involves the debate about
policy space and the building up of domestic institutions. As I will expand later, of the
main disagreements of Brazilian negotiators concerning the discussion of new trade
themes, both at the WTO and within North-South trade negotiations such as the FTAA
and the UE-Mercosur, is the difficulty of combining international agreements with
domestic policy/regulatory space. The dispute over the use of generic drugs to combat the
epidemic of AIDS is an example of how international trade agreements can influence
domestic policies.
43
I will discuss some of these issues in the next section on the political
economy of world trade negotiations. In order to gauge the possible effects of recent
trade liberalization, this next subsection addresses some of the empirical findings
regarding Latin America and Total Factor Productivity (TFP).
The Examples of Mexico and Brazil
Considering TFP improvement, the benefits of integration into the world
economy can work both via trade and FDI channels. The Inter-American Development

43
Brazil argues before the World Health Organization (WHO) and the WTO that international patents
should be violated to allow for the domestic production of HIV medicines at lower costs. Such policy
determination is potentially contentious in current trade negotiations, given the importance of intellectual
property rights for bilateral trade negotiations. The U.S., for example, is currently negotiating and signing
accords, that go beyond the TRIPS/WTO disciplines. See Fink and Reichenmiller (2005).
137
Bank (IDB) (2002) compared several manufacturing sectors in Mexico and Brazil: the
results are consistent with the hypothesis that trade integration spurs productivity. Lopez-
Córdova and Moreira (2004)

also examined the effects of trade liberalization and
regional integration on productivity gains in the recent experiences of Brazil and Mexico
and verified the TFP gains from international economic integration. Albeit somewhat
counterintuitive in the Mexican case, their results support the idea that openness spurs
productivity gains due to import competition and export orientation. Although these
works do not disaggregate in terms of R&D intensive sectors, the results show that Latin
American firms may be adopting more up-to-date production methods, thus narrowing
the technological gap.
The IDB found a significant increase in the number of domestic firms
participating in world markets: from 39 percent in 1996 to 44 percent in 1999 in Brazil,
and from 28 percent to 43 percent in Mexico. During the same period, the internationally-
oriented firms experienced higher productivity gains. Consequently, at least in some
outward-oriented sectors, these countries may be catching up and experiencing
technological and productivity improvements due to export success. Furthermore, FDI
has encouraged these gains, suggesting that there are positive effects caused by
competition, knowledge and backward linkages.
The IDB study also shows that the North American Free Trade Agreement
(NAFTA) shaped the export drive in the case of Mexico, whereas in Brazil, the
destination of exports was more diversified, going both to Mercosur and other regions of
the world. In brief, even considering that other economic factors and policy reforms may
have contributed to these outcomes, Mexico’s and Brazil’s unilateral trade liberalization
138
and regional integration through NAFTA and Mercosur, respectively, contributed to TPF
gains during the 1990s (IDB 2002, 254-265). López-Córdova and Moreira (2004)
indicate similar results. The graph below depicts manufacturing productivity and an
index of average tariffs in the Brazilian economy since 1985. Although one must assume
several other variables may have influenced productivity gains in Brazil, including the
end of hyperinflation since 1994, the negative correlation between the variables tariff
protection and productivity are worth noting
44
.

44
In chapter four, I look at variables that account for technological intensity in selected industrial sectors in
Brazil to gauge how technological content will influence trade policies such as protection (higher tariffs)
and state support (more subsidies).
139
Figure 9: Productivity and trade protection.

Source: OECD (2006)

60
70
80
90
100
110
120
130
140
150
160
1985 1990 1995 2000 2005
0.95
1
1.05
1.1
1.15
1.2
1.25
1.3
1.35
Manufacturing productivity
Average import tariff (right
scale) (1)
1985=100
140
Section III - Multilateral and Regional Trade Integration
In this section, I will depict the status of current world trade negotiations from a
theoretical, but also from a more factual perspective, bearing in mind the contemporary
world economic situation. Thus, I emphasize not only actor-based political economy, but
also the systemic/structural features of the international political economy characterized
by globalization.
45
Globalization encompasses several interrelated phenomena that affect
world economic governance, such as the surge of China in the world economy, the
relative weakening of the Bretton Woods institutions and the changing logic of U.S.
leadership in world economic affairs.
46
I also discuss how globalization limits/alters the
provision of public goods and how regionalism arises as one response to this trend and to
the search for more effective governance of the world economy.
---**---
The Political Economy of Trade and the World Economy
The Bretton Woods institutions of the post World War II era embodied free trade
and monetary cooperation as cornerstones of world economic stability. For the architects
of these international economic institutions, namely the International Monetary Fund and
the World Bank, liberal economic values have public goods characteristics: free trade and
monetary stability are non-rival and non-excludable and create positive spillovers for all
countries. In reality, free trade practiced by one nation has positive effects on others to

45
In this dissertation, I assume globalization to be multifaceted phenomenon with both economic and
political underpinnings. Globalization, narrowly understood, could be interpreted as an increase in the flow
of goods and capital across nations. Meanwhile, new trends in world affairs, such as the demise of
Communism, the end of the Cold War, and more recently, the upsurge of world terrorism, can be also
related to globalization, which blurs the borders between national and international affairs, creating a
transnational arena.
46
Spero and Hart, The Politics of International, chapter 11.
141
the extent that the opening of markets allows participating countries to sell products in
which they specialize. If all countries liberalize, there is a Pareto superior outcome. The
same rationale works in monetary affairs in that a cooperative world monetary order
allows countries to correct imbalances and to avoid financial crises. Both the neo-realist
and the liberal-institutionalist international relations literature highlights the importance
of international public goods, which can be provided by regimes backed by a hegemonic
country (Krasner 1983), and/or by a set of self-enforcing rules embodied in international
institutions (Keohane 1984).
47

Recent trends in the world economy, namely the deepening of globalization,
characterized by the upsurge of trade-oriented countries in the IPE and the financial
crises that erupted during the 1990s and 2000s, have been changing and undermining the
logic of the international institutions. In spite of the still powerful economic leadership of
the U.S., free-market values backed by institutions such as the WTO have been
contradicted by countries that have adopted managed and interventionist economic
policies and which have been growing in importance in the world economy. Conversely,
the flow of (bad) financial assets among countries and the lack of sound regulations,
which spanned the recent crisis of mortgage assets (subprime), is evidence that the
international economic order has been under strain.
In this context, the mounting interest in new regional integration arrangements
can be interpreted as a response to the stalemate at the multilateral level, but also as a
response to the deepening of globalization and to the necessity of creating mechanisms of

47
A more recent literature, based on the liberal-institutionalist tradition, analyzes the effects of
globalization on world economic governance from a rational actor political economy approach (Kahler and
Lake 2003). The message here: despite structural constraints, preferences matter in the carrying out of
domestic trade and monetary policies.
142
regional economic governance.
48
The early example of the European Union and the more
recent drive toward regionalism, which comprises more than tariff related measures and
involves comprehensive rules of economic governance, can be regarded as an attempt to
foster public goods on the regional scale (Brelin et al 2002).
49
As a consequence RIAs
involve deeper integration rules (described below) and mechanisms of institutional
cooperation, in the realm of fiscal and monetary co-operation and convergence, the prime
example being the European Union.
50

On the other hand, there are different types of regionalism: there is a minimalist
sort, market driven, comprising basically trade/investment related rules, called Anglo-
Saxon regionalism; and there is a more institutionally oriented regionalism, which
comprises rules and norms to mitigate market failures, the prime example, once again,
being the European Union (Brelin et al 2002).
Emerging markets and developing countries, Brazil included, are grappling with
these world economic trends including globalization, the difficulties of multilateralism
and the upsurge in contrasting trends in regional integration. Therefore, the very question

48
For an analysis on the impact of the globalization on state institutions see Cerny (1995). The author
argues that globalization, by increasing competition in world markets, undermines the provision of public
goods by national states. Thus, he believes the modern welfare state is turning into a competitive state and
new forms of governance to regulate the global economy are needed.
49
In the initial chapter of their book, Brelin et al. present a theoretical debate about the concept of
regionalism versus globalization, and cover such contending theoretical traditions as constructivism,
realism and liberal-institutionalism. The authors stress the element of governance as a crucial aspect of the
shift toward regionalism. Therefore, nation-states commit regional agreements to control market outcomes
and to alleviate the possible deleterious effects of globalization.
50
For an explanation regarding the upsurge of regionalism and how countries attempt to control market
outcomes by moving economic decision-making to the transnational arena see Hülsemeyer (2000).
According to this author, European Union-style regionalism offers an alternative to mitigate the deleterious
effects of globalization - decreasing information asymmetries and negative externalities - by allowing the
building up of transnational institutions and policies. Conversely, Garret and Rodden (2003), while
analyzing the phenomenon of fiscal decentralization, argue that globalization shifts the balance of financial
institutions and policies not toward the transnational realm but to sub-national arenas.
143
is not if regionalism is a building bloc or a stumbling bloc of the multilateral order, but to
what extent regionalism provides a response to the possible disruptive effects of
globalization in order to tame the deleterious effects of world imbalances.
There is a burgeoning literature in economics and political science which seeks to
understand the apparent contrasting strategies of multilateralism versus regionalism.
Neoclassical economic theory holds that unilateral trade liberalization is the best option
for countries, but in this debate neoclassical economists also opt for multilateralism,
assuming that this strategy is more welfare enhancing than regionalism—which is
regarded as a second best option from this perspective. Meanwhile, in a world
characterized by lobbies, rarely the best outcome prevails and multilateral negotiations
have been plagued by fierce political economic pressures. Therefore, a strand of the
literature supports regionalism, not only as the second best option, but as the best way to
break out of political economy stalemates. Bouzas (2005), following other authors, such
as Haggard (1997),
51
posits that Latin American countries may benefit by committing to
an RIA with more advanced countries in order to lock in domestic economic reforms.
Even considering industrialized countries, regional integration agreements can lead to
domestic institutional change, and trade liberalization can tie the hands of policymakers
and decrease the ability to escape from previously agreed rules in international
agreements (Rosendorff and Milner 2001). The U.S.-Canada Free Trade Area, for
example, can be regarded as an early example of an external commitment signaling

51
Stephan Haggard, “Regionalism in Asia and Americas”, in Edward Mansfield and Helen Milner (eds.),
The Political Economy of Regionalism, New York: Columbia University Press, 1997.
144
Canada’s willingness to reform its domestic economic institutions and tie the hands of
domestic policy makers.
According to another strand of this literature, regional integration is a complement
rather than substitute for multilateral trade liberalization because it triggers a domino
effect and creates a web of complementing and juxtaposing regional integration
agreements that may enhance and compel multilateral negotiations to move forward
(Baldwin 2006). According to this view, the drive toward regionalism in the Western
Hemisphere (NAFTA, Mercosur), in Asia (ASEAN, APEC
52
) in the early 1990s, and the
enlargement of the European Union in the 1980s, provided a catalyst for the stalled
multilateral trade negotiations during the GATT’s Uruguay round.
Current trade negotiations comprise not only liberalization in goods, but also
deeper integration commitments and behind the border measures in areas such as
services, investments, intellectual property rights protection (IPR), and government
procurement. The “North-South” regional integration initiatives have been bolder at
proposing such disciplines, this being the so-called “WTO-plus” approach. The North
American Free Trade Agreement (NAFTA) is an early example of this format, as would
be the FTAA. For a country like Brazil, joining trade integration agreements raises the
fear of losing policy autonomy, particularly in an FTAA sort of agreement which from
the start was cast as a WTO-plus endeavor.
53
On the other hand, integration into the

52
The Asia-Pacific Economic Cooperation (APEC) is an economic forum for Pacific Rim countries to
discuss matters on regional economies, cooperation, trade and investment. It has the following members:
Australia, Brunei Darussalam, Canada, Chile, and People’s Republic of China, Hong Kong, China,
Indonesia, Japan, Republic of Korea, Malaysia, Mexico, New Zealand, Papua New Guinea, Peru,
Philippines, Russia, Singapore, Chinese Taipei, Thailand, United States, and Vietnam.
53
There is an ongoing debate on how joining a trade agreement undermines policy autonomy, which I have
mentioned previously. For contrasting views see UNCTAD (2006) and WTO (2004). Curiously, these two
145
world economy, especially via a regional integration framework, can unleash powerful
dynamic forces with positive effects for economic development: economies of scale,
R&D spillovers and externalities, learning-by-doing, and the clustering of economic
activities (Venables, 2003). The literature on the political economy of regional economic
integration has pointed to the possible productivity gains to be derived from increased
trade flows between North and South as a powerful rationale for these trade agreements
based largely on the assumptions of new growth theory models (Feenstra 2002, chapter
06 and 10). In addition to productivity gains, there are also potential non-conventional
gains of joining RIAs (Fernandez 1997): institutional and regulatory discipline (e.g.
business facilitation, investment, services, government procurement, intellectual property
rights, etc) have been increasingly discussed at negotiations over these modern trade
integration agreements. Apparently, regionalism can produce more profound economic
and institutional modernization, which has not been fully considered by the classical
literature on preferential trade agreements (Ethier 1998, 2001).
Therefore, an analysis focusing only on the political economy of factors of
production ownership may not convey all the dynamic complexities of the new
regionalism. Hence, even in a capital scarce country, domestic groups and firms
connected to FDI and engage in intra-industry trade with capital endowed countries – for
example, the U.S. or Canada - may support North-South agreements in order to gain
access to cutting edge technology and to reap economies of scale. Milner (1997) and
Chase (2003) apply these theories to the case of U.S. industries lobbing for NAFTA.

international organization linked to the United Nation system have different approaches toward trade and
industrial policies; UNCTAD has been historically advocating more state activism. For an academic
discussion, see Shadlen (2005).
146
There is little research, though, regarding the position of firms in less developed
countries
54
.
The reality has been harsh on these theoretical findings, nevertheless. Mounting
protectionism and political constraints have been hampering current multilateral
negotiations, as well as the deepening of current regional integration schemes in the
Western Hemisphere. The stalemate in the FTAA, the acrimony related to approval of the
CAFTA by the U.S. Congress at the last minute, and the inability to broaden the trade
agenda of NAFTA to include issues such as labor mobility and energy security, are
evidence that protectionist trends are on the rise. Within both the multilateral and the
regional arena, the stalemate boils down to a straightforward application of neo-classical
political economy models (Heckscher-Ohlin): owners of scarce production factors do not
gain from trade liberalization and thus they exert protectionist pressures through lobbies
directed at the Executive and the Congress. This explains the position of agriculture and
labor intensive industries in developed countries. In the Doha Round, the power of
agricultural sectors is evident in the high tariffs in Europe and Japan and in the level of
subsidies in the U.S. Equally, labor intensive sectors are also protected by higher tariffs,
cases in point being imports of textiles, apparel and footwear from developing countries
that are penalized (Schott 2006). Conversely, developing countries are wary of accepting
further liberalization in capital intensive goods and sectors, such as high-tech industries
(e.g. telecommunication materials, IT goods) and services (e.g. software development,

54
In chapter four, I will look at variables that measure regional trade participation of selected industrial
sectors in Brazil, wishing to find if industries engaging in intra-industry and regional trade will lobby for
policies of protection (tariff) or state-support (subsidies). For now, it is worth stating that regional
integration initiatives have been a force behind trade reform in developing countries (OECD 2001, IADB
2002, World Bank 2002).

147
public utilities), whereas further liberalization in this field is supported by private sector
constituents in developed countries for whom the export of intangible assets or high-tech
goods is commercially gainful and/or wish to expand opportunities for investment.
Trade liberalization also involves the skepticism and criticism of public opinion in
both developed and developing countries regarding the effects of globalization. In Latin
America, the support for neoliberal structural reforms, as shown by a Latinobarometro
poll of 2005, has been dwindling and it can be interpreted as a response to the recessive
macroeconomic situation of the early 2000s and to the allegedly low income generating
results of these structural reforms. In the developed countries, the case for environmental
and labor clauses in trade agreements reflects the concern about an excessive market-
driven globalization and causes local social tensions. In this context, it is worth asking if
countries will commit to deeper trade commitments.
Deeper Integration Issues: the New Trade Agenda
Economic activities are regulated through countless domestic disciplines endorsed
and implemented at every level of government. These regulations can be sector specific
(agriculture, mining, telecommunications and financial services, for example) or
horizontally specific, that is, applying to all firms within an economy (for instance,
company law, taxation, environmental, labor and employment, intellectual property rights
requirements).
55
In the two decades since the Uruguay round, the WTO/GATT
multilateral framework started to push forward more comprehensive rules to regulate the
domestic economies of signatory countries, attempting to create a more level playing
field between domestic and foreign firms, based on the premises of national treatment

55
See Torrent and Molinuevo (2004).
148
(NT) and most favored nation (MFN). In that direction, the TRIPS, the GATS and the
TRIMS created rules for intellectual property rights, trade in services and investments,
respectively. The WTO Doha round currently being discussed expanded the agenda to
negotiations on government procurement, competition policies and the possible inclusion
of labor and environmental trade related rules. All those issues are much contested by
developing countries, which are not willing to discuss them in the absence of headway on
more traditional trade themes, such as market access and agricultural subsidies. However,
the new regionalism format has embraced and even deepened the commitment to
incorporating these “regulatory” disciplines into new trade accords. They are present, for
instance, in the FTAA and in the EU-Mercosur negotiations. Trade negotiators both at the
multilateral and at the regional level, are increasingly determined to advance regulatory
frameworks based on horizontal rules.
Trade in goods also involves domestic regulatory content, such as standards,
which according to the degree of requirement, can act as a non tariff barrier (NTB). The
WTO also has disciplines on these NTB issues. Finally, deeper integration discussions
also open up the possibility for creating supranational institutions within the framework
of a trade agreement. In this regard, the European Union is the prime example, having
established institutions such as the European Committee and the European Council to
oversee the process of integration
56
as well as a parliament with legislative powers. The
example of the Mercosur is much more modest: the establishment of supranational

56
These institutions have distinct missions within the European Union framework: the European Council
is a meeting of the heads of state or government of the European Union and the President of the European
Commission, while the European Commission is the executive body of the European Union. These bodies
often have different positions regarding the pace of trade liberalization or European policy making.
149
institutions and legislation has been one of the most contested issues within this bloc.
57

The relative delay in discussing the institutional format within Mercosur certainly
contributed to the hesitant position of the bloc in discussing trade agreements with third
parties. The recent turmoil in Mercosur can be understood as a consequence of this
institutional vacuum, which rendered it incapable of sorting out the particular interests
within some sectors from the broader integration aims of the bloc as a whole. This trend
is mirrors Brazilian foreign policy characteristics, which favors a piecemeal approach to
international matters, especially if they may involve the building up of supra-national
institutions.
I discussed in the previous chapter, trade policy in Brazil must be understood in a
broader context, one where by state intervention, is readily embraced as a way of
correcting market failures and providing public goods, even if this has hindered economic
freedom and protected inefficient domestic economic actors. To the extent that
contemporary trade agreements discuss deeper integration issues which comprise
regulatory and institutional rules intended to unleash market forces, reduce state
intervention and establish a level playing field between domestic and foreign firms, there
has been latent tension between long run characteristics of the Brazilian economic policy
model and these trade agreements. The FTAA discussions, for example, were embedded
in the assumption that trade, investment and even economic governance rules are
intrinsically intertwined, hence, triggering a cautious Brazilian negotiating position.

57
For a discussion about the creation of supranational institutions in Mercosur, see Rosenberg (2002). For a
recent account of Mercosur developments from the perspective of a Brazilian scholar, see Camargo (2006).
150
Despite the so-called priority and precedence of Latin American integration in
official Brazilian discourse (Amorim 2005), there are also squabbles regarding deeper
integration, such as the strengthening of supranational institutions to correct the
asymmetries between partner countries. One example is the current disagreement about
the creation of a development bank in Mercosur. Mercosur has been slowly making
progress to create a Fund of Convergence (FOCEM) that may address the special
interests of smaller countries (Paraguay, Uruguay) (Cepal 2006:96). The 2006 ECLAC
report on Latin American international economic integration acknowledge that countries
in the region, particularly in South America, have been lagging behind in committing to
deeper levels of integration. The report mentions that the several free trade areas in the
sub-continent have been timid at proposing disciplines on services, investment,
government procurement, intellectual property rights, competition policy and labor rights.
In short, Latin American integration is not addressing key subjects that are essential for
the competitive modernization of the regional economy.
The lack of deeper commitments is surprising because in Latin America, intra-
regional trade seems to be very much the result of the political will that inspired and
continues to inspire the sub-regional integration trends of the post-war era. This trend is
also starting to spillover to traditional trade: CEPAL estimates that total Latin American
and Caribbean intra-regional trade in 2003 was a meager 16 percent of total regional
exports, a lower level than the peak of 21.1 percent registered in 1997. These smaller
figures were probably the result of the pro-cyclical nature of intra-regional trade in the
region, which presents a declining trend in the combined shares of intra-regional trade
and a growing shift in favor of inter-regional trade, including flows to developing Asia
151
(table 11 in the Statistical Annex) (Agatiello 2005, Kumayana 2005). Summing up,
despite the existence of treaties and tariff reduction mechanisms inside the continent, the
levels of stagnation of intra-regional trade and the absence of deeper integration
commitments and disciplines seems to indicate that Latin America integration is hostage
to an empty discourse and the inability to further advance an integration agenda. During
commodities boom, this is still the main component of export portfolio of the sub-
continent, intra-regional trade shares decline.
Ortiz-Mena (2000) points to the difficulties applying political economy theories
of economic and institutional convergence in the South-South integration process. He
applies the theory developed by Milner (1997) to the case of the G-3 (Colombia, Mexico
and Venezuela; do not mistake with the G-3 of Brazil, India and South Africa), a FTA
that was actually extinct, as an example of how the rise of intra-bloc and intra-industrial
trade was not able to boost regional institutional deepening. In Mercosur as well, in spite
of the impressive growth in intra-bloc and intra-industry trade in the first years of the
common market, which spurred an impressive intra-regional flow of goods during the
1990s (e.g. the automotive sector), deeper trade related disciplines have been stalled.
Mercosur still has very meager rules regarding investments, services, intellectual property
right rules and competition policies, not to mention labor mobility disciplines.
On the other hand, extra-regional integration projects, particularly those with
advanced countries, such as at the stalled FTAA and Mercosur-EU, or at the successful
CAFTA, or even at bilateral agreements, such as Chile-UE, Chile-Japan and Mexico-UE,
deeper trade rules have been proposed, discussed and eventually accepted by the involved
parties. The adoption of disciplines of regulatory and institutional convergence can be
152
regarded as a logical step for less developed countries willing to lock in policy reforms
and to acquire a competitive edge in the world economy via North-South agreements.
Notwithstanding the meager results of intra-regional integration, Latin America
and Brazil are hardly to blame for the stalemate at the hemispheric and multilateral
levels. Despite the possible welfare gains described by several CGE models, interest
groups in developed countries have fiercely opposed further liberalization in agriculture
and textiles—land and labor intensive sectors in which they have fewer comparative
advantages. In the multilateral discussions, achieving the Doha Bargain would require
political commitment and negotiation positions far superior to the ones currently on the
table (Cline 2005; Elliot 2006; Schott 2006). Besides, as the mandate of the WTO
includes a development agenda, such as Aid for Trade and the fulfillment of the
Millennium Development Goals, there is a case for conceding to the demands of the
poorer countries (World Bank Development Report 2006: 209). Given that the trade
policy apparatus and negotiation capacity of the developed countries is far superior to
that of poorer countries, the responsibility to continue the multilateral trade negotiations
lies in the hands of developed country politicians and in their ability to break political
economy stalemates among their constituencies. In the next section I elaborate on the
WTO’s Doha round and the Brazilian negotiating position within that forum.
The Doha Round: State of the Art and the Brazilian Position
The Doha round has been stalled since the Sixth Ministerial Summit of the WTO,
held in Hong Kong in December 2005. The original aim of that conference was the
setting up of modalities (in WTO parlance: actions that guide the negotiations) in order to
conclude the round in 2006. Meanwhile, the same stiff positions that marked Doha from
153
the start prevailed in Hong Kong, thus rendering the failure of the Ministerial meeting
inevitable.
In the last moments of the conference, the WTO Director General was able to
approve, with the support of the U.S. and Brazil, some minimal non-quantitative
measures. In agriculture, for example, the elimination of export subsidies was agreed
according to a timeline ending in 2013, conditional on specific modalities. In cotton
production, developed countries conceded to developing countries in two important
areas: the immediate elimination of subsidies, and increased market access - free from
quotas and other restrictions. Yet, tariffs remain high in some semi-processed goods. In
contrast, in the case of non agricultural market access (NAMA) and in services zero
progress was made. Despite the apparent alliance between Brazil and the U.S. to press the
EU for greater concessions in agriculture, polarization was the rule. The developing
countries, represented by the G-20,
58
pushed for the liberalization of agricultural markets,
whereas the developed countries insisted on greater commitments in services and
industrial goods.
The Brazilian stance at the WTO negotiations sought gains in agricultural
liberalization, where the country has a clear comparative advantage.
59
In contrast, Brazil
is reticent to further liberalize services and industrial goods, because it is relatively less
competitive in both domestic and international markets within those sectors. The
Brazilian government is aware of the potential welfare gains of a successful conclusion of

58
For a description of the G-20, with a special focus on Brazil’s role in that group see Veiga (2006) and
Paquin-Boutin (2005).
59
Brazil, according to several CGE models, is the country with the most to gain from the liberalization of
world agriculture markets. See Polaski (2006).
154
the Doha round. Less overtly, it also acknowledges the potential for positive productivity
effects on domestic export oriented sectors and on sectors exposed to international
competition. Meanwhile, the discourse of Brazilian negotiators is imbued with the
rhetoric of policy autonomy and doubts that excessive liberalization in industrial goods
and services could hamper domestic development (Amorim 2005).
60
Moreover, there is
still a clear commitment to treat trade negotiations as a vehicle for advancing the more
general goals of Brazilian foreign policy (Guimarães 2004).
Brazil, since the election of left wing Labor Party president Luis Ignacio Lula da
Silva, has been assuming a more active position in the WTO negotiations. The country
believes that multilateral agricultural liberalization will benefit world welfare,
particularly those poorer countries that count on basic crops as their main source of
export income. Brazil, meanwhile, is less forthcoming on the fact that the liberalization of
world agriculture markets can also have a negative impact on the income of non-
competitive domestic agricultural sectors in poorest countries, which would see their
domestic markets flooded by cheap imports. (World Bank 2006: chapter 05, Paquin-
Boutin 2005). Brazil basically supports a negotiated liberalization in Non Agricultural
Market Access (NAMA) and services, as this could spur developing countries’ welfare
and productivity, but it has demanded greater discussion on safeguard measures and more
flexibility in pursuing policy goals.

60
In order to illustrate this point, I quote the position the of Brazilian Ministry of Foreign Affairs:
It is clear for that we can not compromise the ability of the state to carry on industrial, technological and
environmental policies. The Brazilian participation experiences in the former rounds of GATT and in the
onset of the WTO suggest a cautious position against potentially harmful concessions that will be realized
only years later” (author’s translation). (Amorim 2005)
155
Amidst this debate, Brazil opposes the negotiation of environmental and labor
clauses as a part of the Doha round. The country sustains that environmental and labor
clauses could be used as disguised protectionism. Though, it recognizes that the
liberalization of services could involve migration and labor force mobility, areas that
would certainly benefit some developing countries. The current WTO agreement on
Services (GATS) – Mode 04
61
- partially addresses labor force mobility in the case of
short-term workers. According to studies of the Financial G-20, demographic trends in
several developing countries create strains in local labor markets, as an excess of low-
skilled labor leads to higher unemployment and social tensions. In contrast, developed
countries have a shortage of low-skilled labor force (Koettl et all 2006). Given this
situation, the economic incentives compel the developing countries’ workers to migrate
to developed countries. Temporary labor contracts could thus be proposed in the trade
agreement framework (Rodrik 2001). Additionally, agreements should include remittance
rules that allow the transfer of money between recipient and source countries, in order to
facilitate the saving of migrant workers and to create positive spillovers for source
countries’ economies and financial markets.
62

Meanwhile, due to the current impasse, Cline (2006) acknowledges that the
proposal of such disciplines is not feasible at the WTO Doha round and he argues that
only regional integration initiatives can move forward on these issues. The liberalization
of labor force/migration discussions also engender political economy concerns in

61
Mode 4 from the GATS agreements refers to the modality in which the service seller moves to the
location of the service buyer. Thus, Mode 4 implies temporary migration.
62
The Financial G-20 is an informal group of developing and developed countries, plus the European
Union, that discusses international macroeconomic and financial issues, possible modifications on the
Bretton Woods international financial architecture and trade related themes. On labor mobility agreements,
see Koettl et al (2006).
156
developed countries. There is protectionism from groups which represent less skilled
domestic workers (trade unions), because the increasing flow of migrants exerts a
depressing influence on local wages. Thus, the inclusion of labor clauses in trade talks is
doomed to be a contentious issue for any audience. Temporary labor mobility clauses in
trade agreements could reduce the negative pressure from public opinion, but politicians
and policymakers in developed countries must also be frank about the fact that trade
liberalization creates winners and losers on both sides. Several developed countries’
sectors could gain. For instance, workers within capital or knowledge intensive industries
could benefit from labor mobility rules and they could exploit open markets in
developing countries.
Complicated as labor issues may be, international commitments do have the
power to create domestic incentives toward best international practices (Fernandez 1997).
Along these lines, further commitments under the WTO could provide a justification to
for lowering agricultural subsidies in the U.S. and for reformulating the Common
Agriculture Policy in the European Union. In the end, one of the consequences of
committing to trade integration initiatives is to provide a rationale to persuade protected
domestic groups to surrender privileges that create domestic economic inefficiencies and
penalize tax payers and consumers. Yet, if the traditional trade agenda lags behind in the
current WTO Doha round due to collective action stalemates, it may be too premature to
commit to a deeper regulatory and institutional agenda at the level of multilateral trade
discussions.
Summing up, the meager results of the Sixth WTO Ministerial Summit may be a
potential source of tension in the world economy. Whereas a steep protectionist wave in
157
the U.S. and in the EU is not likely yet, with the deepening of “subprime” financial crisis
and the fear of global recession, protectionist pressures coming from displaced sectors
decrease prospects for a successful conclusion of the multilateral trade agenda. The
current stalemates at the WTO and within several regional integration agreements like the
FTAA have cast doubt on the extent to which trade liberalization is still desirable.
Current global imbalances have further clouded this picture. The world economy is
currently characterized by severe macroeconomic problems such as the abovementioned
financial crisis, the twin deficits (current account and fiscal) in the U.S and by the
impressive growth of China and India in world markets. To what extent are these trends
detracting from the commitment to liberalize trade? In the next section, I briefly elaborate
on these points.
Global Imbalances: China’s surge as a New Source of Tension in the World Economy
The extraordinary expansion of China, and to a lesser extent, India, in world
markets has been creating positive spillovers for the world economy, but also generating
new political economic tensions. On the positive side, the IMF report (2006: chapter 3)
notes the negative correlation between globalization, narrowly understood as the rising
flow of goods and capital among nations, and world prices. China has been a very active
global player in the supply of industrial goods. The country has shifted its export profile
in the last three decades – from low-tech merchandise (toys, plastics, textiles) to mid and
high-tech goods (appliances, machinery, electronics and electronic components).
According to the IMF, the impact of China on world prices has been twofold: a) due to an
increase in the supply of industrial workers, China has placed downward pressure on
prices for labor inputs; b) due to an increase in the supply of industrialized goods in
158
world markets, it contributes to low inflation in importing countries. According to the
IMF report, the deflationary effect has been particularly intense in information
technology (IT) goods, which are massively produced in China. In fact, China has carved
a competitive niche in the IT market. Finally, there are also productivity gains related to
the increased competition of Chinese goods in importing countries, which also
contributes to lower prices, although in some cases this competition ends up displacing
local production (IMF 2006: chapter 3). Regarding India, the same phenomenon is
occurring, but to a considerably smaller degree and not as much in industrial goods;
India’s success is principally related to the outsourcing of services by Western companies
and by an increase in the supply of high-skilled Indian labor in IT firms in the U.S.
63

The upsurge of China and India must be placed in perspective: since the second
half of the 2000s growth has resumed, particularly in the emerging markets and
commodity exporting countries due to high international demand for oil, minerals, and
crops, mainly from the U.S. and China. Although balance of payments disequilibrium is
still a source of instability in some countries, current account surpluses and higher levels
of dollar reserves provide a cushion against the kinds of financial crises that marked the
1990s and early 2000s.
Yet, sources of tension linger. Among the global imbalances, the twin deficits in
the U.S. (current account and fiscal deficits) and the misalignment of the Chinese
currency have potentially de-stabilizing effects on the world economy, at least in the
short run. The situation of the world economy in the end of the 2000s is affected by the

63
On current trends in the world economy and global imbalances of the mid-2000s brought about by the
escalating importance of India and China in world trade, see “The New Titans - A Survey of the World
Economy”, The Economist, September 16th 2006.
159
burst of the real estate bubble in the U.S., which is likely to create severe recessionary
consequences, whose depth and extension are still unknown. This situation renders the
prospects for trade liberalization on a multilateral and regional scale very improbable.
These global imbalances increase the probability of domestic political economic tensions
and therefore require concerted action by countries and international institutions. These
global macroeconomic imbalances can also provoke additional protectionism on the part
of the U.S., which already faces a battle with the renewal of Trade Promotion Authority
(TPA) by a Democratic majority in the congress (Fergusson 2006). This same scenario
of free-trade backlash is visible in the European Union, which has a more protected
economy and is in need of structural reforms. In short, macroeconomic imbalances can
provoke protectionist backlash not only due to the rise of tariff and NTB barriers, but also
due to measures to support sectors harmed by the severe downturn- the auto industry
being a main case in point. (Brunel and Hufbauer 2009).
In relation to Latin America and Brazil, the Chinese appetite for commodities has
been contributing to the current trade surpluses and accumulation of dollar reserves in
recent years (CEPAL 2006: chapter 2). Yet, the competition from Chinese manufactured
goods is also displacing Latin American industrial exports in third markets and even
inside Latin America. Mexico is a prime example, as China has bumped Mexico down a
notch as a trade partner of the U.S., competing with mid and high technology Mexican
exports. Brazil, as well, has been benefiting from China’s stiff demand for commodities
and suffering from its competition in industrial goods. Chinese hunger for soy
contributed to the upsurge of agribusiness in the interior regions of Brazil, displacing
traditional crops, such as rice and cotton and even cattle ranching. Conversely, China
160
became one of the main destinations of Brazilian pig iron exports. The Chinese have also
been interested in steel production in Northern Brazil. In fact, the South-South flow of
foreign direct investment is a current trend in the world economy, and FDI between
Brazil and China increased in the first half of the 2000s. These new investment links may
enhance the role of both countries in the world economy (UNCTAD 2006).
Meanwhile, within Latin America, the export of Chinese industrial goods, such as
electronics, has been substituting Brazilian for exports. Additionally, Brazil is forming a
triangular relationship with regard to intra-industrial trade with Chinese components. For
example, in the cell phone industry, multinational companies (MNC) have taken
advantage of this triangle and Brazil’s preferences as a member of Latin American
Integration Agreement (LAIA) to sell to the Latin American markets. The CEPAL 2006
report recommends that Latin America firms should aggregate value for MNC’s based in
China and take advantage of Chinese expertise to penetrate foreign markets, instead of
just competing with them in third markets. In short, despite the aforementioned benefits,
the impressive growth of China in the world economy raises concerns and hopes in Latin
America, as everywhere else.
From the macroeconomic perspective there are problems related to the excess of
investment and foreign trade surplus from China and the lack of savings in the United
States. Roubini (2006) provides a diagnostic of current world economic trends,
acknowledging that mercantilist exchange rate policies in China have provoked
macroeconomic disorder. In truth, the misalignment of the Yuan increases the
competitive edge of Chinese goods and contributes to the increasing trade deficit of the
United States. Yet, the big U.S. consumer market is eager to buy cheap imports coming
161
from many countries in the world. Thus, China cannot bear all the blame for today’s
global imbalances, and the U.S. is just as responsible for the problems given its
macroeconomic mismanagement and the lack of domestic savings. On this point, Roubini
cautions that the Chinese appetite for U.S. Treasury bonds, which helps to finance the
U.S. fiscal and current account deficits, may become unsustainable in the long run. The
excess of Chinese savings, associated with the lack of savings in the U.S., can deepen
structural problems in the world economy. Ultimately, in order to curb inflationary trends
provoked by the fiscal deficit, the U.S. Federal Reserve (Fed) may need to raise domestic
interest rates. The impact of these measures in international financial markets may create
strains for several developing countries that still need to finance their current account
deficits. Finally, protectionism, not only in goods but also in assets, has been on the rise:
whereas the U.S. is eager to sell bonds to the Chinese and other central banks, the
participation of these countries in FDI and the buying of tangible assets in the U.S. has
not always been welcome.
The same rationale can be applied to the outsourcing phenomenon: U.S. public
opinion believes that this kind of competition hurts U.S. actors and competitiveness.
Therefore, there are protests regarding the export of jobs outside of the U.S., especially
high-skilled jobs (IT services) for which the U.S. has long had a comparative
advantage.
64
Summing up, these trends have prompted protests from some domestic
groups and the U.S. Congress has sought to counter Chinese competition by proposing
numerous questionable measures. There is also a quest for reforms in the international

64
Bhagwati et al (2004) explain that due to technological shifts, productivity enhancements and innovation,
jobs continue to be provided domestically in the U.S. at the same rate or even faster than job dislocation to
other countries. Therefore, even with outsourcing, there is net job creation in the U.S., particularly in high-
skilled jobs. In fact the demand for these jobs is on the rise.
162
financial institutions in order to tackle these imbalances and improve transnational co-
operation.
These global macroeconomic imbalances contribute to political economic
tensions and to the dwindling of support for a global free trade. The current stalemate on
the WTO multilateral agenda is testimony to this point. Regarding trade politics, the U.S.
is sending contradictory signals: while still expressing support for free trade, it has shifted
its trade strategy from a fierce supporter of the Bretton Woods multilateral order, to a
web of regional and bilateral trade agreements, a strategy called competitive trade
liberalization (Feinberg, 2005).
Finally, regarding Brazil, these international macroeconomic aspects have been
creating strains and opportunities for the country, while also fostering a cautious and
lukewarm approach to further trade commitments. As mentioned, the sizable trade
surpluses can be credited to soaring commodities prices in international markets. The
booming world economy helped Brazil to correct current account deficits and to Brazil’s
mass foreign reserves, which hit to US$ 150 billion in mid-2007. Yet, the weak dollar
and the over-evaluation of the Brazilian real hurt domestic export interests. Despite the
trade surpluses, business interests often complaint about the domestic exchange rate. The
political economy of exchange rate is one of the most polemic policy issues since the
decision to float the real in 1999. For now, the Central Bank is shielded from pressure
and is carrying out a strictly technical monetary policy, but there are critics even inside
the government that defend faster interest rate cuts and limits to currency appreciation.
Against this backdrop of a fairly orthodox financial and macroeconomic policy, trade
policy presents a possibility for more heterodox and autonomist positions.
163
The ongoing “subprime” financial crisis, and its impact on the global economy,
can have dire consequences for Brazil’s trade surplus, which has hugely benefited from
world demand in the mid-2000s. Meanwhile, as I argue in this dissertation, trade policy
in Brazil is characterized by lasting traits that favor cautious and piecemeal liberalization,
even in moments of a trade upturn. Hence, the global economic downturn is an extra
ingredient that impedes Brazil from committing toward multilateral and regional
integration agreements, especially those that involve North-South formats.

Section IV - Conclusion
This chapter applied political economy theories to multilateral and regional trade
negotiations and the role of deep integration issues, or the new trade agenda, in this
context. I adopted a structural approach and I analyzed how trade negotiations are
enmeshed in global economic affairs. I also discussed how Latin American countries,
Brazil in particular, are responding to the challenges of economic globalization, such as
the upsurge of China, and the changing role of multilateral economic institutions. My
main assumption is that several exogenous shocks in the world economy, described in
this chapter, have been influencing trade policies in Brazil. However, the trade
negotiating position of the country is grounded in world views that guide foreign
policymaking, as described in chapter one. In the next chapter, I will expand on this
issue, addressing the role of Brazil in two North-South regional trade integration
negotiations, the FTAA and the EU-Mercosur.
The political economy theories presented in Section II will also be reviewed in
chapter four, where I test the political economy cleavages that have influenced Brazilian
164
trade policy in terms of tariff liberalization and state subsidies for select sectors and
producers. At the same time, those industrial sectors engaged in intra-industry and
regional trade may be subject to positive technological spillovers, according to the “new
growth theories” that I reviewed earlier. My task will be to test if these industrial sectors
will be able to influence domestic policies, to the same extent that \ “factor endowment”
content (Labor x Land x Capital) and trade participation (export orientation and
importing competition) of industrial sectors may influence policies, along the lines of
“endogenous trade policy” theories.
165
Section V – Statistical Annex
Table 11: Export destination, Latin America and Caribbean 2003, percentage of
total exports.

A ll c o u n trie s to In c lu din g M e x ic o E x c lud in g M e x ic o
N o rth 7 4 .1 5 1 .5
N o rth A m e ric a 5 6 .8 3 0 .8
E uro p e a n U nio n 1 1 .1 2 0 .4
Ja p a n 6 .2 0 .3
S o u th 2 5 .9 4 8 .5
Intra - re gio na l 1 4 .3 2 7 .3
Inte r- re gio na l 1 1 .6 2 1 .2
F ro m
T o U .S ., C a na d a , E U
a nd J a p a n
In tra -re g io n a l plu s
D e v e lo pin g A s ia , A fric a
a n d M id dle E a s t
M e rc o s u r 4 6 .1 5 3 .9
A rge ntina 3 2 .6 6 7 .4
B ra zil 5 2 .4 4 7 .6
P a ra gua y 1 1 .2 8 8 .8
U rugua y 3 8 .5 6 1 .5
C hile 5 3 .8 4 6 .2
A nd e a n
C o m m un ity
6 1 .3 3 8 .7
B o livia 2 4 .3 7 5 .7
C o lo m b ia 6 0 .8 3 9 .2
E c ua d o r 5 9 .1 4 0 .9
P e ru 5 9 .5 4 0 .5
V e ne zue la 6 4 .8 3 5 .2
M e x ic o 9 3 .9 6 .1
C A C M 6 7 .9 3 2 .1
C o sta R ic a 6 8 3 2
E l S a lva d o r 6 5 3 5
G ua te m a la 6 4 .2 3 5 .8
H o nd ura s 7 3 .7 2 6 .3
N ic a ra gua 6 7 .1 3 2 .9
E x p o rt s h a re
in w o rld e x p o rts
L a tin A m e ric a a n d
th e C a rib be a n
1 6 5 .2
A nd e a n
C o m m unity
9 0 .8
M e rc o sur 1 1 .9 1 .5
C A C M 2 0 .7 0 .2
C a ric o m 2 1 .3 0 .1
S o urc e : K uw a ya m a 2 0 0 5 , E C L A C 2 0 0 6 .
R e g io n s -
s u b re g io ns
Intra -re g io na l tra d e
166
Chapter 3 - Brazilian Trade Policy and Asymmetrical
Integration: The EU-Mercosur Stalemate and a Thwarted
FTAA.

Introduction
Brazilian Trade Options in the Face of Global Challenges
This chapter discusses how the international scenario and new world trends (e.g.
deep integration issues) discussed in the last chapter have affected Brazilian trade policy
and strategy in the context of North-South negotiations. Recent exogenous shocks, both
economic and political, clearly affected Brazilian foreign economic policies, and a main
task in this chapter is to assess their impact on Brazil’s trade policy. These external
phenomena stopped policymakers from breaking entirely with Brazil’s traditional path
because trade policy is influenced by broader economic and political variables, including
institutional inertia and ideological biases, as described in chapter one. The contradiction
between domestically determined economic policy models and the dynamic and changing
international environment partly explains the country’s failure to adhere to multilateral
and regional trade negotiations, each of which entails a North-South dynamics, such as
the FTAA and the Mercosur-EU, that involves deeper liberalization rules,.
In this chapter I will examine in more detail the stalemate that beset the FTAA,
particularly Brazil’s disagreements with its main trading partner, the United States, as this
is the core example of the difficulty of the country to surrender its managed
trade/industrial policy tradition and to commit to a North-South integration agenda. I
evaluate why these integration projects have been at odds with Brazilian foreign
economic policy and vice versa. My goal in this chapter is to critically assess the
167
contrasting views on trade strategy in the literature and to verify how they apply to
Brazil’s position within North-South trade negotiations.
As I discussed in the first chapter, Brazilian trade policy is carried out with a great
degree of bureaucratic insulation by “technocrats” and professional diplomats. As an
instrument to promote economic development, Brazil’s trade policy is part of a broader
foreign policy strategy. Within this context, trade policy is conditioned by a particular
world view based on the preferences of policymakers. Those diplomats that shape
Brazilian foreign policy remain committed to an autonomous position in the world
economy, a characteristic that has been reinforced by the incumbent Labor Party
government. Deep integration issues intrinsic to North-South integration are at odds, not
only with the developmentalist economic policy that prevails in Brazil, but also with this
autonomous foreign policy tradition. Primarily for these reasons, the Brazilian foreign
policymaking establishment is cautious about economic integration with Northern
markets, a stance that has been even more pronounced in negotiations with the U.S.
65

Different types of regionalism reflect varieties in forms of capitalism and trade
policy models. Brazil, as a country which attempted to build a “developmentalist” state
and promoted active export promotion during its recent history, is struggling to adapt its
domestic political economy institutions and public policymaking to new international
realities. For example, North-South integration places pressure on policymakers to reduce
state economic interventionism and concede more power to supranational bodies.
66
As

65
For a summary of the continuity and rupture in Brazilian foreign policy under the Labor Party
government, see Almeida (2006). Oliveira (2003) analyzes these same trends in Brazilian foreign policy
from the standpoint of the FTAA negotiations.
66
For a detailed analysis of Brazil’s participation in the international system, see Viola (2005).
168
the country is challenged by the possibility of integration with the EU or the U.S., it has
simultaneously sought alternative integration projects in Latin America, including an
expansion of Mercosur.
But Brazil is not the only state to experience problems with North-South trade
negotiations. Other interested Northern parties, such as the EU and the U.S., also failed to
commit wholeheartedly to integration with the South, and they were intransigent on some
key issues, because of similar domestic political economy pressures. Thus, I also analyze
the position of these other actors at the negotiating table so as to better understand the
Brazilian position. These trends are reinforced by global macroeconomic problems.
The chapter is divided into the following parts: section II consists of a
methodological foreword; section III analyzes the EU-Mercosur negotiations; section IV
discusses the FTAA project; finally, in section VI conclude with an overview of the
debate on how the politics of domestic structural reforms, as discussed in chapter one,
have interacted with and become enmeshed with the recent external scenario.

Section I - Methodological Foreword
The upsurge of regional integration agreements can also be interpreted as a
response to the expansion of globalization and the necessity to provide public goods on a
global scale (Cerny, 1995). The expansion in intra-industry trade and the clustering of
economic activities across borders requires supra-national regulations and institutions to
provide a level playing field for enhanced investment and trade in goods and services.
According to the integration literature, the mounting interest in regionalism is due to the
fact that the deeper rules of institutional and regulatory convergence are easily achieved
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on a regional rather than a multilateral scale. In short, the move toward supranational
institutions expresses the concern about economic governance and about taming the
market failure effects of globalization, the idea being that regional arrangements can
better facilitate economic adjustment (Breslin et al, 2002).
Yet, the literature also emphasizes that the band of regionalism pursued by the
U.S., the EU and Japan, is not the same (Wise 2007; Phillips 2001; 2002). The so-called
Anglo-Saxon regionalism is oriented toward market facilitation, rather than the EU model
of building up political institutions that help to mediate market relations and mitigate
market failures. Though the EU is currently at a more advanced level of economic
integration, in its initial years there was a concern with the correction of market failures
within that project. Thus, institutional mechanisms that addressed regional imbalances
and implemented fiscal transferences were created in order to diminish regional income
disparities among member countries. Over time, this has been a constant policy priority
for the EU.
Despite differences in the models of regionalism, trade agreements of Anglo-
Saxon inspiration, i.e., those pursued by the U.S., have been criticized by economic
actors and civil society groups even within the U.S. Domestic constituents have been
asking for more comprehensive rules that address the imbalances allegedly caused by
trade integration. Though the motivation may be market driven (e.g. in order to curb the
competitive edge of developing countries because of lax environmental and labor
standards), this debate is also part of civil society’s desire to regulate the effects of
globalization. In other words, pluralistic interests, and not just the big corporations, have
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a stake in trade agreements. The position of the 109
th
U.S. Congress on trade negotiations
has clearly manifested concern over these issues (Fergusson, 2006).
For developing and emerging market countries the challenges of the world
economy require agile responses, the risk being the loss of market share and governance
capacity. In particular, Latin America and Brazil are now caught between different
regional integration models (Grugel, 2004), both of which include demands for deeper
integration, and beyond border measures (services, investments, intellectual property
rights, government procurement, etc.), and the regulation of deleterious trade effects, in
the areas of labor rights and environmental preservation. The Latin American countries
are further pressed by fierce competition coming from Asia, especially from China, as I
discussed in the last chapter.
In this dissertation, I assume three clusters of analytical tools to analyze trends in
the world political economy:
1. Multilateral and regional trade integration, with a focus on the latter;
2. Trade liberalization, domestic reforms and the role that domestic actors play in
this process;
3. Economic and institutional development, including trade, technology and
innovation.
My working hypothesis is twofold:
1) International economic shocks/trends and the demise of domestic economic
models change policymakers’ and interest groups’ preferences, hence, opening up
the opportunity for (trade) policy reforms; however, 2) entrenched domestic
institutional/bureaucratic characteristics, as well as the ideological biases
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embedded therein, are able to block further liberalization and therefore preserve
some features of an old development model in a new economic era.
In this chapter I draw on the literature on multilateral and regional integration, on
endogenous trade policy formation and on new growth theory to analyze the participation
of Brazil in recent North-South integration negotiations and agreements. In discussing the
EU-Mercosur negotiations, I focus on endogenous policy formation and arguments based
on bureaucratic politics. While analyzing the FTAA, I rely on endogenous policy
formation and new growth theories. Underscoring both discussions, I apply the structural
integration theory reviewed in this methodological foreword, and analyze how the
different types of regionalism can shape distinct foreign policy choices. The underlying
questions in this chapter are:
1) The structural aspects of regional integration: Brazil has a managed/interventionist
trade policy and an embryonic welfare state that attempts to tame globalization/market
failures, yet it has experienced similar hurdles while discussing regional integration with
the EU and the FTAA, which allegedly represent different types of regional integration.
2) Factor ownership and ideas determining policymaking and negotiating positions in
multilateral and regional fronts: Are domestic protectionist interests and bureaucratic-
institutional determinants to blame for Brazil’s reluctance to sign North-South regional
agreements?
3) New growth models and regional integration: Do intra-industry trade flows and the
interest of foreign investors help to determine policy choices within those North-South
integration projects where Brazil was involved?

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Section II. Brazil and the EU-Mercosur Negotiations
The EU-Mercosur agreement has important features of the new wave of
regionalism, two of which are worth emphasizing. First, this is an initiative that
aggregates countries at different levels of development within a North-South format.
Second, it goes beyond border measures, tariffs and the simple trade of goods, meaning
this initiative includes disciplines on domestic rules and regulations and a possible
institutional convergence among the signatories. The EU-Mercosur negotiations
constitute an important case study for discerning if the “new regionalism” offers some
real trade liberalization prospects. To date the position of the EU, though proposing a
deeper integration agenda, is still very protectionist on the agricultural side of the
agreement. Similarly, the Mercosur countries have taken a defensive approach with
regard to disciplines that may be excessively intrusive on the domestic regulatory
framework and that involve further tariff slashes on industrial goods in their market.
In order to interpret the Brazilian and the Mercosur position at the negotiating
table, theories of international political economy are useful. Overall, while the global
economy is based on dynamic industries characterized by technological intensity and
increasing returns to scale, the domestic politics of trade policy is still characterized by a
tight bargain between protectionist and free-trade groups which strive to influence
bureaucracies, all of which have their own agenda. The debate within the EU-Mercosur
reproduces this format: those sectors in Europe pushing for trade liberalization are the
owners of abundant factors of production in the developed North. Conversely, the owners
of the scarce factor –land– fear further trade liberalization, particularly in agriculture
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where Mercosur countries are extremely competitive due to resource endowments. The
inverse picture could be applied to Mercosur.
This endogenous trade policy explanation, however, overlooks the level of
bureaucratic autonomy in setting up the trade negotiation agenda. Bureaucratic autonomy
is a prominent feature of the EU and to a lesser extent in Mercosur, as the foreign affairs
and trade ministries in the latter countries do have considerable leeway to decide on
policy stances and negotiating positions. In comparative terms, the deeper integration
agenda involving regulatory and institutional issues affects domestic political economy
dynamics in both regions. The Mercosur countries possess some political economic
characteristics that resemble those of the EU (Breslin et al, 2002; Phillips, 2001), and in
some respects the integration project of Mercosur emulates the European trajectory in
that Mercosur is a common market that strives toward policy convergence and the
creation of supranational institutions (e.g. Parliament). Thus, the discussion of deeper
integration issues in the EU-Mercosur talks is also embedded in logic of economic
governance, which defends a more regulated economic order, an approach that both the
Latin American and the European countries seem to prefer in contrast to the market-
driven approach that characterized the FTAA. Therefore, co-operation and trade capacity
building are also part of the broad negotiation agenda in the EU-Mercosur talks.
Yet despite this apparent convergence of interests and the mutual recognition that
regionalism involves more than trade-related affairs and requires supranational
institutions, the EU-Mercosur negotiations have been stalled since late 2004. What went
wrong?

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The Heart of the Matter
In October 2004, after intense negotiations in Lisbon, the EU-Mercosur trade
talks ended with mutual objections and vague statements about re-launching the
negotiations in early 2005. Both sides were reluctant to make key concessions. From the
Mercosur vantage point, complaints about agricultural subsides and market access
dominated, whereas the EU demanded greater access to industrial goods and services
markets, as well as the ability of European firms to compete for public procurement
contracts in the Mercosur countries. The Mercosur proposal on investment and services,
based on a positive list and utilizing the classification of the World Trade Organization
was considered to be too timid by the EU. However, in June 2004, the Brazilian Foreign
Minister at the time, Celso Amorim, had already argued that the EU proposal was
approaching a “technical limit for it includes disciplines that would require modifications
on Brazilian domestic legislation” (Novo, 2004).
In September 2004, Mercosur presented its final offer, comprising disciplines in
services, investments and government procurement. The services proposal encompassed
all the relevant fields of concern to the EU, including the financial sector (insurance and
banking); telecommunications (access of European companies to the Brazilian market
long distance, provided it is interconnected with a company already operating in the
country); maritime transportation, professional services (ranging from architecture and
engineering to IT services); environmental services (water and sanitation, pollution
control); postal services (with full access to the express mail market); construction;
tourism and distribution. The investment offer covered most of the primary and
secondary sectors. Just a few exceptions were maintained, and these derived from clauses
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in the Brazilian Constitution, such as the prohibition on acquiring land in border areas,
and the requirement to register foreign investment in the Brazilian Central Bank. The
national treatment principle was applied in almost all sectors. Finally, regarding
government procurement, the Mercosur countries offered a mechanism of consultation
which opened up the possibility of special treatment for Europeans firms, provided that
the Mercosur national governments could retain the capacity to use procurement as a tool
for social and industrial policies (Ministry of Foreign Relations, 2004). The Mercosur
offer, however, did not include disciplines on competition policy or intellectual property
rights, the latter which are covered by the WTO/TRIPS agreements.
Although the offer included some of the new trade themes, Mercosur negotiators
argued that the proposed regulatory framework for several sectors went beyond the
agreement, meaning that the inclusion of such disciplines would require additional
conformity with domestic legislation. According to the expression used by Torrent and
Mollinuevo (2004), the framework of the agreement would be just the “hook” that would
indicate the commitment of the participating governments to further adapt their domestic
legal and policy structures.
Most noticeable in the Mercosur proposal was the interest in maintaining active
industrial policies in the realm of government procurement. In the Mercosur countries,
particularly in Brazil, state-owned companies historically carried out industrial operations
and fostered domestic industrial and R&D capacity. For example, state-owned
telecommunications firms used procurement policy to boost local supplier inputs.
67
With

67
As I have been discussing in this dissertation, new trade themes apparently limit policy capacity. On this
point see WTO (2002) and UNCTAD (2006). For a case study of government procurement in
telecommunications, domestic regulations and trade agreements, see Bastos Tigre (2003).
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the privatization of several utilities during the 1990s, prominent among them the
telecoms, the European companies emerged as main buyers of Brazilian and Argentinean
state-owned companies. Simultaneously, industrial and R&D policymaking shifted to
other governmental actors. Brazil, in fact, has recently launched instruments to encourage
private R&D. The current legal mechanisms for industrial and R&D policies in Brazil
were addressed by the PINCTE (Industrial, Technological, and Foreign Trade Policy),
which includes instruments such as the Innovation Bill (Law No. 10973, 12/02/2004),
launched by the federal government. Thus, as far as the EU-Mercosur trade negotiations
are concerned, the institutional framework for industrial policy already has been
addressed by other governmental institutions and bills within Mercosur.
With regard to investments, despite the current lack of common ground within the
EU-Mercosur agreement, European firms are already important investors in Latin
America in utilities and infrastructure. This is due mainly to the aforementioned
privatization programs undertaken during the 1990s. The degree of European FDI in the
Mercosur bloc is considerable. For example, according to IABD data, the flow of
European FDI to Mercosur grew from 0.73% of Latin American GDP in 1985-1990 to
1.37% in 1995-2000. Mercosur as a whole received more than US$200 billion of FDI
between 1990 and 2000, of which 98% went to Argentina and Brazil, mainly from extra-
regional sources (Inter-American Development Bank, "Beyond", 2002). European
companies, particularly from Spain and Portugal, were the main investors in Argentina
and Brazil in this period (Chudnovsky and López, 2000). After 2001, however,
investment flows to LAC entered a period of decline and FDI inflows from the EU
countries were also negatively affected. From a record level of €46.2 billion in 2000,
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flows receded to €5.0 billion in 2003. In just three years, Latin America’s share of total
extra-EU FDI fell from 10.6 percent to 3.6 percent. Although a worldwide phenomenon,
FDI to Latin America was particularly hit by financial turbulence of early 2000s. As the
region’s economic environment improved in 2004, European investment rebounded
strongly, more than doubling the level of the previous year. Latin America posted the
highest increase in European FDI flows among developing regions, and its share in extra-
EU FDI again rose to over 10 percent (IADB, 2006). In view of this situation, in which
economic turbulence affects the level of FDI, it is worth asking to what extent integration
commitments might act as an insurance against severe crises. Though such commitments
may not completely shield the Southern Cone economies from world economy cycles,
this possibility was not seriously considered in the EU-Mercosur negotiations.
The point constantly raised by Mercosur and the Brazilian negotiators concerned
EU pressure to commit more advanced trade disciplines in the absence of the proper
regulatory capacity, thus jeopardizing domestic policy capacity. Trade liberalization may
increase efficiency and productivity, but it is not a sufficient condition for growth and
development, particularly in a global economic order that requires other policies and
institutions, such as educational and technological capabilities (Bouzas, 2005). As the
“new trade issues” require a greater degree of domestic policy and institutional capacity,
a possible solution for this problem would be to devise, within the framework of the EU-
Mercosur agreement, trade-related capacity building and technical cooperation
mechanisms. In fact, these concerns were expressed at the outset of the EU-Mercosur
conversations. For instance, the EU offered cooperation in the field of enforcement of
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IPR legislation, expressing this in the text of the thirteenth meeting of the EU-Mercosur
committee.
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The scope of cooperation and trade capacity building goes beyond narrow trade
issues and requires a solid political commitment on the part of all involved. However,
such initiatives are often slated too broadly and are cloaked in diplomatic rhetoric about
the benefits of external relations and free trade. Mercosur and the EU, for instance, have
an Interregional Framework Cooperation Agreement, dating back to 1995 and in force
since 1999. This, however, proved to be just a fair statement of interests (Devlin et al.
2005). Recent FTA agreements between the EU and other Latin American countries, such
as Mexico and Chile, offer more concrete examples of policies to support trade–
cooperation and trade capacity building—measures that would also be beneficial for
Mercosur. Such initiatives have amounted to more serious political commitments and
have been coupled with concrete steps, such as the preparation of reports “Country
Strategic Papers” establishing a work schedule and the assignment of financial funds. In
the case of Mexico, € 8 million was contributed to support co-operation and trade
facilitation in several areas, including the regulatory, service and investment disciplines.
In Chile, € 5 million have been earmarked for trade-related technical assistance (Devlin
and Vodusek, 2003). Although these are not sizable amounts, the examples of Chile and
Mexico show that it is possible to generate concrete measures and incentives within these
free trade agreements, which offer possibilities for policy support and adjustment.

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Thirteenth Meeting of the Mercosur-European Union Bi-Regional Negotiations Committee, May 3–7,
2004. Brussels, Belgium.
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Explanations for the EU-Mercosur Stalemate – The Bureaucratic Underpinnings of
Brazilian Trade Policy
The high degree of insulation and bureaucratic divergence within the negotiation
process may be one explanation for lack the ability to reach agreement over the deeper
trade rules within the EU-Mercosur negotiations. On the EU side to date, there has been
an apparent conflict between the European Commission and the European Council, the
first being more free-trade oriented than the latter.
69
As suggested by integration theory,
the European Commission uses the EU external agenda to appease European economic
and social sectors and emphasize the benefits of increased trade. Meanwhile, despite the
Commission’s effort to push forward structural reforms in domestic policies, such as the
Common Agricultural Policy (CAP), it has failed to change the position of the European
Council on several key issues, including trade liberalization in agriculture (Faust, 2002).
An additional motivation of the Commission has been to establish trans-regional relations
that can advance the strategic interests of the EU in order to counter the U.S. influence in
the Western hemisphere (Derisbourg, 2002). Yet, these motivations were insufficient to
break the fierce domestic political economic deadlock that favored protectionist interests
in agriculture over the greater goals of trade opening and diversification of commercial
ties.
On the Mercosur side, there has been as undeniable delay in forging what
currently constitutes an incomplete customs union. The already mentioned inability to
move toward a stronger institutional framework and policy convergence in

69
The European Council is comprised of the heads of states of European countries, which are more
sensitive to political-electoral pressures and may oppose trade liberalization. The European Commission,
conversely, is backed by EU bureaucrats, with more technical and neutral positions on trade policy.
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macroeconomic, industrial, and regulatory matters, poses problems when negotiating
integration agreements with third parties (Rosemberg, 2000). A possible solution would
be to go beyond the diplomatic circuit of negotiation; by this, mean that as the trade
agenda expands in width and depth, other bureaucratic and social actors in Mercosur
should be brought into the trade negotiation process. For instance, the inclusion of
competition rules, a matter that was not even part of the EU-Mercosur proposal, would
require closer participation of several Brazilian ministries (Economy, Justice, External
Affairs) and social society representatives (groups for consumers rights, for example).
Similarly, an agreement that covers investment rules should be coordinated with the
policy directives of the responsible federal bureaucracies. Regarding governmental
bureaucracies, and as I discussed in chapter one, there is a lack of cooperation and an
informal segmentation regarding trade and financial affairs within the Brazilian
government, which undermines any negotiation strategy. As contemporary trade
agreements include disciplines on investment rules or financial services, for instance, this
separation has clearly become anachronistic. Conversely, regarding the participation of
civil society and business groups, Bonomo (2006) notes the lack of mobilization of the
business sector in trade negotiations within the EU, which did not become clear until the
very end of the negotiating process. This same pattern was observed in the case of the
FTAA negotiations.
Another possible explanation for the deadlock is the current Brazilian strategy of
participating proactively in the world trade system, which is not recent but has received a
new boost under the Lula administration (2003-now). Brazil has been seeking an active
leader within the G-20 and the G-3 (Motta Veiga, 2006; Paquin-Boutin, 2005), its goal
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being to counter the protectionism of the Northern countries in multilateral and regional
trade negotiations. In the case of the G-20, Brazil’s coalition-building is specifically
targeted toward leveling the playing field in agricultural negotiations at the WTO. Here
Brazilian diplomacy has joined with that of other emerging markets that share a similar
position in the world trade system, such as India and South Africa (the other members of
the G3). In doing so, Brazil has adopted a “South-South” discourse that has stiffened
positions against the developed countries, not only within the EU-Mercosur negotiations,
but also the FTAA, and the WTO Doha round. It is worth noting that these Brazilian
trade rapprochement projects with similar countries do not include deeper integration, not
even more concrete measures in the realm of tariff cuts. Thus, Brazil’s trade activism
within these various groupings still amounts to little more than diplomatic declarations of
mutual interest (Almeida, 2006). Finally, as Mercosur is a common market and thus
requires a joint foreign economic policy, it is worth asking, to what extent has the overall
position in the negotiating table been damaged by the recent disagreements between the
two main partners Brazil and Argentina? The very same hurdles experienced in
negotiating deeper liberalization of industrial goods with the EU and the U.S. would arise
in reaching an agreement with India and China, for example (Carranza, 2004).
In short, there should be no inherent conflict in committing toward more
comprehensive trade rules with the EU and in the FTAA, while at the same time seeking
deeper ties with the emerging market countries. However, Brazil’s ambiguous position in
trade negotiations stems from Lula’s need to appeal to a domestic audience which, due to
protectionist interests and/or ideological points of view, refutes closer ties with developed
markets.
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Summing up, if there has been any continuity to Brazilian foreign policy, it lies
historically in the search for autonomy in world affairs. Even considering common
historical ties and domestic political economies that are more akin to those of the
European countries, Mercosur’s negotiators were not able to cut a deal with the EU, or
significantly to involve other sectors of civil society in the debate. In Brazil’s particular
situation, where the main stakeholders are bureaucratic actors and the country’s
protectionist tradition was the driving force for the negotiating process, this thwarted
outcome was inevitable. Finally, though the foreign economic policy position within the
government shows some sign of conceding to certain orthodox macroeconomic
requirements, when it comes to trade issues, the autonomist/left view still prevails. The
current shift toward left wing politics in Latin America has not necessarily harmed
external commitments. In the case of Brazil, however, this trend has made the process of
negotiating deals with third parties more complex --- the probable enlargement of
Mercosur with Venezuela being a prime example. In the case of the FTAA, these political
and economic tensions are even more pronounced, as we will see in the following
section.

Section III. The FTAA: Brazil, the U.S., and the Political Economic
Hurdles to North-South Negotiations
The failure to meet the deadline to establish a Free Trade Area of the Americas
(FTAA) by January 2005 confirms the lack of common objectives and unresolved
rivalries between Brazil and the United States---the two main players at the regional
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negotiating table. At the heart of this standoff lies the determination of the U.S. to
negotiate over new trade themes such as services, investment rules, government
procurement, and intellectual property rights, versus Brazil’s concern with facilitating
market access for traded goods, including agriculture, and trade remedy measures (anti-
dumping).
Apart from these important substantive differences, there was also considerable
divergence on the possible format for the FTAA, a point related to the disagreement
regarding economic governance within the RIA. At the November 2003 Miami Summit,
Brazil and Argentina proposed a model in which different topics would be discussed on
separate tracks, instead of the initial single undertaking approach proposed all along by
the U.S. This alternative framework was meant to tackle the liberalization of trade in
goods on track one, whereas a second track would allow countries the option of joining
deeper integration arrangements involving the above-mentioned new trade themes.
Because these new trade themes were also being discussed at the multilateral level within
the Doha Round of the WTO, the South American countries argued that this second track
would gather momentum within the multilateral venue.
This FTAA à la carte was met with skepticism by U.S. and Canadian negotiators,
and even some analysts in Brazil complained that the plan would be counterproductive
and would fail to gather traction (Guilhon de Albuquerque, 2006).
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Sensing a possible
stalemate, and in line with its increasingly bilateral approach to foreign economic policy,
the U.S. then proceeded to complete free trade agreements (FTAs) with other Latin

70
Gary Hufbauer and Sherry Stephenson (2003) posited that this strategy would turn out to be a pyrrhic
victory for Brazil because it would make further liberalization discussions more difficult in exchange for an
incomplete agreement.
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America countries (U.S.-Chile) and sub-regions (U.S.-Central America) while still going
through the motions of negotiating the FTAA. Brazil countered by attempting to
negotiate an FTA between the U.S. and Mercosur, the so-called four-plus-one approach,
which fell into the same void as the FTAA (Masi and Wise, 2005). Additionally, Brazil
reinforced its autonomist foreign policy tradition and emphasized Latin American
integration, with the possible enlargement of Mercosur with Venezuela, the proposal of a
South America Community, and “South-South” talks, for example, the G-3. Yet, these
initiatives faced distant negotiation hurdles, particularly within Mercosur, and stalled at
the level of diplomatic rhetoric.
This section analyzes the political and economic issues that divided Brazil and the
U.S. at the FTAA. The stalemate surrounding the FTAA negotiations is related to the
high levels of asymmetry between the countries involved and hence the differing goals
that sunk the negotiations. Whereas in Brazil the FTAA discussion was contentious and
highly politicized, especially concerning the country’s ability to commit quickly to the
new trade themes, in the U.S. a general apathy and lack of interest in the FTAA rendered
it a low policy priority. My main hypothesis concerns the inability of Brazilian
policymakers to surrender a managed trade policy and to commit toward challenges
posed by the new regionalism and by globalization.
In the bigger scheme of things, Brazilian negotiators would need to take a more
objective stance with regard to the costs and benefits of signing on to a project such as
the FTAA. In other words, although a market opening for trade in goods is important, the
achievement of this goal would inevitably require inclusion of the deep integration issues
favored by the United States. After all, the original justification for pursuing the FTAA
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was the prospect it held for achieving WTO-plus outcomes within the new trade issues
areas; in the absence of these outcomes, the FTAA has become a moot point
In analyzing the position adopted by Brazilian and U.S. actors at the FTAA
negotiations, I rely on political economy explanations proposed at the outset of this
dissertation and previous chapters: endogenous trade policy, new growth theories and
political science models of bureaucratic politics. This section emphasizes the former two.
Concerning the latter, I have already discussed the Brazilian case in more detail in the
first chapter, and thus, in this section I focus on the U.S. case. The following sub-section
reviews these theories as they apply to the varying trade stances of Brazil and the U.S. A
next sub-section relates Brazilian and U.S. negotiating positions and demands to the
broader international trade strategies of the two countries.

Brazilian and U.S. Domestic Political Interests in the FTAA
Endogenous Trade Policy Models
Endogenous trade theories seek to explain domestic trade policy and politics by
applying economic models to political scenarios. The domestic political economy is
treated as a market in which there is supply and demand for protectionist or liberal trade
policies. Ronald Rogowski (1989), for example, was one of the first to use a neoclassical
model like Heckscher-Ohlin (H-O) to explore how trade impacts the political behavior of
domestic actors, and in doing so showed how endogenous trade theory can serve as a
useful explanatory tool.

According to the H-O model, those political actors who own the
less abundant factors of production (e.g. some combination of capital, labor, or land) will
lobby against openness and regional integration. At the same time, those political actors
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who own the abundant factors will support trade liberalization and will lobby in favor of
negotiating an FTA. The H-O theorem asserts that openness will decrease the welfare of
the owners of scarce factors and increase that of the owners of the abundant factors.
Endogenous trade policy models thus allow for variations in domestic political
responses. Another such model by Stolper-Samuelson recognizes, for example, that
lobbying activity may occur along factor lines (e.g. capital versus labor) while the
Ricardo-Viner-Carnes model holds that lobbying can also fall along industry lines (e.g.
importing-competing versus export-oriented sectors). Magee et al (1989) interpret trade
policy outcomes within the context of a democratic regime, whereby competing parties
declare their respective positions, industries then lobby and make party donations that
will advance their own welfare gains, and the parties then use this campaign financing to
influence misinformed voters. In another variation, Grossman and Helpman (1994)
explain protectionism as a function of the structure of industrial organization, trade
dependency and the elasticity of import demand or export supply. The Magee et al
approach suggests that trade policy may vary markedly with a change in government,
while the Grossman-Helpman model implies that political capture by vested interests
perpetuates a stable or more slowly changing equilibrium for trade policy (Noland, 1997).
Endogenous trade policy offers potentially important insights for analyzing the
U.S. and Brazilian cases. Although most often applied to political behavior within sectors
involving traded industrial goods, endogenous trade policy models can also shed light on
political positions assumed within the new trade issues such as services and intellectual
property rights. In the case of Brazil, where capital and knowledge-based factors are
scarce, the owners of these scarce factors have resisted all but a gradual liberalization in
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these sectors. Canuto et al (2003) have analyzed the possible impact of the liberalization
of services within the FTAA on selected Brazilian sectors (Health Insurance, Credit
Export Insurance, Land Transportation, Engineering, Accounting and Legal Services), all
of which are characterized by low levels of foreign investment.
Their study suggests that the liberalization of these service lines would bolster the
ability of Brazilian companies to operate in hemispheric markets, but that the adjustment
costs would also be steep. This is because U.S. and Canadian companies would be fully
positioned to dominate the national market and the majority of Brazilian firms are still
not prepared to meet the competition. The study concluded that the kinds of regulatory
harmonization intrinsic to an agreement in services under the FTAA would benefit those
companies already adhering to international regulatory standards and offers them
competitive advantage vis-à-vis Brazilian companies. Political behavior was not
considered in this study, although one could infer that the highly complex domestic
regulatory framework that governs Brazil’s services sector, including constitutional
clauses against foreign participation (e.g. in the case of health services), presents high
barriers to entry and strong protection of Brazilian interests.
The electoral hypotheses of Magee et al are less compelling in terms of the
Brazilian case, as foreign trade policy still does not hold much appeal for the political
parties and a large share of the electorate. Most often, trade discussions are confined to
specialized groups. The Grossman-Helpman assumptions about political capture seem
more apropos for Brazil, as trade policy debates are basically limited to those with ready
access to small pockets of the Brazilian bureaucracy that deal with trade and industrial
policy. Broadly speaking, the agencies and ministries responsible for trade and,
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particularly, industrial policy have been historically stacked with political rather than
technical appointees, though this picture has changed recently. The world view from a
diplomatic corps that wishes to avoid or delay further integration with the U.S. also
prevails (Viola, 2005; Albuquerque, 2003). The bias toward protection is reflected in
higher tariffs for value-added sectors such as electronics in Brazil, and exceptions for the
automotive sector under Mercosur (Leipziger et al, 1997; Costa Vaz, 2004). As the costs
of protectionism increase for those producers with a comparative advantage for exports,
such as agriculture and select industries, some pushed for a more ambitious and realistic
approach to the FTAA, including the willingness to concede in negotiating over the new
trade themes (Albuquerque, 2004-05).
In terms of the U.S. case, Noland (1997) applies endogenous trade theory to the
behavior of the USTR during the administrations of Reagan, Bush (1988-1992) and
Clinton. Overall, he finds that there is no policy variation between these different
administrations: all used retaliatory actions against other countries according to the size
of the trade deficit a given country was running with the U.S. Despite the fact that the
stakes are lower than those involving big markets such as the EU and Japan, the same
pattern of behavior held in the U.S. commercial relationship with developing countries.
That is, it engaged in similarly protectionist legislation, for example, against Brazil in the
late 1980s with regard to disputes over intellectual property rights.
Within the FTAA process, this easy resort to protectionism was also apparent.
U.S. apparel and textiles led the charge, as has steel and agriculture (Schott, 2003). The
endogenous trade policy logic does seem to hold for the U.S., the agricultural sector
being a case in point. Technological advances have rendered some products competitive
189
(soy and corn) against Brazil, but not others (orange juice concentrate, sugar, cotton).
U.S. producers of these latter crops would be worse off under the FTAA and therefore
pushed for further protectionism under the rubric of the U.S. Farm Bill. In the Western
Hemisphere, Argentina and Brazil have been especially harmed by U.S. agricultural
measures and this caused Latin American negotiators to be wary of U.S. at the FTAA
negotiating table. Despite the fact that the Bush administration bears high fiscal costs for
its agricultural policy, the executive branch has only committed to a slow phase-out of
agricultural subsidies through negotiations at the WTO.
Ultimately, the impulse for further trade opening in the U.S. will come from
representatives of the services and knowledge-intensive sectors. As the owners of
abundant factors---knowledge and capital---these groups will largely benefit from the
liberalization of trade in services, including telecommunication, banking, insurance and
investment. A coalition of these groups helped secure the Trade Promotion Authority
(TPA) bill for the George W. Bush administration, although their pro-trade lobbying for
the FTAA failed to keep this initiative alive in the U.S.
71
Yet, as I discussed in the
previous chapter, the upsurge of India and China in world markets with the outsourcing
of IT jobs may create protectionist demands even in the capital intensive sectors, though
the companies may still favor liberalization. In the next chapter, I discuss how factor
coalitions may change due to globalization phenomena (Rogowski 2004).

71
For more on the pro-trade position of these groups see the websites for: the Coalition of Service
Industries (www.uscsi.org), the National Council for Foreign Trade (www.nftc.org), and the National
Association of Manufacturers (www.nam.org). The latter organization published a memorandum of
understanding with the Federation of Industries of Sao Paulo, Fiesp, the most powerful business association
in Brazil, in January 2005 supporting the resumption of the FTAA negotiations.
190
Summing up, endogenous trade policy models provide convincing explanations
for the respective Brazilian and U.S. stances in the FTAA. This is especially true for the
differing attitudes of Brazilian industrial and technological sectors, which fear integration
because they are less competitive compared to their U.S. counterparts, whereas those
same groups in the U.S. welcome a stronger hemispheric trade/regulatory environment as
a favorable change. The same logic applies to U.S. sectors that are labor intensive, which
stand to lose by liberalizing trade with those labor abundant sectors in Latin America. A
main oversight of endogenous trade policy analysis is that it does not consider the
importance of intra-industry trade and spillover effects in knowledge intensive sectors,
which can provide much of the rationale for trade integration. In the following section, I
discuss this literature and apply it to the cases of Brazil and the U.S. in the context of the
FTAA.
New Growth Theories: Economic Dynamics and Political Cleavages
Despite the asymmetries between the United States and Brazil, and with proper
preparation and reform of the sectors at hand, new growth theory explanations suggest
that with a combined increase in research and development (R&D), technology
adaptation, and competition policies, Brazil could achieve higher levels of sustainable
growth by completing the FTAA. This is partially because of the high levels of intra-
industry trade between Brazil and the United States. The international political economy
literature convincingly portrays the role of intra-industry trade as an impetus for
liberalization, and for productivity growth, as discussed in chapter two.. However, few
political economy analyses focus on the role of intra-industry dynamics in shaping trade
policy in Brazil. A considerable literature, for example, assesses the influence of intra-
191
industry trade in the U.S. decision to pursue NAFTA, as transnational companies sought
to access markets and lower their input costs.
72
Regarding the competitive aspects of
trade liberalization under regional agreements, North-South regionalism does not always
enhance competition. In rules pertaining to FDI participation, for example, Chase (2004)
posits that regionalism can be a mechanism used by incumbent firms to protect
themselves from pressures coming from increased global competition or to delay the
entry of new participants in a given market. Olerreaga and Soloaga (1998) also discuss
these non-competitive aspects of RIAs, in the case of the relatively protected automotive
industry in the Mercosur. Yet, in North-South integration, along the lines of the FTAA,
econometric models point to the welfare enhancing effects, as I discuss below.
In the FTAA discussions, those sectors and industries that pushed for a more
comprehensive liberalization of services, investment and intellectual property rights
mainly belonged to the most dynamic/knowledge intensive sectors of the U.S. economy.
Ostensibly, these same sectors should be lobbied for the FTAA in Brazil, since they are
dominated by multinational companies that similarly favor trade integration as a way to
maximize on technology, productivity and specialization. While political constraints
overshadowed the enthusiasm of an FTAA in both the U.S. and Brazil, the latter has
begun to take some concrete steps in these areas.
Recently, the Brazilian government launched a new industrial policy (PITCE) to
stimulate the linkage between R&D and the private sector. Also, a new innovation bill
was approved before the Brazilian Congress and a debate on how to better foster R&D

72
On intra-industry trade, see Pastor and Wise (1994); Milner, (1997); and Chase (2003). On NAFTA see
Orme, (1996); Mansfield and Milner, (1997); Haggard, (1997); and Cameron and Tomlin, (2000).
192
investment by the private sector is underway.
73
By the same token, the government has
encouraged new investments in infrastructure through partnerships between private and
public agents (The Economist, May 2004). Partly due to these efforts, Albuquerque
(2004-05) notes that those sectors most exposed to international competition since the
first phase of trade liberalization (agriculture, shoes, and textiles) perceived the
advantages to be had by Brazil’s membership in the FTAA, such as cheaper access to
capital goods, production inputs and technology.
Yet, there is still not enough debate that connects issues of economic
competitiveness and the new trade themes with Brazil’s broader trade strategy. On the
contrary, some within the Brazilian diplomatic corps continue to argue that the inclusion
of new trade themes in the hemispheric integration agenda would only “put the future of
the country in jeopardy” (Rossi, 2003: B02). Despite the fact that intra-industry trade is
an important part of Brazil’s bilateral exchange with the U.S., or that the Mexican market
is an increasing destination for automotive exports from Mercosur, closer ties with the
NAFTA countries in the FTAA was not regarded by many in the Brazilian diplomatic or
business community as important for the country’s competitive upgrading.
In the U.S., the issues intrinsic to new growth theories are part and parcel of the
integration debate. Business sectors in the U.S. perceive that the outsourcing of low-
wage production and value-added services, such as software and call centers, are welfare
maximizing and resource saving. As trade liberalization and intra-industry production
have placed a premium on increased economies of scale and the clustering of factor

73
In line with these directives, the Brazilian government created an Agency for Industrial Development
(ABDI) in January 2005 in order to co-ordinate industrial and technological policies, including input from
domestic actors.
193
inputs, U.S. policy preferences have changed (Schiff and Winters, 2003). The case of
NAFTA shows that U.S. companies in leading North American sectors like autos and
electronics moved their operations to Mexico in search of more cost effective production
curves. The upsurge of China and India increases such trends and poses new challenges
and opportunities to firms and consumers in the United States.
In the FTAA, the same incentives were present, as reflected by the lead role that
knowledge-based and service-oriented industries in the U.S. took in lobbying for it. For
the U.S. business sector, the liberalization of regulatory frameworks in Latin America
would make it possible to invest in several sectors currently characterized by high
barriers to entry, such as energy, mining and communications. The main incentive for
U.S. sectors is that the FTAA would have allowed for the design of more comprehensive
rules and would involve considerably fewer actors than in Doha-WTO negotiations.
Despite the fact that the potential gains from an FTAA would outweigh the losses,
there is little ground for optimism, as political-ideological interests in both the U.S and
Brazil superseded the discussions. Quantitative research - computable general
equilibrium (CGE) models – has estimated the economic welfare gains of trade
liberalization under unilateral, multilateral and regional scenarios. The aforementioned
Michigan Model of World Production and Trade shows that an FTAA would increase
economic welfare of member countries by $118.8 billion, with the largest increases
ensuing to the United States ($67.6 billion) and to South America ($27.6 billion) (Brown,
Kiyota and Stern, 2005). Non-trade costs and benefits are difficult to gauge, though. For
example, trade liberalization inevitably entails FDI flows and institutional reform, but
also comprises domestic adjustments, such as bankruptcies and labor-market
194
displacement. RIAs are often trade-diverting in terms of their impact on non-members.
Ultimately, economic theory holds that trade liberalization under RIAs may spur dynamic
growth and enhance productivity, but it would take a few years following the
implementation of an FTAA before such an evaluation would be possible. For now, it is
apparent that Brazilian negotiators did not fully consider these numbers and instead
surrendered to protectionism.
On the other hand, quantitative research that estimates the static effects of an
FTAA clearly show welfare gains for Brazil (World Bank, 2004).
74
These gains will be
greater for those poorest households, where the most abundant factor, unskilled labor, is
concentrated. Protection in Brazil favors capital intensive manufacturing relative to
unskilled labor intensive agriculture and manufacturing, therefore, trade liberalization
raises the return of unskilled labor relative to capital, thereby helping the poor.
Based on recent global trends and due to the untapped dynamic possibilities,
capital intensive industries may also be able to accrue gains. For example, figures from
the U.S. State Department show that technology-intensive goods are now the largest
export sector of the middle-income developing countries (Hasset and Glassman, 2003).
75

According to this same data, information and communication technologies represent
US$450 billion in exports from the developing nations, compared with US$235 billion

74
For a shorter version of this World Bank study, see Harrison, Rutherford, Tarr and Gurgel (2004). These
papers are based on a static CGE model using the GTAP 5.0 database. According to the results,
liberalization under an FTAA would provide net welfare gains for the Brazilian economy. Results are also
positive in other scenarios such as a Mercosur-EU agreement, multilateral tariff liberalization, a WTO
Doha agreement, and even with a Mercosur unilateral tariff cut of 50%. These studies find that the poorest
households in Brazil would experience percentage gains of between 1.0 to 5.5 percent of their consumption,
about three to five times the average for the country.
75
See also National Science Foundation Division of Science Resources Studies, “Latin America: High-
Tech Manufacturing on the Rise but Outpaced by East Asia,” 2002.
195
for raw materials and US$405 billion for low-tech goods. Latin America fits into this
mold, as data from the National Science Foundation show an increase in higher-tech
exports from this region, with the U.S. as the main importer.
76

The National Science Foundation report also notes that there has been an increase
in private R&D expenditures in the region, as the subsidiaries of U.S. companies
increased their share of investment four-fold from 1990 to 1996. In Brazil, for instance,
such investments grew from US$113 million to US$489 million during this same time
span. With regard to the particular relationship between the U.S. and Brazil,
manufactured products and intra-industry trade now account for 70 percent of U.S.
exports to Brazil and almost 75 percent of Brazilian exports to the U.S. (Fishlow, 2004).

Although numerous factors help shape a given investment decision, the fact that countries
in the region would be trading higher value-added goods and operating according to the
same rules within an arrangement like the FTAA indicates a better probability that FDI
will increase. Overall, these data show that the forces of economic dynamism, driven by
intra-industry trade and technological spillover effects, are already at work in the
relationship between the U.S. and Brazil. In turn, this structural logic provides at least
some incentive for U.S. actors to engage in closer trade and investment ties with Brazil.
To the extent that these sectors failed to mobilize in actually launching the FTAA reflects
their inability to exert influence over entrenched bureaucracies in Brasilia and
Washington, which is the focus of my analysis in the following section.

76
National Science Foundation Division of Science Resources Studies, “Latin America: R&D Spending
Jumps in Brazil, Mexico, and Costa Rica” 2002.
196
Brazil and U.S. Trade Strategies
Clashes between the United States and Brazil in multilateral trade talks are not
new, nor did they start with the advent of the Doha Round in 2001 or with the election of
the left-leaning Lula administration in 2002. As Albuquerque (2003, 2006) points out,
even during the more market-oriented administration of President Fernando Henrique
Cardoso (1994--2002), the initial years of the FTAA negotiations were characterized by a
defensive position on the part of the Foreign Affairs Ministry. This trend has increased
under Lula, because the leading senior diplomats appointed from his Labor Party are now
formulating Brazilian foreign policy and remain biased in favor of an import substitution
industrialization strategy (Viola and Pio, 2003). This said Brazilian international relations
in recent years, and the position of the Foreign Affairs Ministry and parts of civil society
as well, have been characterized by a considerable degree of dogmatism and even anti-
Americanism on certain issues, trade being one of them. Given that the Ministry of
Foreign Affairs has had the higher profile in FTAA negotiations, it is no wonder that the
trade talks have faltered.
Regarding U.S. trade policymaking, there are some similarities with Brazil but
also some important differences. The U.S. trade bureaucracy is also spread across several
departments, such as Commerce, Treasury, Agriculture, Labor, State, and the USTR.
Executive-level advisers in the cabinet also play an important role in foreign economic
policymaking. But at the end of the day, the executive office is instrumental in bringing
trade policy to center stage (Destler, 2007). Along with the institutional landscape, the
economic ideology of a given administration can therefore be crucial for the importance
that trade will assume on the national agenda. The early Clinton years proved, for
197
example, that an administration’s commitment to the idea of free trade can transcend
opposition within the president’s own party.
The U.S. Congress is certainly more powerful in influencing trade policy
outcomes than is the Brazilian legislature. This is evident in U.S. protectionist legislation
that has had considerable impact on the regional trade negotiation process and confirms
that parochial interests are never far from the surface of U.S. congressional politics. As
noted in a March, 2005 issue of the Economist, U.S. trade policy suffered at the hands of
the George W. Bush administration, despite its rhetorical commitment to liberal
economic principles. This appears to be due, first, to the USTR’s lack of leverage within
the administration and to the turnover of two trade representatives between 2005 and
2006; and second, to the low levels of international economic expertise within the Bush
cabinet---until, that is, the 2006 appointment of Wall Street’s Henry Paulson as secretary
of the U.S. Treasury. The commitment and leadership of the USTR seems important in
influencing the U.S. Congress on trade issues, the FTAA and Doha included. During the
brief stint of the very capable Rob Portman as the U.S. trade representative, Congress
ratified the Central American Free Trade Agreement (CAFTA).
Whether the U.S. bureaucratic process and ideological commitment toward free
trade could maintain momentum under Portman’s replacement at the USTR (Susan
Schwab) was a source of doubt even before the 2006 U.S. midterm elections. Now, with
the Democratic Party in control of both houses of Congress and the appointment of some
avowed protectionists to key trade-related congressional committees, the prospects for
reviving the FTAA and the Doha negotiations have become all the more remote
(Fergusson, 2006). The election of Democrat President Barack Obama and the deepening
198
of macroeconomic imbalances derived from the 2008-09 financial market crisis add
complexity to trade policymaking and to the historically contentious relations between
the Legislative and the Executive on this issue.

Brazil’s External Ambitions and Strategy
Apart from the FTAA, Brazil has recently sought to deepen trade integration with
a number of commercial partners, including the enlargement of Mercosur with other
Latin American countries (Venezuela), and the Andean Community. In addition, Brazil
has been active on the multilateral front at the WTO. Historically, Brazil’s trade strategy
has been to promote the multilateral forum of the GATT/WTO as the best option for
developing countries to challenge the economic hegemony of the developed countries.
The current Labor Party government (2003-present) has been forthright in pushing this
line of Brazilian economic foreign policy, which has been especially apparent since the
launching of the Doha Development Round in 2001 (Masi and Wise, 2005).
At the Doha WTO meetings, Brazil and other countries that share similarities as
large developing economies moved to form the G20 group, its purpose being to present a
joint proposal for the liberalization of crucial markets (agriculture) and to protest the
distorting consequences of subsidies upheld by the developed countries. Within the G20,
Lula’s government has pursued the goal of expanding bilateral trade among big emerging
market economies like China, India, Russia, and South Africa, which have now become a
priority in Brazilian commercial policy.
77
This is so despite the fact that these markets

77
See “The Americas: Looking South, North, or Both? Brazil’s Trade Diplomacy,” Economist, February 7,
2004, p. 51. For a more sympathetic interpretation of Brazil’s trade policy, see William Greider and
Kenneth Rapoza, “Lula Raises the Stakes,” Nation, December 1, 2003, p. 11.
199
accounted for only 3.4 percent, 0.5 percent, 1.9 percent, and 0.6 percent, respectively, of
Brazilian exports in 2001 (Paiva Abreu, 2001). But Brazil’s emphasis on a multilateral
and autonomous strategy is understandable since its exports to large trade partners now
render the county a truly global trader. Brazil’s exports in 2005 were 22.4 percent to the
EU, 19.2 percent to the United States, 8.4 percent to Argentina, and 3.4 percent to
Mexico. Non-traditional markets accounted for 37 percent of Brazilian exports in that
year.

Table 12: Brazilian Exports by Main Markets, 1997, 2004 and 2005.

The biggest challenges for Brazil to overcome regarding either a regional (FTAA)
or multilateral (Doha Round) deal are the political and economic obstacles to integration
with the more advanced economies. Obviously, for many small Latin American nations
with non-diversified economies the stakes for achieving WTO-plus outcomes are very
high. In Brazil the prospect of joining an FTA with the biggest and most advanced
US$ billions % of total US$ billions % of total US$ billions % of total
53,0 100,0 96,5 100,0 118,3 100,0
14,5 27,4 24,6 25,5 26,5 22,4
9,4 17,8 21,3 22,1 22,7 19,2
6,8 12,8 7,4 7,6 9,9 8,4
1,1 2,1 5,4 5,6 6,8 5,8
0,8 1,6 3,9 4,1 4,1 3,4
3,1 5,8 2,8 2,9 3,5 2,9
17,3 32,7 31,0 32,1 44,8 37,9
Russia 0,8 1,4 1,7 1,7 2,9 2,5
South Africa 0,3 0,6 1,0 1,1 1,4 1,2
Iran 0,2 0,5 1,1 1,2 1,0 0,8
Uruguay 0,9 1,6 0,7 0,7 0,8 0,7
Paraguay 1,4 2,7 0,9 0,9 1,0 0,8
Sources: Central Bank of Brazil and Brazilian Ministry of Development, Industry and Foreign Trade
1
Includes Puerto Rico.
Others
European Union
USA
1
Argentina
China
Mexico
Japan
1997 2004 2005
Total Exports
200
economy in the world creates economic opportunities, but also complex problems. These
challenges coincide with Brazil’s need to undertake deeper market reforms to
complement and sustain the rules around the new trade issues (Pastor and Wise, 1998;
Navia and Velasco, 2003) Modernizing reforms are needed, for example, to improve
economic institutional structures, to enforce property rights, and to encourage more
flexible rules for investment and to foster innovation. Broadly, Brazil will require a
much-upgraded institutional and regulatory environment to succeed in a technology-
driven world economy.
78
Brazil’s cautious and piecemeal approach to foreign economic
policymaking hinders this process.
The connection and complementarities between deeper reforms and further trade
integration has yet to be fully appreciated by Brazilian economic actors and
policymakers. Although the Lula administration has committed to pursuing the new trade
issues at the WTO, with the breakdown of the Doha negotiations the FTAA would have
ostensibly been a viable fallback strategy. But the reluctance of political and economic
elites to broach the discussion of deeper integration within Doha, the FTAA, and even the
EU-Mercosur talks, has foreclosed all of these options for the time being. This political
intransigence defies the economic realities. First, sectors damaged by U.S. competition
could surely be won over with the promise of some transitional support from the
government (Mesquita Machado and Ferraz, 2005). And second, the long-term benefits
of conceding on the new trade issues could mean a sizable increase in Brazil’s
international economic standing. While the habit of sitting on the fence politically in the

78
For instance, a sound regulatory environment creates incentives for foreign investment in knowledge-
intensive sectors such as telecommunications and services. Similarly, a modern and enforceable intellectual
property rights regime is more likely to stimulate investment in R & D and to foster human capital
development.
201
face of badly needed economic reforms is common to the Latin American region, by
continuing to do so Brazil risked an incredible opportunity to break out of this mold.
U.S. Reactions and Reticence
Since comparative advantage for the United States has come to rely primarily on
trade in services and high-technology products, the prompt liberalization of Latin
America’s barriers in these areas would pave the way for a major incursion of U.S.
service-based companies into the region. Hence U.S. interests in gaining deeper access to
Latin American markets, especially in South America, have been concentrated on these
sectors at the WTO. Since the outset of the FTAA proposal in 1994, the U.S. position has
been that the FTAA would be meaningful only if it reached beyond what the WTO had
accomplished with regard to these new trade issues: steeper liberalization in traded
services and investment, the opening up of government procurement, the quick and
comprehensive enforcement of intellectual property rights, and even the inclusion of
labor and environmental issues on the trade negotiating agenda.
U.S. objectives in the hemisphere must also be considered in light of the
difficulties that have surrounded efforts to complete the Doha Development Round at the
WTO. For some, the gradualist and piecemeal nature of hemispheric integration under the
auspices of the FTAA seemed a more promising option for the United States (Weintraub,
2001). Just as NAFTA enabled its members to advance in areas that had eluded
agreement at the Uruguay Round (dispute settlement, services, investment, intellectual
property rights), the FTAA could have provided incentives for negotiating breakthroughs
at the multilateral level. This appeared to be happening in 2004, when the United States
202
and the EU expressed a willingness to negotiate the reduction of agricultural barriers at
the WTO (Narlikar and Tussie, 2004)
79
.

Yet it was also the intransigence of both on this front that led to the 2006
breakdown of the WTO negotiations. Faced now with the collapse of both the WTO and
FTAA negotiations and the recent election of a U.S. Congress even more suspicious of
trade deals than its predecessor, and the global downturn, the U.S. ability to provide the
necessary leadership seems greatly diminished. Concerning U.S. interests in hemispheric
integration, two additional points should be emphasized. First, the FTAA was originally
viewed by the United States as a means of strengthening its own bargaining position with
regard to Europe and East Asia. This is so in a direct sense, as the United States continues
to seek greater access to European and Asian markets and as it has pursued these same
goals within the WTO’s multilateral framework. Second, the FTAA is the only regional
process that promised to promote Latin America’s global ties while retaining the United
States as the main hub.
Relegating Latin American countries to be spokes to the U.S. hub would allow for
the elimination of the patchwork of sub-regional preferences that has evolved since the
early 1990s. However, whereas Latin American countries deemed the hub-and-spoke
model acceptable and even desirable a decade ago, many have now rethought this stance.
The persistence of intraregional asymmetries and the disappointing returns on trade
liberalization and market reforms are behind this change of heart, and nowhere this is
more apparent than in Brazil. Ironically, this is so despite the country’s impressive trade
advances.

79
See also Sing (2004).
203
Brazil’s Prospects in Retrospect
While Brazilian negotiators insist that the FTAA is only one of several options for
the country’s trade strategy, this specific integration project had important consequences
for the economic advancement of the country. With the usual delays in the multilateral
trade arena and with increasing competition from Chinese goods in world markets, the
FTAA could constitute the logical next step for sustaining the external trade boom that
has seen a doubling of Brazil’s share of exports in recent years: from 9 percent of GDP in
1990 to 16 percent in 2003. The trick would be to finesse the antitrade bias on the
domestic political front and to tilt responsibility for the reactivation of hemispheric and/or
multilateral talks toward the economic ministries and export-oriented interests.
As Brazil is a pluralistic and complex society, the challenge is to further broaden
the trade policy debate to include not only the official and business positions but also
opinions from the media, academia, and labor. Some of these civil society sectors have
already embraced the notion that integration is an important instrument for the
modernization of the country within today’s highly competitive global context. These
sectors have also gradually accepted the inevitability of incorporating environmental and
labor standards into trade agreements, as well as the imperative to address related social
issues.
Again, quantitative assessments so far show that the poorest households and the
most unskilled laborers will benefit the most from further trade liberalization. These
findings may lead some sectors to support trade agreements, particularly with the United
States. The 2006 reelection of President Lula and his pragmatism concerning economic
affairs may also give extra impetus to trade talks and help diminish the influence of stiff
204
ideological positions. Yet as the Mexican experience with NAFTA has shown, trade
liberalization under a North-South FTA is no panacea: concurrent institutional
modernization is crucial for realizing the projected gains.
80

For the United States, where the stakes in an FTAA have always been low, the
challenge for incumbent administrations is to publicize the economic and political
benefits of trade agreements, such as the FTAA. The acrimony that surrounded the U.S.
domestic debate over the passage of the trade promotion authority legislation and then the
CAFTA agreement revealed that the completion of the FTAA from the U.S. vantage
point would require executive leadership and statecraft. With the collapse of the FTAA
and Doha negotiations, the Bush administration simply failed to rise to this occasion. As
the U.S. Congress continues to oppose even small initiatives involving trade policy (for
example, bilateral deals recently negotiated by the USTR with Vietnam and Colombia), it
seems likely that U.S. trade policy will remain on hold until after the 2008 presidential
election. Thereafter, a main task will be to work to convince domestic import-competing
sectors and labor and environmental groups that the benefits of further trade agreements
will outweigh their costs. The fast approval of the US-South Korea bilateral trade
agreement, just days before TPA expiration, indicates that when the stakes are higher,
executive leadership can overcome legislative anti-trade biases.
With regard to the FTAA, the quantitative evidence to date shows its potential to
spur economic growth, foreign direct investment, and the transfer of technology (Brown,
Kiyota and Stern, 2005). But the onus was on U.S. politicians and policymakers to

80
Tornell, Westermann, and Martinez (2004) discuss the case of Mexico under NAFTA. According to
these authors, the lack of a proper regulatory framework, a domestic credit crunch, and lax judiciary
enforcement created strains and bottlenecks within the domestic economy that impeded the realization of
NAFTA’s full benefits. See also Wise (2007).
205
publicly convey these findings and to use them to forge the kind of coalition that came
together to support the NAFTA agreement. Granted, Mexico’s struggles to succeed under
NAFTA may have had a negative demonstration effect on Congress and the U.S. public,
but rather than shun future trade deals with developing countries, the parties should
directly address the adverse aspects of NAFTA and negotiate within those areas, like
market access and agriculture, that directly address the asymmetries. In this respect,
Brazil’s insistence on gradualism---on holding out for agricultural and market access
concessions from the United States before signing on to a new trade agreement---
represents an important departure from Mexico’s strategy in negotiating NAFTA.
This chapter’s main objective was to assess the North-South regional negotiations
in which Brazil has been involved. Regional trade integration with developed countries
would require steep domestic adjustments – particularly in the Western Hemisphere
where the U.S. economy dwarfs other countries. Brazilian policymakers still regard
globalization cautiously, rather than as an opportunity and they propose, on the external
front, an alliance with similar countries (BRICS, G-3) as a mechanism to correct the
asymmetries in the world system and to deter the deleterious consequences of the market
driven global order. Conversely, on the domestic realm, they propose an economic model
based on state regulation of market forces, through public-private partnerships in infra-
structure investments, for example. The recent governments have crystallized the
historical trend of managed trade and industrial policies.
However, the complexities of economic and political ties with more advanced
countries indicate that Brazil would have a lot to gain from integration with developed
democracies that foster liberal political and economic reform. Brazil could seek this
206
rapprochement and still maintain its independent foreign economic policy. Instead, the
North-South trade negotiations of the mid-2000s were poisoned by the lack of
pragmatism – an expression that senior diplomats and commentators like to use, but not
apply.

Section IV - Conclusion
Domestic Obstacles, International Crises and Brazil’s Place in the World Economy
By the late 1980s, the failure of the ISI model in Brazil was reflected in the
conspicuous levels of state economic intervention and the favoring of special interest
groups; the effectiveness of public policies had dwindled and large segments of the
population were economically bereft. Because countries such as Argentina, Brazil and
Mexico benefited from a favorable world economy in the early post World War II period
and from cheap international bank loans in the 1960s and 1970s, the ISI strategy endured
long past its efficacy. From 1950 to 1980, for instance, Latin American GDP grew at an
average of 5.5 percent a year (2.7 percent per capita), and high domestic investment
ratios sustained these vigorous rates (French-Davis and Ocampo, 2002). When the initial
high rates of investment waned, protected social groups, such as industrialists, continued
to demand favors. The intrinsic inability of Latin American states to perform basic tasks,
while public spending and special privileges soared, explains the resilience of several
domestic sectors in pushing for protection, despite the financial strains and lack of
economic competitiveness. Market reforms since the late 1980s have attempted to re-
establish the fading credibility of Latin American states in the eyes of the international
community.
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Yet, as I discussed in chapter one, there has been a failure in Brazil and in other
Latin American countries to credibly commit to further trade liberalization and the
enactment of deeper institutional reforms during the 2000s. Long lasting characteristics
of the Brazilian domestic policymaking apparatus explain this reform delay. The financial
crisis of the mid-1990s and 2000s, with deleterious domestic macroeconomic
consequences, also created a backlash against further economic reform, including trade
liberalization (Panizza and Yañes, 2006). The more recent financial crisis experienced by
countries that adhered to strict free-market rules makes it doubly difficult to convince
domestic audiences about the benefits of liberalization. Although this debate is beyond
the scope of this dissertation, the downturn in world markets further tempts policymakers
to try and shield the country from the vagaries of the world economy through measures
that protect special interests. As I will discuss in the next chapter, protection and support
doled out to special interest groups (industries) has endured the economic reforms in the
1990s, not to mention several financial crises.
In the case of Brazil, the international financial community did not falter in
providing credit during the 1999 financial crisis, when the U.S. Treasury Department
provided a US$42 billion bailout package. U.S. and international support was also
fundamental at the onset of the 2002 presidential elections to tame wary financial markets
about the possibility of the election of a left wing President (Sachs 2000; Eichengreen
2002). Confidence then was regained when Lula’s incoming economic team reinforced
its allegiance to orthodox economic policies. These actions were important to help the
country re-assure investors about its commitment toward macroeconomic soundness and
contributed to a favorable end of the crisis. Macroeconomic stability finally became a
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reality in Brazil, up to the point that the country began repayment of its IMF loans in
early 2006.
There has subsequently been a backlash of domestic politics concerning further
market reform, for complicated reasons. First, the state cannot credibly commit to these
reforms because of their asymmetrical distributive consequences among constituents,
most prominently the favored business groups. Second, entrenched interests refuse to
cooperate, adding pressure for the curbing of deeper reforms. Brazil’s difficulty in further
advancing a regulatory and institutional agenda in trade agreements can be explained by
this lack of consensus concerning increased competition in the economy, which will
clearly produce winners and losers. Finally, party and legislative politics have constituted
an additional setback in advancing these reforms. There has been a shift in executive-
ruling party relations, which obliges the executive to use pork in order to advance
structural reforms. This trend has been reinforced by Lula’s team, which has weakened
regulatory agencies and filled technical appointments with party members.
It is thus no coincidence that the Regulatory Agencies Law and the Competition
(Antitrust) System reforms have remained stuck in at the Congress since Lula’s first
presidential term. The rise of technopols, which overshoot reforms as a symbolic
instrument to gain the confidence of international markets, and as expressed in the high
qualifications of officials at the Finance Ministries and Central Bank, does not disguise
the fact that the executive is entangled in a precarious political coalition that impedes
public policy management capacity in key areas. The Federal executive has to offer
targeted favors to compensate both the potential winners and actual losers, while at the
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same time needing to entice foreign investors, i.e. offering concessions of exclusivity,
weak regulatory mechanisms, lax enforcement of anti-trust laws, and license guarantees.
The current trade strategy of the Labor Party government favors the overseas
expansion of Brazilian conglomerates. This has been facilitated by high world demand
and the overvaluation of the Brazilian Real, making it easy for Brazilian companies to
sell commodities or to purchase assets abroad. This trend, however, is occurring at the
expense of a relatively non-competitive domestic environment. Failure to inject
competition in several deregulated markets characterizes the Brazilian and other Latin
American privatization experiences. Taming dinosaurs and offering special benefits to
economic groups, such as tax exemptions on exports and subsidies on production, may
prompt economic activity on a short term-basis but also fuels the country’s fiscal
problems. Schneider (2008) depicts how states in Latin American countries nurture
domestic special interest groups (business) as a reaction to globalization forces, even
before market reforms.
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Brazil’s macroeconomic inroads are underscored by the sound performance of
exports, which have been steadily increasing for a decade. Export performance has
benefited from the positive international scenario, particularly the high demand for
commodities from China (Cepal, 2006: Ch. 2). Yet, despite the importance of external
trade for the country’s recent economic recovery, Brazil has taken stiff negotiation
stances at the WTO Doha round, the FTAA and the EU-Mercosur discussions. Although
international financial organizations like the IMF and the World Bank continue to

81
Drawing on the literature of “varieties of capitalism” (Soskice and Hall 2002), he coins the term
“hierarchical market economy,” typified by a large MNC sector, weakly intermediated labor relations, high
labor turnover, and low skills, which characterize many countries in Latin America and the developing
world.
210
promote market-enhancing reforms, Brazil’s stronger macroeconomic situation reinforces
its autonomist position in areas other than macroeconomic and fiscal policy. Even though
macroeconomic populism seems a thing of the past, trade and industrial policies are
increasingly active and the government caters to an internal audience when it blares the
importance of an independent foreign economic policy. In short, the difference in Brazil’s
macroeconomic/financial and microeconomic/trade discourse baffles political economic
analysts. The danger is that today’s interventionist approaches in the realm of trade
policies could spill over to macroeconomic management.
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Chapter 4 - The Political Economy of Brazilian Trade Policy: Domestic
and International Determinants - Empirical Testing and Data
Investigation
Section I - Introduction
In the previous chapters, I analyzed the domestic and foreign determinants of
Brazilian trade policy, focusing on the debate regarding Brazil’s refusal to surrender its
trade policy tradition and to commit toward deeper trade liberalization with advanced
markets, both in regional and in multilateral integration negotiations. I discussed as well
the hurdles surrounding the conclusion of world trade negotiations, which are a
consequence of both developing and developed countries’ domestic cleavages and the
changing world economy, which have perpetuated protectionist forces. Certainly, neither
Brazil nor other developing countries can be exclusively blamed for the world trade
stalemate. Yet, in the first half of the 2000s, Brazil shirked from North–South regional
(FTAA) and trans-regional (EU-Mercosur) integration agreements and contributed to the
faltering o the Doha round of multilateral trade liberalization at the GATT/WTO.
Notwithstanding neoclassical trade theory, which typically suggests that the
benefits of trade would be greater among countries with different resource endowments,
Brazilian policymakers have consistently refused to engage in North-South integration
and have opted instead for managed a trade policy. On the domestic front, Brazil has
adopted higher tariffs and state support, aimed at promoting and protecting industrial
sectors. Activist industrial policy has been a constant in the economic policy of the
country, even after the neoliberal reforms of the 1990s. Conversely, on the external front,
Brazil’s strategy has been linked to the pursuit of a regional integration bloc, Mercosur, a
customs union that aims to eventually become a common market. As I discussed in
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chapter 3, the bloc is characterized by a certain level of economic dirigisme and the
protection of industrial sectors.
A logical strategy for a country trying to implement trade and structural reforms in
the face of occasional setbacks in public sentiment toward greater immersion into the
globalizing world is to lock them in through free trade agreements. The model of “open
regionalism,” which welcomes FDI and creates a competitive environment within the
bloc, was part of the initial motivation for Mercosur in the early 1990s. In the 2000s,
however, Brazil refused to surrender its managed trade policy tradition, and avoided free
trade agreements with advanced markets in order to protect its industrial sectors.
After some years of considerable trade opening and structural reforms, which have
decreased not only tariffs but also the state’s role in the economy, it is worth asking: what
is the nature of those differences between economic groups regarding further trade
liberalization with advanced markets? Is it feasible to suppose that some industrial sectors
in Brazil would benefit from integrating with advanced markets? Is Mercosur the most
beneficial strategy for the insertion of Brazil into the world economy? What, ultimately,
is the explanation for such extremely cautious positions toward trade liberalization in
Brazil?
I draw on political economy theories in my quest to answer these questions. This
quantitatively oriented chapter uses econometrics, descriptive data and stylized facts to
address the questions posed here
82
. The underlying hypothesis is that Brazilian trade

82
In the social sciences, and especially in the field of economics, a stylized fact is a simplified presentation
of an empirical finding. While results in statistics can only be shown to be highly probable, a stylized fact
can be presented as true. Stylized facts are a means to represent complicated statistical findings in an easy
way. A stylized fact is often a broad generalization, which, although essentially true, may have inaccuracies
at the level of specific detail (http://en.wikipedia.org/wiki/Stylized_facts)
213
policy targets special industrial interests. Despite various shocks
83
that Brazil faced
during the last two decades, trade policies remained quite stable and were dictated by
these special interests.
In pursuing answers to these questions, my first aim in this chapter is to undertake
an empirical analysis of political economy differences among 10 different industrial
sectors. With data from the Brazilian Industrial Survey (PIA) of the Brazilian Institute of
Geography and Statistics (IBGE), I use three clusters of explanatory variables – trade
shares; factor endowments and industrial organization/competition - to explain the
dependent variable: trade policy, expressed in terms of either protection (tariffs) or
subsidies (state support). I claim that, despite shocks, state policies toward these special
interests have remained relatively constant over the period 1988-2005.
Regression results show that Brazilian trade policies are characterized by a
Heckscher-Ohlin pattern of trade policy, that is, that factor use by industries determines
their policy position. Hence, the scarce factor in Brazil (capital) receives relatively more
protection and support. However, there are some qualifications. Capital exerts more
pressure over subsidies rather than tariffs; this is also a noticeable increase in the
protection of labor intensive industries. Additionally, industrial concentration and scale
are significant intervening variables, explaining differences in protection and support
across sectors but with the caveat that the latter acts upon tariffs while the former
influences only subsidies. Non-traditional variables, i.e, those proposed by recent “new
trade theories,” such as the technological intensity of a given by sector, do improve the

83
These shocks were examined in previous chapters and are comprised of events such as the debt crisis of
the late 1980s, the structural reforms prompted by the Washington Consensus, the financial crises of the
late 1990s and early 2000s, and the multilateral negotiations of the WTO; either exogenous or endogenous
to the Brazilian economy, these impacted domestic economic policymaking and economic performance.
214
explanatory power of my model. Trade intensive variables, such as export orientation and
import penetration, on the other hand, do not exert strong statistically significant effects
on the dependent variables, though regional intra-industry trade seems to play a role in
influencing state support policies. Adding time trends and dummies to the specifications
changes some of the variable’s significance, while also highlighting the importance of
globalization trends and mounting intra-regional trade flows in shaping policy outcomes.
The second objective of this chapter is to discuss the link between domestic trade/
industrial policy measures and Brazil’s external trade strategy. I claim that this policy
stance was ultimately responsible for the failure of trade talks with developed countries in
the first half of the 2000s. Based on descriptive data, I discuss trends in Brazilian foreign
trade balances and the destination of export flows and relate them to the political
economy implications of my empirical results. According to data from the Economic
Commission of Latin America and the Caribbean (CEPAL 2006) and Lall et al (2007),
Brazil sells more high value added goods to the Western Hemisphere (Mercosur/Latin
American countries, and secondarily to the U.S.), whereas its transactions with emerging
market countries (e.g. Russia, China, and other East Asian countries) are concentrated on
natural resource manufactures. I examine why Brazil protects and supports its capital
intensive sectors domestically, but does not advance trade agreements with markets that
buy these goods
Following this introduction, section II discusses methodological issues related to
the theories and the underlying assumptions thereof for use in empirical testing. These
theories were also discussed in other chapters of this dissertation. This section specifies
the hypotheses to be tested and expected signs of variables, it briefly comments on the
215
estimation techniques and, finally, it discusses the statistical results. Section III analyzes
the geographic as well as commodity content of Brazilian trade flows (1990-2005), and
explains how it relates to the debate regarding openness and industrial policy as well as
the overall macroeconomic situation of the country. Section IV offers conclusions. The
annex to the chapter presents data sources and the methods used to construct the
variables, tables, and graphs.

Section II - Methodological section
In the next paragraphs, I review the literature on endogenous trade policy, the
political economy of industrial policy/export promotion and economic integration. This
literature was reviewed in other parts of the dissertation, but here I systematically explain
how these various theories relate to my particular hypotheses. I then explain my choice of
dependent variables (tariffs and state support) and I provide a detailed account of the
three clusters of explanatory variables (factor endowments, industrial
concentration/competitions and trade shares). I elaborate on the possible effects (expected
signs) of the explanatory variables (table 13). I examine the industrial and trade related
characteristics of ten manufacturing sectors (table 21) and I perform an empirical analysis
in which I regress these three clusters of explanatory variables on trade policies. Finally, I
discuss methodological strategies dealing with the empirical tests and model
specifications and present the results.
I treat protection (tariffs) and state support (subsidies) as the main measures of
trade policy, the basic variables to be explained. The literature on endogenous trade
policy emphasizes mechanisms of protection (tariffs, non tariff barriers, quotas, voluntary
216
export restraints). However, trade policies in Brazil, as well as in other large emerging
economy countries, must be also addressed in terms of the kinds of industrial policy that
have been used to bolster exporting capacity. Brazil has upheld these mechanisms of
industrial promotion during the second half of the twentieth century and retained them
even after the structural reforms of the 1990s and its adherence to various agreements
within the GATT/WTO framework.
84

Theory
This section discusses how the theories mentioned in this dissertation provide
tools with which to analyze the political economy of Brazilian trade policy. Following the
broad premises of endogenous trade policy theory, Brazil should be expected to
protect/support its capital intensive sectors, vis-à-vis labor- or land- intensive sectors.
Conversely, according to alternative propositions within this literature, which emphasize
lobbying along sector lines – governmental policies are likely to financially support
exporting interests and protect import competing sectors. The level of market power and
concentration is also an important intervening variable such that economically powerful
and concentrated sectors (oligopolies, monopolies and conglomerates) should be able to
exert pressure and capture governments, resulting in higher tariffs or state subsidies.
Finally, recent literature on the political economy of trade asserts that industrial sectors
characterized by increasing returns to scale and dependent on foreign inputs may lobby
for trade liberalization, particularly within regional agreements.

84
Industrial state support mechanisms, such as subsidies and tax breaks, are aimed at both domestic and
foreign markets. Therefore, any attempt to discuss the political economy of trade policy should also look at
industrial policy measures. For a discussion of the Brazilian export promotion policies, see Shapiro (1997)
and Veiga (1998); for a more recent account, see Veiga and Iglesias (2002). For a general discussion of the
role of government policy in building industrial competitiveness, see Lall (2003) and Kohli (2005).
217
A rich political economic literature has long been assessing the impact of factor
ownership and the trade orientation of industries as determinants of trade policy. Hence,
tariffs (or subsidies) set by policymakers can be understood as prices that clear political
markets. Coalitions of industries are formed to influence the redistribution of
protection/support. Endogenous protection theories address both the demand side- how
interest groups organize to influence policy- and the supply side- how policymakers
choose to grant (or not grant) these benefits (Rodrik 1995). According to Magee et al
(1989), the Heckscher-Ohlin (H-O)/ Stolper-Samuelson (S-S) (henceforth H-O/S-S)
hypothesis suggests that lobbying activity will occur along factor lines (e. g. capital vs.
labor vs. land); whereas the Ricardo-Viner (henceforth R-V) hypothesis suggests that it
will occur along industry lines (import-competing vs. export-oriented). Factor mobility
also influences outcomes: the H-O/S-S model asserts that, in a two-factor world with
complete mobility within domestic industries, the liberalization of international trade will
lower the real income of the scarce factor and increase the real income of the abundant
factor. Conversely, the R-V model suggests that factors of production are industry-
specific (thus R-V is also referred as factor specific) even in the long run, so that trade
liberalization would benefit all factors in the exporting industry but hurt all factors in the
import competing industry.
Magee et al (1989) have advanced these highly stylized theoretical models drawing
on the contributions of Olson (1967). They formalize Olson’s intuition about how the
free-rider problem makes lobbying difficult and arrive at predictions regarding the
relationship between industry’s expenditures on lobbying spending and government
benefits to industry. According to those authors, since protection has a public goods
218
character it tends to be underprovided. Concentrated industries may be better able to
overcome the free-riding problems, facilitating collective action to influence trade
policies more effectively.
As an alternative to interest group theories, the median voter or direct democracy
approach assumes that government adopts policies (trade policy included) in a manner
that reflects the majority opinion on the issues. In the two-sector, two-factor, Heckscher-
Ohlin model, trade policies are expected to fall along these lines: if the median voter’s
ownership of capital is lower than that of the average owner (as is the case in most
countries), trade policy will be biased in favor of labor (as opposed to capital). As stated
by the Stolper-Samuelson theorem, in the two-sector Heckscher-Ohlin model a change in
tariffs raises the return to one factor and lowers that to the other. If the median capital-
labor ratio in the economy is low, the median voter will opt for a tariff policy that favors
labor over capital (Gawande and Krishna 2003).
Grossman and Helpman (1994) (henceforth G-H) refine the assumptions in the
literature, explaining protectionism as a function of the structure of the industrial
organization/competition, trade dependency and the elasticity of import demand or export
supply in industrial sectors. In their “protection for sale” model, protection is “bought” by
industries through contributions to the political process; by politicians, who in turn,
weigh the aggregate welfare loss of constituents vis-à-vis their rent-extraction gains and
decide whether or not to protect/support the special interests. Conversely, certain
industries weigh the deadweight loss of tariffs arising from the consumption of imported
inputs while deciding to “buy” protection. Therefore, the G-H model is applied in an
imperfect competition setting in which industries may be price-setters in downstream
219
markets, selling goods to final consumers, but may be price-takers in upstream markets
for inputs. In the G-H model, industries depending on imported inputs may lobby for
liberalization, or ask for state support to finance the purchase of those inputs.
85
Thus, the
degree of intra-industry trade may also be an important intervening variable. Rodrik
(1995) affirms that neither the R-V nor the H-O/S-S models can account for the large and
growing global share of intra-industry trade. In the presence of increasing returns to scale
(IRS), intra-industry trade is assumed to make everyone better off: it will increase the
number of varieties available for consumption in intermediate inputs without reducing the
real income of any one sector. Considerations of increasing returns to scale (IRS) and
imperfect markets can have important consequences when it comes to analyzing the
political economy of regional integration.
There are potential complications to those theories brought about by the
phenomenon of globalization, which has facilitated and quickened the international
mobility of factors of production.
86
These trends can also be enhanced by regional
integration agreements. Factor-specificity models (R-V) can transcend the conventional
cleavages in that developed countries can have both low-skilled labor and high-skilled
labor opposing trade, while in developing countries capital-intensive sectors might
benefit from liberalization, due to the increasing variety of inputs and economies of scale
that trade offers. Rogowski (2006) reviews these complex distributive effects and notes

85
The same industries that favor protection for final goods, for example, automobiles, may lobby for lower
tariffs on inputs, for example, steel. Of note, the second generation of the political economy of trade
literature draws on industrial organization theory. See, for example, Krugman (1995) and Rodrik (1995).
86
Globalization is a far-reaching concept in social science. Rogowski (2006) discusses globalization as an
equivalent of trade liberalization; that is the free flow of factors of production (labor and capital), which can
by understood as well in terms of increasing immigration and foreign investment. Lall (2003) also
discusses the concept of globalization as an equivalent of trade liberalization and foreign investment
facilitation and how it may constrain the policy latitude of national states.
220
that anomalous factor coalitions can arise as a consequence of globalization. For
example, there is the possibility that skilled labor in a developed economy, despite being
the abundant factor, may advocate protection (e.g. high-tech industries leaving the U.S.
and outsourcing IT jobs in India); or scarce skilled labor and capital-intensive sectors in a
developing country can favor free trade (e.g. engineering firms benefiting from
subcontracting and technology transfers from developed country firms). Low skilled
labor in developed countries, despite being scarce, might oppose trade and feel threatened
by immigration and the downward pressure this places on wages. Scheve and Slaughter
(2001) discuss these trends indicating that even capital – the abundant factor in the U.S.
economy - can be badly affected by declining economic activity in regions affected by
import competition (e.g. the Rust Belt). These authors model the attitudes of owners of
financial asset values (mortgages) in regions affected by slumping economic activity
because of foreign competition and find that these owners of mortgages are opposed to
trade liberalization.
It is worth reviewing these theories in order to grasp the complexity of
contemporary international economic relations, and the accompanying debates as these
address the role of immigration, foreign investments and trade in services. However, for
this dissertation I focus only on trade in manufactures and industrial sectors.
The upsurge of regional integration agreements (RIAs) - also referred to in the
literature as preferential trade agreements (PTAs) – further increases the political
complexity of global economic forces. Neoclassical trade theory, based on the Vinerian
tradition (see Bhagwati and Panagariya 1996), suggests that PTAs are often welfare-
reducing because politically motivated governments set up higher tariffs in order to
221
protect special interests within the bloc from world competition, causing trade diversion.
Grossman and Helpman (1995) and Krishna (1998), similarly, argue that PTAs reduce
national welfare as a result of pervasive rent-creating trade diversion. The incentives for
lobbying/protection are different when the PTA is a free trade area (FTA) or a customs
union (CU). In the case of CUs, when external tariffs are jointly set by country members,
lobbying activity shifts from the domestic to the regional arena. Therefore, there are
increases in co-ordination and transaction costs among members of an economic sector,
which may hamper lobbying and tariff escalation. Meanwhile, as Ferreira and Fachini
(2005) point out, free-riding tends to be overcome by the repeated interaction of
economic actors. Thus, the protection of special interests is pervasive in RIAs, be they
FTAs or CUs and even common markets, such as in the case of the European Union
(Francois, Nelson and Pelkmans-Balaoing 2008; Tavares 2006).
By contrast, there is a recent line of research that defends regionalism as a building
bloc for liberalization and argues that it can actually encourage trade. Accordingly,
regional integration can have a negative effect not only on internal tariffs among the
members but also on tariffs toward third countries, due to a process known as the domino
effect (Baldwin 2006). Ornellas (2005), for example, argues that preferential trade
agreements are in fact “rent-destructing” because of tariff-elimination among members,
thereby enhancing exports within the bloc and giving exports from partner countries
greater access to domestic market. By sharing the benefits of higher tariffs with the
producers from partner countries in the bloc, domestic producers become less willing to
compensate their government for raising external tariffs on excluded countries. The PTA,
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in that case, can spawn lower external tariffs and reduce lobbying. Increasing trade within
the bloc will, therefore, lower external tariffs.
Ornellas (2005) argues that his model holds in imperfect competition settings as
well, but the application to other instruments of trade policy is not straightforward. On
the one hand, export subsidies may undermine the very logic of PTAs; on the other hand,
countries often engage in regional integration to get around stricter rules for industrial
incentives that have been set up within the WTO framework. Subsidies and state support
for economic sectors and regions are part of RIAs. For example, the European Union has
fiscal transference policies to help the poorer regions in Europe (Hulsmayer 2000; Grugel
2004). In Mercosur, incentives to industrial sectors are ubiquitous, prompting industrial
sectors to lobby for special treatment within the bloc.
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Explanations for the political economy of exporting interests in regional
agreements are found in other branches of international trade theory. For Baldwin and
Venables (1995), Venables (1999), Venables (2003), and Venables (2006), proximity
tends to boost trade flows of neighboring countries, particularly in products which are
vertically integrated with respect to different phases of production. The clustering of
economic activities is resource-saving and hence regional strategies of transnational
companies can contribute to growing commercial flows within the bloc, along intra-firm
and intra-industry lines (flows of inputs, components and parts). With integration, firms
will operate in larger regional markets, which may enhance their possibility for achieving
economic gains. Therefore, industries with regional interests will lobby for and demand

87
Members often design escape clauses within international agreements to allow for these exceptions
(Rosendorff and Milner, 2001).
223
state support, and invest in large scale plant operations. Scale effects may generate
positive spillovers, enhancing export capacity not only inside the bloc, but toward
external markets as well. Special treatment of the automobile industry in Mercosur is
often justified by policymakers and industry representatives on the grounds of gaining
regional and external competitiveness for this industry.
Literature coming from political science also discusses the political economy
rationale of exporting interests in regional integration initiatives (Milner 1997; Chase
2003). According to these authors, political economy pressures are particularly intense in
increasing returns to scale and technology intensive industries. This literature, in line with
factor specificity anomalies, suggests that skilled-labor and technology intensive sectors
in developing countries may support trade integration with advanced markets. FDI and
transnational companies’ interests provide further incentives for these RIA North-South
(e.g. NAFTA) and South-South (e.g. Mercosur) RIA arrangements (see, for instance,
Grether et all 2001; Pastor and Wise 1994). The prospect of productivity gains compels
these industries to join RIAs (Lopez-Córdova and Mesquita Moreira 2005). Summing up,
domestic groups may lobby governments to join or to establish an RIA. When the RIA is
created, domestic sectors will continue to press policymakers to set tariffs and to provide
state support accordingly. My task is to identify such political economy evidence in the
Brazilian case.
In addition to integration theory, there are other political economy explanations for
exporting activities, especially non-traditional manufacturing exports.
The economics literature, since mercantilism, tends to justify the importance of
exports for balance of payments and the accumulation of capital. Bhagwati and
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Srinivasan (1978) maintain that export growth can change the pattern of comparative
advantage and assert that developing countries should attempt to shift exports from low-
tech natural resource-based exports toward low-tech manufacturing (see World Bank
1987). More recently, economic research based on the new growth theories discusses
how openness to trade and FDI can improve the productivity of the domestic economy
because industries benefit from technological spillovers due to increasing access to
foreign inputs.
88
This literature discusses the impact of exports in the technological
upgrading of emerging economies – the presumed benefits of “learning by exporting” and
“foreign market discipline” - which can enhance not only productivity, but also total
factor productivity. Hausmann, Hwang and Rodrik (2007) associate export diversification
with economic growth. They empirically test a measure of export sophistication to
examine the extent to which this measure can predict future growth.
89
New growth theory
explanations are also applied in a regional integration framework: industries consuming
foreign R&D benefit from technological spillovers and market expansion in RIAs.
According to Schiff, Wang and Olarreaga (2002) and Schiff and Wang (2006), North-
South integration fosters technological spillovers between high-tech and low-tech
industries of developed and developing countries, while South-South integration
promotes spillovers only in low-tech industries.
90

88
See, for example, two books from the World Bank, edited by Hoekman and Javorcik (2006) and by
Schiff and Winters (2003), which assess trade openness, in general, and in a regional integration context. A
theoretical perspective about technology transfer and trade is found in Grossman and Helpman (1995).
89
Tybott (2006), in the book edited by Hoekman and Javorcik (2006), provide firm level empirical
evidence about the impact of exports in productivity. His findings do not support the new growth theories
and argues that there are several unexplained factors that may account for productivity growth besides
export orientation.
90 These authors examine the impact of TFP on North-South and South-South trade related to R&D
spillovers. To measure at the industry level for developing countries, they construct North-South and
225
From a structuralist approach, exporting activities are also growth enhancing;
however, developing countries will be plagued by the underinvestment of risk-averse
private agents, who may not tap into exports of manufacturing goods because of fear of
low return. This rationale justifies government intervention in promoting value-added
exports. The book edited by Kim and Nelson (2000) provides a review of theories and
case studies about the experience of new industrializing economies in fostering the
technological and manufacturing content of their exports. This literature recognizes the
importance of state policies to improve industrial and export capacity in selected sectors.
Exporting interests and state industrial policies have been enmeshed, thereby cross-
influencing each other. Focusing on East Asian case studies, Haggard (1990) and Wade
(2004), for instance, emphasize policy and bureaucratic autonomy explanations in
amassing resources and crafting policies for the technological upgrading of exports; but
they also look at the behavior of business groups, conglomerates in particular, that
lobbied governments for special favors. The policy instruments used by East Asian
countries to bolster industrial capacity and foreign competitiveness included tariffs and
subsidies, but also training of personnel and incentives for R&D investments. Climbing
the value chain of exports and shoring up emerging sectors, such as electronics, consisted
of a common project of entrepreneurs and governments in the East Asian experience.
Ocampo and Martin (2004, chapter 4) examine how Latin American countries
perform in terms of export diversification. Their findings show that, despite having

South-South R&D flows based on industry-specific R&D in the North, North-South and South-South trade
patterns, and input-output relations in the South. Their main findings are: North-South and South-South
R&D flows have a positive impact on TFP, though the former is larger; and, R&D-intensive industries
benefit mainly from North-South R&D flows while low R&D intensity industries benefit mainly from
South-South R&D flows.
226
adopted policies of import substitution and export promotion during the 1960s and 1970s,
Latin American countries have been experiencing difficulties in climbing the value-chain
of exports following the structural reforms in the 1990s. Argentina, Brazil and Mexico,
for instance, adopted strategies for promoting value-added exports with different degrees
of success during the 1970s, but the severe fiscal and macroeconomic imbalances of the
1980s broke the sequence of public policies and delayed this process (Katz 2000).
Ocampo (2004) also highlights how productivity has been stalled in the region since the
late 1980s, despite industrial policies that attempted to foster technological capacity
during the ISI years and the reforms of the 1990s that scaled back state intervention.
This heterodox literature suggests that export interests in Latin America,
particularly in industrial goods, are pretty much intermediated by governments, in
granting subsidies, tax breaks and selected protection. In industries where there is no
comparative advantage, the role of governments in gathering resources, pushing for
technological upgrading and promoting exports is crucial (Lall 2003). From a
methodological point of view in trying to determine how the export intensity of industries
is likely to influence their propensity to lobby governments for tariff protection and state
support, one has to confront the possibility of reverse causality. I will address this issue in
a following section on model specification.
These questions are particularly important for a case such as Brazil, which has had
a sizable share of exports in high value-added manufacturing industries since the late
1980s (aircraft, electronics, and machinery) and has adopted somewhat successful export-
diversification policies. It is worth asking if, after the liberalizing reforms of the 1990s,
these export interests have acquired an autonomous stance – independent of the
227
government – in lobbying for trade liberalization. As I described in former chapters, due
to the institutional characteristics of foreign policymaking, business interests did not take
an active role in the recent trade negotiations with advanced markets (EU-Mercosur;
FTAA). Is there by now an exporting coalition proper in Brazil? My purpose in this
chapter is to determine whether or not there exists such a coalition among industrial
sectors: I will test if the export share influences the position of a sector regarding trade
policy. At this level of aggregation, it is difficult to make such inferences, but I believe
that an econometric exercise can provide some clues about the behavior of industrial
sectors.
It is worth reiterating that exporting business interests may differ between sectors
that are more oriented toward Mercosur or toward other Western hemisphere countries.
This is also influenced by differences in patterns of intra-industry trade with the sub-
regions. For example, the three sectors that are most engaged in intra-industry trade
within Mercosur are transport equipment, chemicals and pharmaceuticals, and textiles
and clothing, while for the Western Hemisphere these are food products, machinery and
electrical and electronic equipment. Given these differences, the automobile sector in
Mercosur – albeit exported-oriented - would oppose deeper integration with the U.S.,
Canada, or Mexico. Yet, there is a considerable degree of correlation between exporting
interests in both Mercosur and the Western Hemisphere. Paper, publishing and printing is
an example of a sector with high trade participation along intra-industry lines with both
regions. Case studies could be the appropriate methodological alternative to evaluate how
sectors behave regarding trade liberalization. Baumann and Carneiro (2002), for example,
228
present findings regarding potential differences in options of trade liberalization
influenced by the geographical origin of firms.
91

A final piece of the literature that could provide hypotheses to be tested in my
empirical exercise relates to institutions. Trade policies are a function of the interaction
between politicians, policymakers and constituents, and they are shaped by domestic
institutions. As a result, domestic institutional characteristics can explain not only the
level of protection and state support toward economic sectors, but also the mechanisms to
correct eventual disruptive effects caused by globalization. For example, welfare states
have not only different attitudes regarding state interventionism and trade liberalization,
but also different policy responses toward the effects of openness. As Hall and Soskice
(2000) explain, “varieties of capitalism” among developed nations will influence policies
used to compensate the factor or industry harmed by trade liberalization and economic re-
structuring. For instance, mechanisms for job protection in declining industries tend to be
a greater policy priority in the European Union than in the U.S., where there is a bias
toward the self adjusting properties of unregulated labor markets (Grugel 2004; Breslin et
al 2002; Wren 2006).
As I describe in chapter 1, domestic institutions and ideas shape attitudes toward
trade policy. In the case of Brazil, trade policies are characterized by patterns of
bureaucratic autonomy in economic policymaking dominated by the executive;
interaction with industrial/economic lobbies is insulated and rarely intermediated by

91 Those authors analyze the geographical orientation of the leading Brazilian export firms and on that
basis they infer the potential impact of the effects of the FTAA. The hypothesis is that, by taking into
account the significance of subsidiary firms in the country’s foreign trade and the geographical
concentration of these firms’ external commercial transactions, the results derived from the creation of an
FTAA may differ from those obtained through simulations based on the simple reduction or elimination of
trade barriers.
229
legislative or electoral politics. Policy makers choose “strategic industrial sectors,”
supporting and protecting national champions and capital intensive sectors.
92
Labor
politics, likewise, has a left-wing orientation and a protectionist attitude, and favors, at
most, piecemeal liberalization. This arrangement conflicts to a large extent with the H-
O/S-S model, which suggests that the factor abundant sector (labor) would support trade
liberalization. The Brazilian Constitution of 1988 consolidated this corporatist undertone,
with an anti-trade and anti-FDI bias, preserving both capital and labor interests. The
Constitution attempted to create welfare state policies, particularly in public health and
social insurance, to appease labor interests, while also protecting domestic capital in
certain economic activities (e.g. mining) from foreign competition (Alston et al 2005).
Hence, the Brazilian case would seem to corroborate R-V/factor specificity assumptions
wherein both labor and capital in importing-competing industries would oppose trade
liberalization, while both factors would support it in export oriented industries. However,
preferences and attitudes, even in export-oriented sectors, will be intermediated by an
anti-trade bias in the labor movement and by a nationalistic orientation of business
groups.
Structural reforms in the mid-1990s, which prompted the privatizations of state-
owned companies and economic de-regulation, despite the piecemeal approach, did
modify the Brazilian economy considerably (Pinheiro et all 2004). However, my
assumption is that the main traits of the political economy of trade policy have remained
stable. Reforms were not able to steer the attention of the public toward trade

92
Haggard (1990), Schneider (1995) and Evans (1995) have developed qualitative models analyzing how
bureaucratic autonomy and the “developmental state” bear on these special industrial interests.
230
liberalization in general, and trade integration with developed countries in particular.
Broad interest group and citizen input was absent in the negotiations with advanced
markets in the first half of the 2000s, diplomats and economic bureaucrats maintained a
high level of insulation in discussing the FTAA and the EU-Mercosur agreements. This
situation benefited domestic industrial interest groups because, as the negotiation process
was abandoned due to divergence in modalities of liberalization, the relative level of
protection toward several industrial sectors was maintained (Albuquerque 2003, Bonomo
2006). Attitudes toward state subsidies became less controversial: in general, workers,
business interests and the public as a whole have come to support industrial policies to
improve manufacturing exports. But this issue is also characterized by a lack of general
knowledge of the public, since BNDES funds are financed by worker payroll taxes and
its interest rates on loans to economic groups are below market interest rates set by the
Central Bank. Recently, some groups inside academia and specialized circles have been
questioning the costs and benefits of industrial policies for the economy as a whole. I
expand on this debate in Section III. In short, domestic institutions, be they the
organization of economic policymaking, the patterns of relations between the executive,
the legislature, the private sector and the public, and the constitution itself, all contribute
to a cautious approach to integrating the Brazilian economy into global markets.
Having mentioned these theories, I do not intend to model institutions or ideas in
my econometric exercise. My purpose here is to show the complexity of existing political
economy cleavages.
93
My purpose in this chapter is to grasp the policy positions of

93
I have discussed these domestic institutional characteristics with more detail in chapter one.
231
different industrial sub-sectors, based on specific industrial indicators such as the level of
factor intensity, trade flows and concentration/market power.
How do the various above-mentioned theories perform in empirical tests? To
Gawande and Krishna (2003), early political economy models of trade policy were highly
stylized and were tested with different degrees of success. Overall tests were subject to
empirical shortcomings, mainly derived from regressor endogeneity and a lack of
rigorous sensitivity analysis. Those authors acknowledge the headway that such theory
has made in establishing increasingly strong microeconomic foundations, contributing to
more robust empirical results. Several variables are proposed as determinants of trade
policy: industry size, employment, concentration ratios, volumes of imports and exports,
changes in imports and exports, elasticity in the use of factors of production, campaign
contributions, the level of unionization in industry, the levels of low and high skilled
labor, and intra-region/intra-industry trade. Trying to grasp the political economy of
trade policies in a developing country framework using quantitative evidence can be
problematic due to data constraints and problems of model specification. I hope to
advance this debate in the next sub-section.
This section presented the theories for my hypothesis testing. However, I did not
limit myself to the assumptions of endogenous trade policy theory. Rather, I considered
the contributions coming from other branches international political economy and
international economics. To show how this will be translated into empirical tests will be
my next task.

232
Hypotheses and the Expected Signals of Variables
Applying endogenous protection models to analyze the trade policies of developing
countries is relatively uncommon. The modeling of policy process and lobby influence is
not as straightforward as in developed countries because data on campaign
contribution/legislative decision making – variables that would capture the position of
sectors and politicians toward policy issues - is limited. Therefore, the analysis of the
demand side is complex. Conversely, the supply side of policies is influenced by
institutional determinants that shape policymakers’ choices, as explained by the theories
that emphasize bureaucratic autonomy. This void has been filled by recent research.
Olarreaga and Soloaga (1998), Chen and Feng (2000), Grether et al (2001) and Ferreira
and Fachini (2005) have all tested variations of the theory, respectively, on Mercosur,
China, Mexico, and Brazil.
94
Overall, these works confirm that factor endowments and
industrial organization/concentration influence the level of protection/support of
industrial interests. But variables not particularly addressed by endogenous trade policy
theory, such as FDI (Grether et al 2001) and technological content of industries also
influence policies (Chen and Feng 2000).
Furthermore, one of the complications of testing the applicability of these theories
to developing economies is that the political economy of trade policy in countries such as
Brazil, China and Mexico is expressed not only in terms tariff protection but also in
industrial promotion (subsidies), as I discussed earlier. My choice of dependent variables
attempts to get around this methodological shortcoming. Tariff protection and state

94
Applied to the Brazilian context, Arruda de Almeida (2004) and Ferreira (2004) have also analyzed the
role of special interests in setting domestic tariffs. The latter also comment on the negative impact of
protection on labor productivity and Total Factor Productivity (TFP).
233
subsidies are both instruments of trade policy. Whereas tariffs are the traditional variable
used by endogenous trade policy models, I also deem it important to include the level of
state subsidies received by special interests in the analysis.
Brazilian MFN nominal tariffs are my first dependent variable. As Brazil is part of
Mercosur, an exercise to explain the protection of industries in the bloc could use
Mercosur nominal tariffs instead, following Olarreaga and Soloaga (1998). However, it is
worth noting that Brazil’s consolidated nominal tariffs are subject to several exceptions
under the Mercosur Common External Tariff (CET). Therefore, Brazilian nominal tariffs
and Mercosur CET tariffs differ in several lines, such as heavy manufactured products,
machinery and equipment (Flores Jr and Watanuki 2008).
95
Furthermore, the Mercosur
legal framework for tariffs was established in 1994 by the Asunción Treaty, and one of
my interests is to gauge the effect of this RIA on Brazilian trade policy. Finally, my series
begins in 1988, and Mercosur was created only in 1990. Yet, there is a high degree of
correlation between Brazilian and Mercosur nominal tariffs (0.94). Both series come
from the same source (TRAINS-UNCTAD) and, certainly, I could use the
Mercosur/Brazilian tariffs interchangeably. The annex to this chapter elaborates on the
variable construction.
96

95
Brazilian nominal tariffs are not the only ones that differ from Mercosur’s CET nominal tariffs. The legal
framework of Mercosur allows temporary exceptions to the CET applied to each country individually on an
ad-hoc basis and subject to the approval of other members. Hence, even at this level of aggregation (two-
digit Standard International Classification - SIC), differences in consolidated tariffs among Mercosur
partners exist.
96
At this level of aggregation, effective tariffs would gauge each sector’s political economy differences
more efficiently, also because they differ considerably inside the bloc due to each country’s exceptions to
the CET. Since my data series for Brazilian effective tariffs’ is shorter, I opted to use nominal tariffs (See
annex for explanations).
234
My other dependent variable, “State support share,” measures the proportion of the
National Development Bank (BNDES) loans received by each industrial sector relative to
its output. Although Brazilian subsidies are not targeted exclusively toward the export
market, subsidizing domestic industry can be viewed as a deviation from a situation of
free trade, with welfare-reducing effects from the perspective of the world economy. In
an open economy, factor endowments would be the only determinant of industry
international competitiveness. Therefore, from the perspective of theory, tariffs and
subsidies are equivalent (Krugman and Obstsfeld 2004, chapter 09). The annex to this
chapter explains the methodology for constructing this variable.
While I do not model bureaucratic or institutional characteristics, my choice of
dependent variables captures policymaker’s discretion in “picking winners” and the
interaction between government officials and industry representatives. Trade policies are
endogenously defined by policymakers in their interaction with industrial representatives.
The period of analysis (1988-2005) allows me to make inferences about trade
policymaking in Brazil during a period of important policy reforms aimed broadly at
scaling back state intervention and opening up the economy. Furthermore, there were
exogenous financial shocks during this period and the creation of Mercosur itself. My
main purpose is to track how these changes have affected policies toward different
industrial sectors over time.
My general hypothesis in this chapter is that Brazil still maintains a level of
protection and support to special industrial interests. My main purpose is to compare the
policy treatments received by ten industrial sectors and to relate these to differences in
factor intensity, foreign trade shares and levels of competition (the sectors are described
235
in table 21 of Section VI – Tables and Graphs). Although my level of aggregation is high,
it allows me to determine the extent to which the fundamentally different characteristics
of these sectors influence the policies directed at them. Finally, it is worth acknowledging
that these two policies – tariffs and subsidies - are closely related: both are mechanisms
of industrial policy to address the interests of economic sectors and domestic
constituents, hence, they can be regarded more as complements than as substitutes.
Table 13 below explains and summarizes the effects of three clusters of explanatory
variables –that derive from the different theoretical alternatives and authors identified in
the previous sub-section– on the two dependent variables. Table 22 in Section VI
presents summary statistics for all the variables. Next, I discuss the possible influence of
each of these independent variables on the dependent variables (trade policies). Because I
am using the same set of regressors to explain two different dependent variables,
estimation problems may arise, which will be addressed in the next sections. These
regressors, however, do not necessarily have opposing effects on the explanatory
variables, for reasons explained in the next paragraphs.
236
Table 13: Effects of Explanatory Variables on Brazilian Trade Policies.

Tariffs State
(Effective/Nominal) Support Share
(+) (+)
(+) (+)
(-) (-)
(+/-) (+)
(-) (+)
(+) (+)
(-) (+)
(-) (+)
(-) (+)
(+) (+)
(-) (+)
(+) (+) Herfindhal Index
*Variable’s construction methodologies and data sources are detailed in the annex.
(Magee et al; Grossman-Helpman)
Scale (employment/number of firms)
Competition (number of firms in sector/ total firms)
Index of Intra-industry trade (Western Hemisphere)
Industrial organization/competition variables
Share of Imports (imports/domestic demand)
Share of Imported inputs (imported inputs/ output)
Index of Intra industry trade (Mercosur)
Trade related variables
(Ricardo-Viner; Increasing Returns to Scale)
Share of Exports (exports/output)
Capital Intensity (fixed assets/industrial output)
Labor Intensity (wages/value added)
Skill Intensity (share of wages/employment) (Factor Specificity)
Factor intensity variables
(Heckesher-Ohlin/Stolper-Samuelson)
Capital Labor ratio (fixed assets/employment)
Independent Variables
(theories; authors):
Dependent Variables
(Trade Policies)
237
The first set of explanatory variables is related to factor intensity. At the sectoral
level, factor use may reflect technology absorption more than endowments. Assuming
sectors use different technologies, these variables gauge the relative content of labor and
capital used in production. Brazil is a middle-income emerging market economy more
well-endowed with the factor of production labor relative to capital.
97
According to H-
O/S-S theorems, in a country such as Brazil, capital intensive industries should receive
higher protection than labor intensive industries. Similarly, subsidies should be directed
more toward those capital intensive industries. Regarding “labor” intensive industries,
because these sectors employ many workers and because of electoral concerns, for
instance, Brazilian policymakers will also attempt to create mechanisms to support
industries that use this factor intensively. But due to relative differences between sectors,
according to the H-O/S-S assumptions, it is expected that the labor intensive industries
will receive relatively less protection/subsidies than capital intensive ones.
I measure “Capital Intensity” by the ratio between fixed assets and industrial
output. The numerator and denominator are in constant 2005 U.S. dollars, thus, the
number is a ratio in units. This variable is expected to exert a positive effect on tariffs and
on subsidies: the higher the ratio, the more capital has the sector and the higher are tariffs
and support. Conversely, I measure “Labor Intensity” by using the wage bill to value-
added ratio; in this case, numerator and denominator are in current Brazilian currency

97
Comparatively, Brazil is even more endowed with the factor of productive land. Although I do not
include this factor as an explanatory variable, certain industrial sectors (food products, metallurgical
products, and non-metallic minerals) include this factor in their production function. Harisson et al (2004)
and World Bank (2004) present an estimation of factor shares use by sectors in Brazil.
238
units.
98
The number is a ratio in units. This variable is expected to exert a negative effect
on both tariffs and support: the higher the ratio, the higher the content of labor and the
smaller are tariffs and subsidies. Meanwhile, there is also rationale to support a median
voter model of democracy: as a result, Brazilian policymakers could be expected to grant
benefits to labor intensive industries to appease constituents. Thus, in this case, labor
intensive industries will receive benefits, expressed either in higher tariffs or subsidies.
Therefore, there is a degree of uncertainty related to the expected sign of this variable.
But since Brazil is a labor-abundant country, I believe that labor intensity should exert a
negative effect on tariffs and on state support.
The “Capital-Labor Ratio” is the ratio of fixed assets (stock of capital at the end of
the year) to employment, end of year. It measures the proportion of capital to labor use in
each industry. I have these data for the U.S. and for Brazil. Due to variations over time in
methodologies of gathering data in the Brazilian statistical service and to avoid
endogeneity, I choose not to use the Brazilian time series in the econometric exercises.
Instead, I use the U.S. ratio.
99
The higher the number, the more capital relative to labor in
the sector, hence, this variable will have a positive effect on tariffs and on state subsidies.
This variable is expected to have the same sign as “Capital Intensity” and the opposite
sign of “Labor Intensity.” Again, there is an issue of technology adoption by different
sectors: industries such as electronic and electrical equipment or transport equipment,
because they tend to embody more advanced technologies in production, are more capital

98
Notice that Brazil has experienced three different currencies in the period 1988-2005.Values from 1994
on are in BR reais.
99
Factor use by industry is similar regardless of the country of activity. Factor share use by U.S. industries
can be considered exogenous to policy choice in Brazil.

239
intensive than food products or textiles and clothing. Differences in the use of “labor”
and “capital” should also be understood in terms of asset specificity. For example, capital
intensive sectors may have more immobile assets – such as larger plants with specialized
machinery, while labor is a more mobile factor.
100
Hence, capital intensive industries will
have higher incentives to influence policy against trade liberalization, favoring higher
tariffs.
In order to get around these complex technological characteristics of the sectors, I
include a variable to measure the content of skilled labor (wages relative to employment),
which can be interpreted as a proxy for “human capital.” Here, I attempt to capture the
possible political economy interests of technology advanced industries. Sectors that have
the higher skilled labor content are transport equipment, electronics and electronic
equipment, chemicals and pharmaceuticals, industries considered high-tech by
international standards. The methodology of Lall (1999) also includes these sectors in
either middle or high technology manufactures.
101
In order to capture the effects of
technology, I also use a dummy variable (Tech), assigning 1 to those high-tech industries
and 0 otherwise. “Skill intensity” and “Tech” measure the same thing and they are
expected to have the same sign and effect on policies. Brazil is a country more endowed
with low-skill labor relative to high-skilled labor (Harrison et all 2004), hence, consistent
with H-O/S-S assumptions, human capital intensive sectors in Brazil would receive more

100
Capital intensive industries have higher “asset-specificity” and tend to rely on government policies
because they are characterized by high sunken costs, increasing returns to scale and their assets tend to be
immobile. For instance, “metallic products” are more capital intensive than “textile and clothing”, thus, the
former will apply more resources to influence governments, especially tariffs. (Routledge Encyclopedia of
International Political Economy 2002)
101 “Skill intensity,” however, presents a relatively high level of colinearity with the variable
“competition,” for that reason; I suppress this variable in several regressions.
240
tariff protection and more state support. Nonetheless, in line with factor anomalies and
increasing returns to scale (IRS) explanations, high tech industries could lobby for
smaller tariffs in order to access foreign inputs and to acquire newer technologies. Hence,
regarding tariffs, the expected sign of the coefficient is ambiguous. But, regarding state
support, the treatment of technology intensive sectors is similar to capital intensive
sectors. Indeed, since technology is in even scarcer supply they could be expected to
receive even more state support relative to abundant factor sectors. Hence, “Skill
intensity” and “Tech” should definitely exert a positive effect on the “State support
share”. The high level of aggregation in my data turns the interpretation of these
assumptions into something of a stylized facts exercise.
Trade share variables attempt to capture the effects of international exposure to
foreign competition on these industrial sectors and resulting compensation/benefits.
Policymakers, based on their incentives and cost-benefit analysis, will then grant or not
grant special treatment. Basically, as supported by the R-V assumptions, put forward by
Magee et al and the G-H model, export orientation and import competing interests can
endogenously influence trade policies. Export-oriented sectors will be pro-liberalization
and thus favor further multilateral or preferential trade liberalization, seeking reciprocity.
They are more competitive by virtue of their export capacity and therefore do not fear
tariff reductions. Indeed, even unilateral liberalization would benefit them. On the other
hand, domestic sectors competing with imports will prefer to maintain tariff barriers.
But here we encounter a problem of reverse causality. One could argue that the
causation goes in a direction that is opposite to what is hypothesized: higher tariffs could
produce less competition, less import penetration and, consequently, an anti-liberalization
241
bias. Similarly, export incentives in the past spurred the export orientation of sectors in
the present. Brazil adopted policies in the later phase of ISI (1960s-1970s) to improve the
export orientation of industrial sectors, especially in high value-added industries, often
involving direct subsidies and state-intervention in production (Kholi 2004; Haggard
1990:181-183). In theory, these policies influenced the international orientation of the
sectors rather than the contrary. Hence, import and export shares at time t could be a
consequence of previous policies that have slashed tariffs and/or granted subsidies.
In order to sustain my hypothesis, in which the causality goes from exporting
interests to lobbying activity and policy treatment, there is a time lag requirement.
Policies in time t are influenced by trade share characteristics in time t-1 or t-2. For that
matter, in my model specifications, all trade-oriented variables are lagged one period.
Similarly, the literature addresses this problem by assuming that trade shares by sector of
each country (level of export orientation or import penetration) are the consequence of
comparative advantage in the long run, which are unconditionally exogenous to policies
(Magee et al 1989). For instance, Brazil is land abundant, thus, agricultural goods will
naturally have a high export orientation, despite policies that improve (or damage) the
international competitiveness of the sector.
Industries that are heavily oriented toward exports, indicated by a large share of
output going to exports, are likely to take part in trade liberalization lobbies. Since they
are competitive, they do not require protection, but since they also benefit from greater
integration with world markets, they may demand subsidies to help them compete abroad.
Hence, the variable “Export Share” is expected to exert a negative effect on tariffs and
positive one on subsidies. Conversely, industries experiencing foreign competition and
242
import penetration – the share of domestic demand that is supplied by imports - are likely
to participate in protectionist coalitions and attempt to deter further trade liberalization
but may seek compensation for any losses that they might eventually experience. As a
result, a higher import share should exert positive effects on both “Tariffs and State
Support.” The literature also uses “change in import penetration” as an explanatory
variable: a positive change in import penetration increases tariffs (Gawande and Krishna
2003). I include this last variable in several regressions.
Having said that, the variables “Export Share” and “Import Share” are candidates to
be instrumented, due to problems of reverse causality and endogenous regressors.
102
Due
to difficulties in finding strictly exogenous regressors to be used as instrumental variables
for the trade shares, I use an estimation technique (Seemingly Unrelated Regression –
SUR) that partially addresses the issue of simultaneity of regressors, particularly the
problem of contemporaneous correlations between residuals. In a very rigorous work,
Trefler (1993), for instance, in analyzing endogenous protection in the U.S., tests several
specifications and performs sensitivity analysis to address the simultaneous determination

102
Reverse causality and endogeneity can be understood in econometric terms. More technically, given the
cross section regression:
i i i i i
x x y ε β β α + + + =
2 2 1 1
' , (A)
Where y
i
is a dependent variable, x’
1i
is a vector of explanatory variables, x
2i
is another explanatory
variable, and ε
i
the error term, that includes unobservable factors that affect y
i
. The most common
interpretation is that (1) describe the best linear approximation of y given x
1i
and x
2i
. This requires us to
impose that:
0 } ' {
1
=
i i
x E ε (B)
0 } {
2
=
i i
x E ε , (C)
Coefficients in a regression model are interpreted as measuring causal effects. In such cases, it makes sense
to discuss the validity of conditions like (B) and (C). If E{ε
i
x
2i
}≠ 0, we say that x
2i
is endogenous (with
respect of the causal effect β
2
). We must identify an instrumental variable, say z
2i
, a variable that can be
assumed to be uncorrelated with the model error ε
i
but correlated with the endogenous variable x
2i
(Verbeek
2000)
243
of dependent variables and regressors. He uses imports (import penetration) and non-
tariff barriers (NTBs) interchangeably as dependent and independent variables. The
import equation captures the negative impact of NTBs on imports, and the NTB equation
captures the positive impacts of imports on NTBs. His findings are consistent with
endogenous protection theory, that is, when trade policy is treated endogenously; high
levels of import penetration will lead to greater protection. Conversely, he finds that
business interests are more relevant than labor interests to define the character and
orientation of U.S. trade policy.
103

Testing these models is basically therefore a static exercise, since traditional
endogenous protection (R-V) models do not address the possibility that trade opening
may enhance or diminish sector competitiveness in a future period. Hence, sectors are
mainly preoccupied with short term losses/gains based on their long run comparative
advantage characteristics. But, as assumed by IRS theories, some industries may benefit
from trade integration, even when they do not have comparative advantage in the short
run. This is due to increasing returns to scale effects caused by market expansion and
access to better inputs. I test this hypothesis with the intra-industry variables. I wish to
investigate the political economy of industries that trade more with Mercosur and the
Western Hemisphere regions. I use the Grubel-Lloyd index of intra-industry trade to
create two variables, respectively, “Intra-industry trade Mercosur” and “Intra-industry
trade Western Hemisphere,” which measure the levels of exports and imports in the

103 This result is probably the same in Brazil, as in other parts of the world, meaning the greater capacity
of business to lobby policymakers. Yet, this exercise will enable us to better assess labor oriented variables.

244
sector that are regional
104
for each area. While being comparative static in nature, the
testing of such variables introduces some elements of new trade theory, encompassing
increasing returns, imperfect competition and technology transfers. In sectors with intra-
industry trade, regional trade liberalization allows firms to differentiate their products and
specialize for niche markets. As a result, these sectors tend to be more favorable to open
trade and decreasing tariffs. (Chase 2003). According to the theories advanced by
Baldwin (2006) and Ornelas (2005), increased regional transactions may also cause
downward pressure on tariffs toward third markets.
The same rationale present in Mercosur can be applied to those sectors that trade
more intensively within the Western Hemisphere. Since there is no Western Hemisphere
FTA, my assumption is that sectors that trade comparatively more within the continent
will favor a future FTA in the region, and they will prefer to decrease third party tariffs.
Hence, this variable will exert a downward pressure on tariffs. On the other hand, these
same sectors that have geographically concentrated interests may be able to exert
protectionist pressures because they tend to be more concentrated. Therefore, the effect of
intra-industry trade on lobbying for regional trade liberalization may be uncertain (Chase
2003). However, following Ornelas (2006) and Baldwin (2005), I assume that downward
effects on tariffs should predominate. In this econometric exercise, I also examine
measures of industrial concentration to assess how these might influence tariffs. In any
case, I expect that the regional intra-industry trade variables would have the effect of
lowering tariffs.

104
The formula for this index is: 1 – [ |exports – imports| / (exports + imports)]. The annex to this chapter
explains the methodology for constructing these variables.
245
The effect of such regional intra-industry trade variables on state support is not as
clear-cut because subsidies, i.e., export subsidies, often undermine the logic of
preferential trade liberalization. Subsidies to domestic industries in RIAs create strains
between countries because the companies or sectors that receive such benefits take
advantage of them to artificially increase their participation in partners’ markets, causing
not only unfair competition within the bloc, but also the possibility of trade balance
disequilibrium. Countervailing duties have been used to tackle the problems of unfair
subsidies within Mercosur, for example. Antidumping measures, however, have been
accused of constituting disguised protectionism, being a questionable remedy for the
allegedly trade-distorting effects of domestic subsides. In theory, the appropriate policy is
to draft common rules in the framework agreement that restrict the ability of RIA
members to use industrial policies in ways that are detrimental to the welfare of other
member countries. In practice, this may be difficult to achieve; only a limited number of
RIAs have done much to discipline the ability of members to grant industrial support. The
Mercosur legal framework does not prevent the use of industrial incentive policies in
Brazil (BNDES loans), but this issue perpetuates the need for mutual consultation among
members.
My hypothesis is that Brazilian industrial sectors with regional interests will
increase their demand for state support in order to improve their participation not only in
regional but also in extra-regional markets. The same rationale applies to sectors with
higher Western Hemisphere orientation, with the difference that, since there is no
Western Hemisphere FTA, there is no institutional constraint on asking for state support.
WTO agreements, however, limit the latitude of national government in granting
246
subsidies, as established in the Agreements on Subsides and Countervailing Measures
(ASCM) of the WTO Marrakech Treaty. But to get around WTO rules, loopholes have
been used by the Brazilian government, which often are related to the complex domestic
tax legislation of the country (Shadlen 2005; WTO 2004).
105
If ever there were to be a
Western Hemisphere Trade Agreement, such policies would probably be restrained. One
of the reasons for the failed FTAA negotiations was the difficulty to even start a
discussion on how domestic/regulatory trade measures for industrial incentives should be
addressed with the U.S. proposing a WTO-plus framework, while Mercosur – especially
Brazil – insisted on industrial policy mechanisms.
Finally, industries engaged in intra-industry trade in regional markets are generally
characterized by increasing returns to scale (IRS) technologies. In these industries,
clustering and vertical integration of production lines have competitiveness enhancing
effects. Thus, it is feasible that these industries will lobby for state support in order to
improve their competitive edge and their participation in regional and external markets.
Summing up, sectors engaging in regional intra-industry trade can be expected to receive
comparatively more state support. In my specifications, I test interaction terms between
these intra-industry and regional trade shares and time trends in order to track their
effects over time.

105
Brazil has been subjected to investigations at the WTO, initiated by Canada, due to incentives received
by the aircraft industry. The incentives comprised the equalization of domestic and international interest
rates and were offered by the BNDES (Proex equalization). A panel found that payments on exports of
regional aircraft under the PROEX equalization scheme were export subsidies inconsistent with Article 3 of
the Agreement on Subsidies and Countervailing Measures (SCM Agreement). The Panel recommended
that subsidies should be withdrawn, but Brazil appealed certain issues of law and certain legal
interpretations. The Appellate Body upheld the Panel's recommendation. Modifications were made in the
domestic legislation, in order that subsides received by the aircraft industry do not conflict with the WTO
legislation. These new modalities often come under the rubric of R&D investments (WTO 2004).
247
Another trade related variable is the share of imported inputs - how much the
domestic sector uses foreign inputs in proportion to its output. Based on the theories
discussed above, sectors that require large inputs of foreign goods in their downstream
production chains may prefer lower tariffs. The example of steel – an important input in
the car industry - is one that comes to mind. Tefler (1993), for example, uses a variable
“buyer concentration” to measure the ability of input consumers to lobby for smaller
NTBs. But, domestic producers of inputs to other industrial sectors which compete with
imported industrial inputs may oppose tariff cuts. Hence the sign of “Input Share” on
tariffs is undecided. Regarding state support, I would expect a positive sign, because
sectors that use inputs intensively demand more state subsidies, compared with those that
do not use them.
106
Unfortunately, my data on the share of imported inputs in the
consumption of inputs by Brazilian industrial sectors begins only in 1990. By this time,
trade liberalization had already started and would not be able to capture the important
policy differences between the late 1980s and 1990s. For this reason, I do not include this
in regressions variable.
Finally, I look at a third set of explanatory variables in order to assess the impact of
industrial concentration/competition on domestic policies. According to theory, the
more concentrated sectors will be able to co-ordinate and lobby successfully. Therefore,
they have the ability to influence policies more effectively by overcoming free-riding
problems (Magee et all 1989). The G-H model, using insights from new trade theory,

106
As theoretical as these arguments may be, in the case of Brazil, one of the landmarks of industrial policy
has been loans from the government (BNDES) targeted at industries that use intensively foreign inputs
(petrochemicals) or are willing to enhance production capacity with foreign technologies (machinery).
These loans often involve sectors characterized by increasing returns to scale, requiring high machinery
content (chemicals, metallurgical, mining, non metallic minerals) (Batista 2002).

248
looks at the structure of the industrial organization as an explanatory variable for
protection. Industrial organization theory also employs the degree of concentration of the
market as a more effective means of measuring economic power and the capacity to
influence policies. Therefore, market power will lead to higher tariffs and subsidies
My indicator of industrial concentration is scale – total employment in the sector
divided by the number of firms. Generally, industries with larger scale are comprised of
larger companies, which have more employees, are more concentrated and have the
ability to exert pressure on policymakers more effectively. Hence, the higher the scale,
the more concentrated the sector and the larger the capacity to influence policies. Scale is
expected to exert positive effects on both tariffs and state support. Alternatively, this can
be considered a proxy for “labor unionization,” because more concentrated sectors, with
fewer companies, tend to have more powerful unions. Following Olarreaga and Soloaga
(1998), I also use another variable to measure concentration, namely, the ratio of the
number of firms in each sector to the total number of firms in the ten industrial sectors.
Sectors with smaller ratios have fewer firms; sectors with higher ratios have more firms.
More concentrated sectors will receive more protection and subsidies. This variable will
exert negative effects on tariffs but positive effects on state support. For example, the
transportation equipment sector is more concentrated than textiles and clothing, thus the
ratio of the former is smaller. Again, concentrated sectors have a higher capacity to
influence policymakers effectively, through lobbying, because they are able overcome
free-riding problems. It is worth stressing that the effects of concentration are related to
the level of competition in a given market. It is in the best interest of firms in
249
concentrated sectors (oligopolies) to limit the contestability of markets.
107
Oligopolies
and cartels have incentives to exert direct leverage over governmental bureaucracies to
deter free entry, for example, because they have higher profit margins than non-
concentrated sectors. Tariff cuts lower barriers to entry, and improve competition, but
also harm profits. Moreover, concentrated sectors, due to political organization, may be
also able to overcome co-operation problems and influence industrial policies more
effectively. From the government’s viewpoint it is rational to appease sectoral demands
for protection and support due to employment, investment and revenue concerns.
108

A more precise indicator to assess market concentration is the Herfindhal index,
which measures the market share of firms in terms of sales and it is usually considered
good proxy of “market power.” Here, I rely on data from Resende and Lima (2005),
calculated from sales data in the main industries in each sector, from 1986-1998. Sectors
with higher market power are able to influence policies more effectively, avoiding
competition from imports by raising tariffs and/or state subsidies. I use the “Herfindhal”
index only in alternative specifications, since the availability of this measure is
insufficient to cover all the years for my data on nominal tariffs and state support.
Following Ferreira and Facchini (2005), who affirm that causation goes from market

107
Earlier literature of industrial organization asserts that free entry and low barriers, making markets
contestable, are the best incentive to foster competition. The fact that an industrial sector is concentrated
creates incentives among the incumbent firms to restrain entry and keep barriers high (Baumol, Panzar and
Willig 1982).
108
For example, automakers – an oligopoly in the Brazilian economy, as in other parts of the world - are
gathered around the powerful business associations ANFAVEA, which has an important seat at FIESP - the
Industrial Federation of the state of São Paulo. FIESP has direct leverage over governmental ranks. Its
directors and advisors are frequently appointed to governmental jobs – even as Ministry of Industry and
Commerce. Similarly, former governmental authorities assume jobs in the private sector and business
associations. Conversely, sectors such as Textiles and Clothing or Rubber and Plastic have thousands of
small /middle companies which much less ability to have a seat at FIESP and organize and influence
policy.
250
power to tariff, I lag the Herfindhal index variable by two periods. For the same reason,
the variables “Scale” and “Concentration” are lagged in the regressions. Ferreira and
Facchini lagged their concentration variables only for two years, but a wider time span –
say five or ten years- would provide a robust indication of how causation goes from
concentrated sectors to high tariffs. It is well known that oligopolies often arise because
of artificial policies, which keep their markets captive. This business pattern is ubiquitous
in the crony capitalist model that has evolved in several Latin America countries
(Krueger 2002). My hypothesis is that, given a previous situation of low competition,
concentrated sectors will exert lobbying power to keep high both tariffs and industrial
subsidies.
In the next section, I consider the empirical strategy and model specification to test
the assumptions put forward here.
Empirical Strategy and Model Specification
Based on Tavares (2006), which adopts a similar empirical strategy, I treat policy
preferences for each sector - industry tariff rates (or subsidies) - as if they were the result
of a politically optimal deviation from free trade. From the perspective of international
trade theory, an export subsidy is equivalent to a tariff because it distorts free trade. Thus,
I treat these equally in the base model. Letting p
it
be the relative price of the product of
industry i = 1, ..., n at time t; p
*
it
the world price of that industry good (so that p
it
- p
*
it
= τ
it
, the tariff rate (or subsidy) on good i at time t), and π
it
(·) indicating the profit function
for the industry, the government’s trade policy function is:

251
[ ]
* *
), ( ) (
it it it it it it
it
p p p p f
TP
− − = π π
(1)

in (1) the first argument indicates the gain in industry profits or rents, and the second
term represents the loss of consumer welfare from the tariff (or subsidy). The setting of
the tariff or subsidy for an industry involves the interests of the industry through profits
or rents; the interests of domestic consumers of the commodity, who seek to maximize
their utility; and interests of the government, which trades off between industry and
consumer preferences, and performs its own judgment about the importance of the
industry for itself and the economy as a whole.
My purpose is to explain the difference in the structure of protection/support across
industrial sectors over the time span 1988-2005. Since my interest is simply empirical,
the trade policy functions come not from a formal model, but from previous empirical
and theoretical work (for instance, Rodrik 1995). The variables described in the previous
section will influence how these policies are set. The policy process is endogenous,
meaning that the interplay between governments, industry representatives and consumers
are all included in the objective function.
My inquiry departs from the empirical observation that, even though Brazil has
implemented trade reforms in the 1980s and 1990s, the country still has comparatively
high levels of protection. Figure 10 in the annex shows median nominal tariffs (MFN) for
selected countries in 2005. Brazil’s position in the second half of the distribution
indicates that its domestic economy is considerably more protected than several other
countries, including similar emerging market economies. The issue is not only the still
252
high level of protection but also its variance. Figure 11 in the annex shows nominal and
effective tariffs in 2007 at the three digit level of Brazil’s National Classification of
Economic Activities (CNAE). Nominal tariffs vary from 0 to 35 percent, the consolidated
margin at the WTO,
109
an interval high enough to raise doubts about rent seeking and the
associated costs on domestic resource allocation. From the point of view of effective
tariffs - which take into account protection for both final products and inputs – the
distortions are even higher, varying from -4 to 133 percent (Mesquita Moreira 2008).
Table 21 and figures 12 and 13 in the annex show the variations in tariff rates over time,
using a more concentrated industrial classification (two digit CNAE, equivalent to
Standard International Classification - SIC). Historically, Brazil has been characterized
by high levels of variance in tariffs among sectors. In chapter 1, tables 5 to 8 pinpoint this
peculiarity in the variance of effective tariffs among different sectors in the second half of
the twentieth century, with numbers reaching the thousands. In the 1980s and 1990s, after
the negotiations of the GATT/WTO framework which aimed to decrease differences of
treatment among sectors and to apply more linear tariffs, the variance among sectors was
still high. For example in 1987 the variance was 2900 points, dropping to 70 points in
1994 and going up to 215 in 1999. What are the explanations for a still relatively high
level of protection and, principally, for the high variance among sectors? Why are some
sectors more protected than others?

109
As discussed in chapter two, the multilateral trade system, first with the GATT and, then the WTO, was
successful in promoting tariff slashing since the late 1940s. According to the norms of the WTO, countries
commit to an upper bound – the current level is 35 percent – of its domestic tariff lines. For that matter, 99
percent of domestic tariff lines in developed countries and 78 percent in developing countries stay below
the upper bound consolidated at the Uruguay Round. See, for example,
http://www.wto.org/english/thewto_e/whatis_e/tif_e/agrm2_e.htm#con.
253
As analyzed in other parts of the dissertation, trade and industrial policies are part
of an economic development strategy. That strategy came to an end in the 1980s. Even
though Brazil liberalized via unilateral and WTO-led trade reforms, I support the idea
that the country has maintained some policies in line with the ISI years. It is
unquestionable that the absolute level of protection dropped, as showed in figures 12 and
13. However, policies are a function of policymaker’s discretion and influenced by
domestic economic institutions, which have high resilience over the years. In this chapter,
I review specific technological (factor use) and political economy variables to explain
why trade policies toward some sectors have changed only partially.
To estimate the policy preference (industry tariff rate and state support share) I use
a balanced panel of 10 industrial sectors comprising a period of 17 years, from 1988 to
2005. These years account for a pre-liberalizing period (1988-1990); the years of tariff
schedule reduction which accelerated in 1990 and finished in1994, which is also the year
in which the Common External Tariff of Mercosur was formally established, the Real
Plan macroeconomic stabilization plan was initiated, and there was a certain amount of
scaling back in tariff reductions due to macroeconomic imbalances caused by external
crises between 1995 and 2005. The latter period was one that included the Mexican, East
Asian, Russian and Brazilian crises. My main hypothesis is that the aggregate level of
protection has changed markedly over the years, but the relative level (variance over
sectors) of protection/support remained more stable and is affected by technological
(factor endowments use) and political economy variables. I believe special interests –
bureaucratic and technocratic ones included - have maintained their ability to influence
policies, despite market reforms and exogenous shocks. The use of panel data allows me
254
to look for specificities of each sector, which are a function of the political economy
variables, such specificities would not be captured in an OLS pooled regression.
Basically, I believe that the absolute levels of protection and state support have changed
over time – as the graphs in the annex may indicate - but the relative (sectoral variance)
level of “protection and support” has not changed that much due the rather static
condition of the sector and policy characteristics. In that line, I deliberately avoid creating
a variable “political favoritism,” as a composite of tariffs and subsidies, because there are
different assumptions regarding the sign of the explanatory variables.
In short, I wish to measure the relationship between benefits received by each
sector - tariff and subsidy - and the various components of the trade policy function
which may be changing over time. The estimating equation is:

it it i it
C ε β α τ + + =
1
(2)

Where τ
it
is the policy for industry i in time t, (tariffs or support), also understood as the
difference between domestic prices and international prices. I include α
i
which represents
unobservable industry fixed effects that may be correlated with the explanatory variables.
Such industry-level fixed effects are useful to control for sector heterogeneity which is
common given the relatively few explanatory variables included and the many
differences among sectors, aside from those measured. These effects may also control for
unobservable characteristics that are fixed over time. C
it
is the vector of characteristics for
industry i at time t and includes trade orientation, factor endowments and competition
255
variables, ε
it
is the error term, composed by the v
i
, assumed to be attributable to
differences between the individual unit, which is known as heterogeneity, and the second
component λ
it
, the error term modeled in normal OLS regressions, assumed to be i.i.d..
Equation (2) will be estimated using different techniques – ordinary least squares, fixed
effects, random effects, generalized least squares, panel corrected standard error and
seemingly unrelated regression, but only the last two are reported. After a set of initial
tests, I also include time trends and year dummies to see how much the results change.
My base model is given by the next equation:

(3)

In the specification above, the trade variables are all lagged in one period. These
include “Export share,” “Import share,” and “Import share change” (and measuring the
change in import penetration), and the variables measuring the content of intra-industry
trade in Mercosur and in the Western Hemisphere. The factor endowments variables
include the “Capital-labor ratio,” “Capital intensity,” “Labor intensity,” and “Skill
intensity.” I also include a dummy for technological-advanced sectors “Tech.” Finally are
the competition variables “Scale,” which measures employment relative to the number of
firms and “Concentration,” the ratio between the number of firms in each sector and the
total number of firms. These variables are also lagged. To check for the robustness of
coefficients, I include a regression with year-dummies alone and another regression
including two time trends starting in the second half of the 1990s (1995 and 1997),
it it it it i
it
n Competitio Endowments Trade ε β β β α
τ
+ + + + =
− − 3 1 2 1 1
256
making the time trends interact with the Mercosur and Western-Hemisphere intra-
industry trade variables, respectively. Finally in this last regression, I add a dummy
(Globalization dummy), creating a time trend after 1995 to account for the policy shock
after the conclusion of the Uruguay Round in 1994 and the establishment of the WTO.
Results for the dependent variable “Nominal Tariffs” are displayed in table 14 “Model
1;” table 15 “Model 2” displays results for “State Support Share” as the dependent
variable. In an alternative model specification, I add the variable “Herfindhal index” as
an explanatory variable for Nominal Tariffs and State Support. Since data for this
variable are limited, this last model was estimated for the years 1988-1999. Again, all the
trade and competition variables (Herfindhal, Scale and Concentration) are lagged one
year. I run this regression with the PCSE and SUR estimation techniques adding the
mentioned time trends and dummies. Table 16 and table 17 (model 3 and model 4)
present this alternative model.
Finally, in a last round of tests, using PCSE and SUR techniques with the first
baseline specification (not adding time trends and dummies), I test interaction terms
between the trade share variables (export and import) and competition variables (scale
and competition), using only the longer series (1988-05). Results are displayed in Table
5.
Comments on the Choice of Estimation Techniques
I will briefly discuss my choice of estimation techniques. This section relies heavily
on Certo and Semadeni (2006) and Beck and Katz (1995). These authors discuss
applications of panel data estimation methods to management studies and comparative
political economy research. First, I discuss the advantages of panel data; then the
257
advantages and flaws of using ordinary least squares (OLS), fixed effects, random effects
and generalized least squares (GLS) estimation techniques. Based on these authors, I
justify my choice of the panel corrected standard errors (PCSE) technique, as the more
appropriate one for my data, since this technique clusters by sector and year. Finally,
since I am using the same set of regressors to explain two different dependent variables, I
estimate the model with Seemingly Unrelated Regression (SUR) models. The discussion
of the regression results will be based on the PCSE and SUR techniques.
A panel data set is one that follows a given sample of individuals (firms, industrial,
sectors) over time, providing multiple observations on each individual in the sample. The
use of panel data allows one to resolve or at least reduce some of the econometric
problems that often arise in empirical studies. One such problem occurs when the
estimation results are influenced by omitted (not observed) variables that are correlated
with the included explanatory variables (see note 18 above). More technically, panel data
provide “internal instruments” for regressors, which are probably endogenous or subject
to measurement errors. Panel data estimation tackles the problem of endogeneity by
transforming the original variables using their mean. These transformations are often
argued to be uncorrelated with the model’s error term but correlated with the explanatory
variables themselves. As a result, no external instruments are needed. For instance, if x
it

is correlated with v
i
– the time invariant component of the error term ε
it
-, it can be argued
that x
it
– x_
i
, where x_
i
is the time average for individual i, is uncorrelated with v
i
and
provides a valid instrument for x
it
. Moreover, estimation with fixed effects, by
eliminating v
i
from the error term, eliminates the problem of endogenous regressors
(Veerbeek 2000)
258
Panel data models are classified according to intercepts and slopes. (1) If it has
homogenous intercepts and slopes, it means the intercept and parameter values are the
same for all units of analysis over time (pooled cross section). (2) If it has heterogeneous
intercepts and homogenous slopes, it means that the intercepts can vary through time or
among the units of analysis, being fixed or random, and the parameters can be the same
for all units of analysis and over time. (3) Having both heterogeneous intercepts and
slopes would mean that the intercept and slopes can vary through time or among the units
of analysis, being fixed or random.
110

Notwithstanding these advantages, the use of panel data often creates potential
statistical problems for ordinary least squares regression. Specifically, panel data may
create analytical problems in the form of error terms containing heteroskedasticity,
autocorrelation, or contemporaneous correlation. The presence of such conditions creates
nonspherical (non-i.i.d.) error terms (Certo and Semadeni 2006).
In the first regression in each model, I pool all the data and run an OLS regression
model, with robust standard errors. OLS with robust standard errors is recommended to
tackle the problem of heteroskedasticity, e.g. when residuals do not have the same

110
In econometrics choosing between random or fixed effects panel data models is not trivial. When only a
few observations are available, it is important to make the most efficient use of the data. The appropriate
interpretation must consider that the fixed effects approach is conditional upon the values for α
i
, the
intercept, which is specific to each individual in the data. This approach considers the distribution of y
it
, the
dependent variable, given α
i
, when α
i
represents a particular country, company, or industry, as in my case.
One way to formalize this is to note that the random effects models states that:
E{y
it
/x
it
} = x’
it
β, (D)
while for the fixed effects model estimates,
E{y
it
/x
it
,α
it
} = x’
i t
β + α
it
. (E)
Coefficients of the βs in these two conditional expectations are the same only if E{α
i
/x
it
}= 0. In my
regressions, I ran Hausman tests between fixed effects and random effects specification. Most often the
results favor fixed effects.

259
variance. With this technique, the variance-covariance matrix of errors is corrected. In
case neither the sector nor temporal fixed effects were significant, the OLS with robust
standard errors estimates would suffice. However, this assertion is at odds with my
hypothesis; I wish to measure differences across both sectors and time. My time span is a
period of alleged significant policy shifting. Even though my hypothesis asserts that
relative special treatment has not changed substantially among sectors, there has been a
decrease of tariffs and state subsidies across the years; hence, it is very probable that the
error terms will have different variances. Additionally, such estimates are subject to
contemporaneous correlation, which arises when the errors of unit i at time t are
correlated with the errors of unit j at time t.
Hence, I use both fixed effects and random effects techniques. Fixed effect models
assign a dummy variable to each unit that remains constant over time; accordingly, they
are also referred to as the least squares dummy variable (LSDV) model. In this model the
effects of the independent variables remain consistent across units, with each unit in the
models containing its own intercept. The fixed effect estimator is also known as the
within estimator. Random effect models are similar to fixed effects models, because they
also include a panel level disturbance (v
i
) and a normal disturbance (λ
it
). They can also be
estimated by equation 2. The key distinction between them is the way in which they
estimate the panel level error term. Fixed effects models estimate this panel level error
with dummy variables and the disturbance for each unit remains stable over time for each
unit (e.g., firm). Random effects on the other hand employ a specific GLS variance-
covariance matrix of the disturbance terms to estimate equation 2. In contrast to fixed
effects models, random effects models assume that the panel level disturbance changes
260
over time, that is to say, compared with fixed effects estimators, which remain stable over
time for each unit, random effects estimators allow the unit effect to vary over time (see
note 21).
Certo and Semadeni (2006), based on Katz and Beck (1995), also discuss the use of
GLS panel data techniques. In case the disturbances are assumed to be spherical (i.i.d.),
OLS provides the most unbiased and efficient estimator. OLS regressions with robust
standard errors include the variance-covariance matrix of the residuals in the computation
of regression coefficients. But, as I have stated, such assumptions are unrealistic in this
kind of data, as not only heteroskedasticity and auto-correlation of the residuals but also
contemporaneous correlation will arise. GLS techniques involve analyzing the data while
considering the influence of non-i.i.d. disturbances. In that case, GLS becomes a more
efficient estimator than OLS because it weights the influence of residuals based on a
specified disturbance matrix.
Meanwhile, Katz and Beck (1995) discuss the methodological impossibility of the
GLS technique when the number of cross section units i (N) is higher than the time
dimension (T), and they show how the GLS technique provides biased standard errors
estimators and upward bias in t-statistics “to the extent that the ratio N(N-1)/2
approaches NT.” They propose the use of panel corrected standard error (PCSE)
technique, that is to say, OLS with corrected standard errors, as being more appropriate to
political economy data and studies in which the time points (T) have a smaller or similar
magnitude of cross sectional units (N). PCSE allows one to correct for heteroskedasticity,
autocorrelation and contemporaneous correlation in analyzing datasets of a political
economy nature. My data include a sample size in which N equals 10 industries, each
261
with time periods T of 17. This is the dataset available for estimating models 1 and 2.
But, for model 3 there are only 11 years of observations. Were N greater than T, this
would qualify me to use the GLS technique. However, Katz and Beck (1995) assert that
the PCSE technique provides more efficient estimators, especially in the presence of
contemporaneous correlation. Only when T is at least twice as large as N, which is not
the case here, would the use of GLS be justified. I tested my dataset for
heteroskedasticity and autocorrelation and I cannot rule out the possibility that my panel
has these problems. For this reason, I use the panel corrected standard errors techniques
(PCSE) with autocorrelation correction (AR1).
Lastly, since I am attempting to explain two dependent variables using the same set
of regressors, there is a high probability that the problem of contemporaneous correlation
of residuals will arise. Seemingly Unrelated Regression (SUR) estimation is
recommended for analyzing a system of multiple equations with cross-equation
parameter restrictions and correlated error terms. The SUR technique estimates both
models simultaneously – using the GLS variance-covariance matrix of disturbance errors-
while accounting for simultaneous correlated errors, leading to efficient estimates of the
coefficients and standard errors. The SUR estimator requires that the T exceeds N, hence,
my data fit. The gain in efficiency depends on the magnitude of the cross-equation
contemporaneous correlations of the residuals. The software STATA performs a test to
verify if SUR has yielded a significant gain in efficiency, based on a Lagrange Multiplier
(LM) statistic which sums the squared correlations between residual vectors i (e.g. from
the model of tariffs) and j (e.g. from the model of state support), with a null hypothesis of
262
diagonality – zero contemporaneous covariance between the errors of different equations
(Baum 2007).
Having discussed all these possible techniques, the tables below depict two models
– one for tariffs and the other for state support, respectively, as the dependent variable -
estimated by two different methods: panel corrected standard errors (PCSE) with
autocorrelation correction (AR1), and Seemingly Unrelated Regressions (SUR). The
PCSE and SUR techniques are estimated more than one time to account for lagged
variables and interaction terms. Below the variables’ coefficients, t-statistics are showed
between parentheses. Number of observations, R
2
and Wald statistics are reported on the
regressions. Overall, with respect to signs, there is not much variation, but the statistical
significance of the coefficient of certain variables does vary considerably.
Table 23 in the annex presents the correlation matrix of the variables used in Model
1 and Model 2, in order to check for the degree of multicollinearity among explanatory
variables. Particularly, the “Capital-labor ratio” should be positively correlated to
“Capital intensity” and negatively correlated to “Labor intensity.” Besides, labor intensity
and scale (a proxy for union participation) and the competition variables might also
present high correlations. However, the correlation of “Capital-labor ratio” with “Capital
intensity” is negative (-0.176), while with “Labor intensity” is positive (0.269). I will
discuss these apparently conflicting results in the next section. Similarly, “Scale” is
weakly correlated with “Labor intensity” (-0.094). “Concentration” and “Scale” are
negatively correlated (-0.318). More highly correlated are: “Concentration” and “Skilled
labor” (-0.677), meaning that sectors with more firms might employ less skilled labor;
and “Scale” with “Skilled labor” (0.546) indicating that sectors with larger companies
263
might be able to employ more skilled workers. In order to avoid colinearity problems, I
exclude the variable “Skilled labor” in the regressions.
111
Table 24 presents
multicollinearity diagnosis tests for the variables used in Model 1 and 2. The results do
not show a high degree of colinearity among variables. The VIF (Variance Inflation
Factor) of individual variables is in acceptable ranges.

111
As discussed earlier, the variable “Tech” is a proxy for a technological intensive sector that employs
more skilled labor; hence, it can be considered a substitute for the variable “skilled labor.”
264
Table 14: Model 01 - Dependent variable Nominal Tariffs, 1988 - 2005.

Estimation Technique
Baseline Year effects TimeTrends Baseline Year effects TimeTrends
Variables Regression 01 Regression 02 Regression 03 Regression 04 Regression 05 Regression 06
Export Share 0.057 -0.126 -0.046 0.083 -0.131 -0.083
(0.26) (-1.23) (-0.55) (0.51) (-1.54) (-1.06)
Import Share 0.105 0.172* 0.220* 0.288* 0.238*** 0.276***
(0.69) (2.01) (2.53) (2.10) (3.66) (3.99)
Intra-industry trade 2.766 0.906 2.577 3.387 0.065 1.907
Mercosur (1.18) (0.60) (1.25) (1.42) (0.06) (1.26)
Intra-industry trade -8.927* -2.020 -3.673 -10.767*** -2.515 -3.696*
Western Hemisphere (-2.52) (-1.07) (-1.73) (-3.59) (-1.62) (-2.38)
Import change lagged 0.012 -0.001 0.003 -0.018 0.019 0.007
(0.57) (-0.15) (0.37) (-0.73) (1.32) (0.54)
Capital-Labor ratio -0.087* 0.014 0.012 -0.092*** 0.002 0.007
(-2.16) (0.58) (0.55) (-3.70) (0.16) (0.50)
Capital Intensity 22.670*** 1.457 3.389 30.336*** 2.955 3.959
(3.64) (0.60) (1.43) (5.83) (1.03) (1.39)
Labor Intensity 23.079 36.424* 28.038* 24.976 39.317*** 30.907**
(0.73) (2.40) (2.43) (1.41) (3.81) (3.17)
Tech -5.773 -2.458 -3.296 -10.007** -3.987* -4.703**
(-1.60) (-1.29) (-1.90) (-3.12) (-2.50) (-2.90)
Scale lagged 0.125*** 0.061** 0.060*** 0.153*** 0.084*** 0.079***
(3.84) (3.29) (3.39) (6.45) (7.01) (6.48)
Concentration lagged -43.861 23.100 18.473 -50.130* 18.922 18.973
(-1.71) (1.46) (1.28) (-2.51) (1.88) (1.86)
Intra-Industry trade - - -0.373 - - -0.277
Mercosur x 95 Trend - - (-1.18) - - (-1.03)
- - 0.103 - - 0.083
Intra-Industry trade Western - - (0.29) - - ( 0.27)
Hemisphere x 97 Trend
- - -7.222*** - - -7.124***
Globalization dummy - - (-17.75) - - (-23.21)
N. Observations 170 170 170 170 170 170
R2 0.549 0.890 0.875 0.3967 0.876 0.8622
Wald (Chi2) 40.05 10935.73 587.48 111.8 1200.78 1063.95
legend: * p<0.05; ** p<0.01; *** p<0.001, t-statistics in parenthesis below coefficients. Constant and year dummies suppressed.
PCSE SUR
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Table 15: Model 02 - Dependent variable State Support share, 1988-2005.

Estimation Technique
Baseline Year effects TimeTrends Baseline Year effects TimeTrends
Variables Regression 07 Regression 08 Regression 09 Regression 10 Regression 11 Regression 12
Export Share 0.051 0.158** 0.052 0.118** 0.212*** 0.121**
(0.94) (2.72) (0.97) (2.88) (4.95) (2.93)
Import Share -0.063 -0.096* -0.070 -0.167*** -0.147*** -0.156***
(-1.30) (-2.15) (-1.46) (-4.85) (-4.49) (-4.30)
Intra-industry trade 0.687 1.112 0.499 1.553** 2.241*** 1.678*
Mercosur (1.07) (1.68) (0.57) (2.58) (3.87) (2.12)
Intra-industry trade 2.308* 2.023* 2.369* 3.599*** 2.329** 3.821***
Western Hemisphere (2.39) (2.00) (2.09) (4.77) (2.97) (4.69)
Import change lagged 0.001 -0.003 0.001 -0.002 -0.010 -0.004
(0.15) (-0.64) (0.22) (-0.28) (-1.40) (-0.58)
Capital-Labor ratio 0.059*** 0.055*** 0.058*** 0.060*** 0.059*** 0.063***
(4.85) (4.28) (4.42) (9.61) (8.99) (9.11)
Capital Intensity 0.879 0.129 0.763 0.261 -1.813 -0.317
(0.67) (0.09) (0.56) (0.20) (-1.25) (-0.21)
Labor Intensity -3.735 -14.355* -3.582 -3.843 -17.848*** -5.691
(-0.69) (-2.23) (-0.63) (-0.86) (-3.42) (-1.11)
Tech 0.477 0.297 0.546 2.140** 1.102 2.007*
(0.42) (0.28) (0.49) (2.66) (1.37) (2.36)
Scale lagged -0.003 -0.008 -0.004 -0.024*** -0.022*** -0.025***
(-0.34) (-0.77) (-0.38) (-3.96) (-3.67) (-3.86)
Concentration lagged 24.989*** 19.338** 24.769** 22.726*** 20.046*** 24.492***
(3.45) (2.64) (3.27) (4.53) (3.94) (4.57)
Intra-Industry trade - - 0.052 - - -0.014
Mercosur x 95 Trend - - ( 0.35) - - (-0.10)
Intra-Industry trade Western - - 0.025 - - -0.108
Hemisphere x 97 Trend - - ( 0.13) - - (-0.66)
Globalization dummy - - -0.096 - - -0.031
- - (-0.47) - - (-0.20)
N. Observations 170 170 170 170 170 170
R2 0.347 0.511 0.359 0.673 0.728 0.675
Wald 39.85 951.24 44.45 349.78 455.87 353.29
legend: * p<0.05; ** p<0.01; *** p<0.001, t-statistics in parenthesis below coefficients. Constant and year dummies suppressed.
PCSE SUR
266
Table 16: Model 03 - Dependent variable Nominal Tariffs, 1988-1999.

267
Table 17: Model 04 - Dependent variable State Support share, 1988-1999.

268
Discussion of Results
The results I am going to discuss are mainly those reported on the in Model 1 and
2, based on the longer series (1988-2005). The results presented in Table 14 and 15,
overall, display a pattern of protection/state support consistent with the H-O/S-S
assumptions; that is, factor share used by industrial sectors is a main determinant of trade
policy, but there are some qualifications. “Capital-Labor ratio” and “Labor Intensity” do
not portray the predicted signs in Model 1. This result was expected for “Labor”
because, as I have discussed, politicians may prefer to protect sectors that employ many
workers. On the other hand, “Capital Intensity” has a positive and significant effect on
“Tariffs”, but results do not hold in the year effects and time trend regressions. I expand
on the explanation of these results below. In Model 2, the “Capital-Labor ratio” has a
positive and highly significant effect on the dependent variable; hence it can be argued
that it is an important determinant of subsidies policy, whereas “Labor Intensity” has a
negative and significant effect on that policy in the year dummy regressions. “Capital
Intensity” has no statistical significance on “State Support”. These contradictory results
might reflect the fact that the “Capital–Labor ratio” is negatively correlated with “Capital
Intensity” (-0.176), while it is positively correlated with “Labor Intensity” (0.269). As
noted before, tests have not revealed colinearity among these variables (Table 24 in the
annex). Sectors with the higher “capital-labor” ratios are “Transport equipment” and
“Electric and electronic equipment”, while for “Capital Intensity” they are “Machinery”
and “Non-metallic minerals”. These different results indicate that these variables measure
different things: while one measures asset specificity (fixed assets to output), the other
measures the share of capital to labor, hence they have different effects on the policies. I
269
mentioned in the theoretical section that sectors characterized by high asset specificity
have incentives to look for protection.
Concerning the “Industrial concentration/competition” variables related to
collective sector characteristics in Model 1, only “Scale” is statistically significant and
has the predicted signs in all the regressions. “Competition” has the predicted negative
effect on “Tariffs” in the Baseline regressions, but it loses significance when dummies
and time trends are added. In Model 2, both “Scale” and “Concentration” have the
predicted signs, but only “Concentration” is highly significant in all specifications.
“Scale” has a statistically significant negative effect on state subsidies in the SUR
estimations. Hence, R-V and G-H assumptions, which stress the ability of industrial
sectors in overcoming free-riding problems and lobbing effectively, are consistent with
the Brazilian case regarding protection, but only partially with subsidies, since scale-
intensive industries receive less, not more, support. It is also noticeable that coefficients
are sensitive to changes in model specification because, in Model 2, “Scale” becomes
significant with a negative sign in all SUR specifications. Yet, results of regressions with
PCSE and SUR techniques show that the broad patterns are maintained.
Sectors with higher degree of concentration and larger scale are “Transport
equipment”, “Electric and electronic equipment” and “Chemical and pharmaceutical
products”. Incidentally, those are also technology-intensive sectors and characterized by
relative high-skilled labor. The variable that specifically accounts for human capital
intensity, “Tech” – recall that “Skilled labor” was omitted due to problems of colinearity
– does display statistical significant results in both Models 1 and 2. “Tech” exerts a
negative effect on “Tariffs”, while it has a positive and significant effect on “State
270
support.” “Tech” is also significant at a 10 percent level in the PCSE estimations with
“Tariffs”. Hence, my data allows me to partially support new growth theory and “factor
specificity anomalies” assumptions; that is, sectors with high technological content (a
scarce factor in Brazil) might benefit from greater trade integration and lobby for tariff
slashing and for more subsidies: the technological sector, for instance, may want to have
access to cheaper imported modern inputs, lobbying policymakers accordingly.
As I have commented in the beginning of the chapter, policymakers may wish to
entice constituencies in sectors that employ many workers; therefore, labor content is also
a significant determinant for protection. “Labor intensity” exerts positive and significant
effect on tariffs in Model 1. These effects, however, are only existent when adding the
time trends and dummies. Political concerns certainly explain this outcome. This result
may also reflect the fact that Brazil is not as well endowed with a labor sector as new
entrants in world markets, namely, China. Hence, trade policy in Brazil, as I will be
discussing in the next section, is increasingly reflecting the huge impact of imports in
low-tech manufacturing goods in the domestic market coming from China, ensuing
protectionist pressures from workers and business owners in labor intensive industries.
Meanwhile, this effect is not so recent because “Labor intensity” does exert a positive
effect on “Tariffs” in the time trend regressions in Model 3, with data from 1988 to 1999.
Along the same lines, the variable “Scale” is also related to labor mobilization in
industry: more concentrated sectors have more powerful trade unions, which may be able
influence policymakers and policies more effectively. Therefore, the positive and very
significant effect of “Scale” on “Tariffs” can be explained on this basis. This is
particularly true with “Transport equipment,” for example, where the auto-industry has
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one of the most powerful trade unions in Brazil. Conversely, “Scale” has also a negative
and very significant effect on “State support”, in the SUR estimations. “Labor intensity”
also exerts negative and statistically significant effects on “State support” in the “Year
effects” regressions. One can interpret these apparently contradictory results on the
following basis: politicians provide protection to labor intensive industries, but these
sectors are not sufficiently influential to ask for state subsidization. The political
economy pressures are reflected only through tariff protection.
“Concentration” exerts positive and highly significant effect on “State support,”
meaning that more concentrated industries will lobby more effectively, overcoming
cooperation problems in looking for subsides. However, these effects are not noticeable
on “Tariffs” – this variable even accounts for smaller tariffs, although only at a 10
percent level in the PCSE estimation– in the Baseline regression. An explanation for this
might be the number of companies has increased in all sectors after liberalization; hence,
there have been more, not less competitions over the years. Yet, coefficients are
insignificant in the other regressions.
Year dummy and time trend variables were created and added to the specifications
in order to account for the effects of both domestic and external shocks on the variables.
First, the tariff schedule phasing out that was initiated in 1990 and concluded in 1994,
coinciding with the launching of the Real Plan in the second half of 1994, which
established a new currency pegged to the dollar in 1995. As a consequence, the
macroeconomic environment of the country improved markedly – inflation dropped from
941 percent in 1994 to 23 in 1995 (Figure 2, Chapter 1). In 1994, the Constitutional
amendments that provided the legal framework for the privatization and deregulation
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reforms ensued. As a consequence, the pattern of BNDES support changed: financing
was increasingly geared toward infrastructure and utility companies and less so to
industry. In order to check for the effects of these changing policy patterns over the
years, the interaction variables are created. These are two dummies coded with ordinal
numbers beginning with 01 after 1995 and after 1997, until 2005, which interact with
“Mercosur Intra-industry share” and “with Western Hemisphere Intra-Industry share”,
respectively. Because sectors that perform regional trade are expected to receive more
state support, these variables might capture differences over the years, as the finance
pattern changed. Their coefficients, however, are not statistically different from 0,
meaning that the time trends do not influence the dependent variables and the coefficients
of the “Intra-industry Trade shares” remain robust.
From an international political economy point of view, important events also took
place. Mercosur was formed and its legal tariff framework was concluded with the setting
of its Common External Tariffs (CET) in 1994, and finally, the WTO itself was founded
with the successful conclusion of the Uruguay Round (1986-93). The absolute levels of
protection dropped drastically after 1994 (table 21 and figures 12 and 13 in the annex). In
order to capture the effects of the regional integration in Mercosur and of the multilateral
trade order on domestic policies, a “Globalization” dummy variable was created, coding
years in a crescent order – from 1989 to 1994 - until the creation of the WTO and
establishment of the CET, after which the value remains constant. This variable accounts
for the effects of these international regimes on domestic policymaking. “Globalization”
exerts a significant negative effect on “Tariffs,” indicating that levels of protection were
higher before 1994. The same does not happen, however, with subsidies; “Globalization”
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is not significant on “State support”. As figure 14 in the annex shows, state support (in
terms of BNDES favored loans) presents a more linear and stable pattern along the years,
with the exception of “Transport equipment,” which stands out as the main recipient of
BNDES loans since late 1990s. It is also noticeable that these subsidies increased mildly
along the years, towards the end of the 1990s and early 2000s. In Model 3 and Model 4,
with the shorter time series (1988-99), the “Globalization dummy” has a very significant
negative coefficient in the regression with “Tariffs” as the dependent variable, but it has
no statistical effect with “Support” as the dependent. In short, this variable wishes to
capture the effect of international and supranational commitments on domestic policy
decisions. The results show that, concerning tariffs, the international commitments have
indeed influenced the domestic decision toward liberalization. Regarding subsides,
however, the policy regulations agreed on the Uruguay Round negotiations and under the
Mercosur umbrella were not able to hamper governmental special treatment toward
selected manufacturing sectors. Quite to the contrary, a mild offsetting trend is
noticeable: the Brazilian government compensates those sectors affected by previous
tariff drop with favorable loans. This is true for capital-intensive sectors, as the
coefficient for “Capital-labor ratio” is very significant in Model 2, and remains
significant in the time trends specifications. In short, the results of regressions with
“Globalization Trend” should seen from the perspective that globalization forces
(multilateral and regional trade agreements) are very important to influence just one of
the policies (tariffs), whereas they have no effects on industrial supporting mechanisms.
Finally, the trade variables present different outcomes with “Tariffs” and
“Subsidies” as the dependent variable, the latter providing much more robust results. In
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Model 1, however, some of results do support my hypothesis. “Import Share” and
“Western Hemisphere Intra-industry trade” depict statistically significant results with the
predicted positive and negative signs, respectively. In the SUR estimation and with the
time trends, the effects on “Import change” are magnified. I support that increased
competition from imports would prompt domestic sector to lobby for higher tariffs,
whereas sectors with regional trade interests would prefer smaller tariffs. Since SUR
estimation improves the efficiency of coefficients, the “Import share” result allows us to
infer that increasing competition with foreign goods might explain lobbying reactions
from domestic industries. Yet, the relevance of the variable in influencing policies is not
as high as factor use shares and collective action (competition/scale) variables. In Model
3, the only trade variable exerting significant effects on “Tariffs” is “Export share,”
which is significant in the SUR “Year effects” specification, with the predicted negative
sign. I sustain that competitive sectors do not require protection and may, indeed, lobby
for liberalization.
These weaker results, nevertheless, are not at odds with the findings of the
literature, In addition to estimation problems (causality and endogeneity), several studies
did not document import competition, export orientation and intra-industry trade as
significant explanatory variables for protection. The Gawande and Krishna (2003)
literature review displays a table reporting the Baldwin (1985) and the Trefler (1993)
estimation results, in which trade variables are insignificant, while factor use and
concentration indicators are substantive determinants for protection policies - tariffs and
NTBs. Conversely, in their study about Mercosur, the Olarreaga and Soloaga (1998)
variables on import penetration and intra-industry trade do not show statistical
275
significance, although their model suffers from flaws, since variables change signals in
alternative model specifications. In Ferreira (2004) – a non-published study about
Brazilian trade policy – import penetration displays a positive and statistically significant
effect on both nominal and effective tariffs as dependent variables. However, in a more
recent paper, Ferrreira and Fachinni (2005) do not use these variables and their
regressions focus on competition/concentration variables, which turn out to be robust
determinants of tariff policy.
My results show that the increasing competition with imports and the increasing
internationalization of the Brazilian industrial sectors is a secondary aspect influencing
tariff determination. Hence, the assumptions of Ornelas (2005) and Baldwin (2007), who
argue that RIA commitments might decrease tariffs toward third parties, are only partially
verified by my tests. The variable “WH Intra-trade” does display negative and significant
effects, whereas “Mercosur Intra-trade” is insignificant. However, the former may be
capturing the effects of the latter.
Regarding the trade variables, it is worth noting that model specification techniques
influenced the results, since I used PCSE with autocorrelation of errors correction.
Removing autocorrelation correction from the PCSE regression makes some of the
coefficients of trade variables statistically significant, but possibly inefficient and biased.
Hence, with this kind time series data, one cannot rule out the possibility of serial
correlation of errors. I tested my data for serial correlation and the results showed that
this problem was present.
For Model 2, however, the estimates reveal that trade effects are quite robust,
especially in the SUR specifications: all trade related variables, with the exception of
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“Import share change” are significant with the predicted signs. Results are also strong
with both PCSE and SUR techniques. The negative sign of “Import Share” suggests that
sectors experiencing higher import penetration in a given period are less able to obtain
subsidies, quite possibly because the firm’s position was already too weak so that they
had neither the means nor the will to make much of an effort to secure those subsidies.
Sectors experiencing steeper increases in import penetration include some capital
intensive industries, which certainly would in other respects be more likely to be
successful in obtaining compensation, but also segments such as “Rubber and plastics”
and “Textiles and clothing”, whose other characteristics are not favorable to such success.
Indeed, the latter experienced a fivefold growth in import penetration in the period, but
they are comparatively less concentrated – and probably less politically powerful - and
cannot lobby effectively. This suggests that an interaction term between import
penetration and collective action variables (scale/competition) might provide important
insights about the leverage of sector. In Table 6 – Model 5, I test specifications with these
interaction terms.
Certain sectors experiencing import penetration are also characterized by high
export share (Machinery, Transport equipment, Electrical and electronic equipment),
which means that they present high levels of intra-industry trade as well. Although “Intra-
industry trade Mercosur” is non-significant in the PCSE specifications, it is significant in
all SUR ones. “Intra-industry trade Western Hemisphere” does display statistically robust
results in all the above-mentioned regressions. Adding time trends interacting with the
“regional intra-industry shares” has not changed the coefficients of the regional intra-
trade variables. They continue being robust. This result suggests that, in fact, sectors
277
experiencing increasing returns to scale and with regional trade participation might be
more active in searching benefits and influencing state support policies. These effects
may also be enhanced by the size of the market, which is larger in the Western
Hemisphere than in Mercosur. The very robust results for trade variables in the SUR
specification, in which coefficients are jointly calculated and are more efficient, indicate
that intra-industry and regional trade are important forces behind state supporting
policies. In fact, as I will discuss in the next section, certain sectors have great
participation in regional trade flows.
Results of models 3 and 4, reported in Tables 16 and 17, with data from 1988-1999
and including the Herfindhal index (supposedly a more efficient benchmark to measure
market power), do not portray very different figures from the models with longer time
series. The Herfindhal index is insignificant in all regressions on “Tariffs”; however it
does exert a significant and negative effect on “State support” in the “Baseline” SUR
regression in Model 4. This counter-intuitive outcome probably reflects the decrease in
subsidies in the mid-1990s, which affected even sectors with concentrated “market
shares.” The result, meanwhile, does not hold with the time-trends and dummies. “Scale”
is very significant with “Tariffs” as the dependent variable, probably indicating an
immediate and defensive response of concentrated and unionized sectors after the initial
years of liberalization. Likewise, this variable exerts a negative and significant effect on
“State support” in Model 4, suggesting that powerful sectors have fewer incentives to act
upon subsidies compared to tariffs. Of note, the very significant result of “Capital-Labor
ratio” on subsides and “Labor intensity” on tariffs. Finally, the performance of trade-
related variables with “state support” as the dependent variable, with the exception of
278
“Import share change,” is also robust. These results might be capturing the initial trade
liberalization drive and the creation of Mercosur itself, when export orientation increased
a great deal.
Finally, in order to check for the joint effects of trade share variables (import share
and export share) and the characteristics favorable to collective action
(scale/competition), I test specifications with interaction terms (“Import share” x “Scale”
and “Import share” x “Concentration” on “Tariffs;” “Export share” x “Scale” and “Export
share” x “Concentration” on “State support;” and all four interaction variables
simultaneously on both dependent variables) for the longer series (1988-2005) with the
PCSE and SUR techniques. These results help us verify the hypothesis that economic
powerful sectors (or those with more active unions) experiencing import penetration
might have a higher capacity to influence tariff policy. Conversely, higher exporting
shares interacting with “Scale” and “Competition indicate that sectors might be able exert
more leverage on industrial subsides policy. Results displayed in Table 5 show that the
interaction terms do not have an effect on “Tariffs”. Only the interaction variable
between exports and competition has statistical significance on “State Support” in the
SUR specifications, with a negative sign. This rather counter-intuitive result suggests that
less concentrated exporting sectors demand fewer subsidies, which might reflect the fact
that sectors with numerous firms, such as “Textiles and Clothing,” “Food Products” and
“Metallurgical Products” are important exporters but do not receive as much
governmental financial assistance as concentrated segments, such as “Electronic and
Electric equipments” and “Transport Equipment,” which are also important exporters.
279
Table 18: Model 05 - Dependent variables - Nominal Tariff and State Support
share, 1988-2005, with interaction terms

Estimation Technique PCSE PCSE SUR SUR
Variable Nominal Tariff State Support Nominal Tariff State Support
Export Share 0.079 0.133 0.730 0.256*
(0.37) (1.25) (1.64) (2.27)
Import Share 0.547* -0.072 0.559 -0.309**
(2.10) (-1.46) (-1.43) (-3.12)
Intra-industry trade 2.980 0.961 4.578 1.862**
Mercosur (1.29) (1.55) (1.91) (3.06)
Intra-industry trade -8.519* 1.979 -9.125** 2.691***
W estern Hemisphere (-2.32) (1.95) (-2.84) (3.30)
Capital-Labor ratio -0.098* 0.052*** -0.097** 0.054***
(-2.15) (4.09) (-3.14) (6.81)
Capital Intensity 19.607** 0.727 24.388*** 0.272
(3.15) (0.58) (4.43) (0.19)
Labor Intensity 42.526 -1.575 59.597** -6.945
(1.27) (-0.28) (2.26) (-1.22)
Tech -5.905 0.868 -8.997** 2.665**
(-1.67) (0.75) (-2.80) (3.27)
Scale lagged 0.133*** -0.005 0.172*** -0.028***
(4.16) (-0.52) (7.07) (-4.47)
Concentration lagged -32.176 36.359*** -16.727 37.287***
(-1.27) (3.97) (-0.51) (4.45)
Scale x Import Share -0.025 -0.006 - 0.011
(-1.63) (-0.23) - (1.59)
Concentration x -4.482 -6.200 - -0.002
Import Share (-1.24) (-1.46) - (-0.21)
Scale x Export Share 0.001 -0.053 - 1.201
(0.11) (-1.56) (1.11)
-
Concentration x -0.777 -2.405 - -1.207*
Export Share (-1.50) (-1.01) - (-2.00)
N. Observations 170 170 170 170
R-Squared 0.558 0.376 0.4476 0.6951
W ald 42.42 45.57 137.75 387.59
legend: * p<0.05; ** p<0.01; *** p<0.001, t-statistics in parenthesis below coefficients.
280
My contribution sets out to stress the importance of policymaking discretion in
determining policies in early 1990s, as I have discussed in other chapters; the fact that
slow changing technological (factor of production used by sectors) and political economy
(collective action) aspects explains the high variance of protection among sectors, despite
the noticeable drop in average tariffs during the 1990s; and the impact of globalization on
domestic policies.
Summing up, overall results show that the degree of factor share used by industries
and collective action variables are important variables influencing both “Tariffs” and
“State support,” whereas trade shares act only upon “State support.” This pattern was
somewhat maintained in the several specifications. These results confirm the H-O/S-S
assumptions, although there are some qualifications. “Capital” exerts more pressure on
subsidies than on tariffs and an increasing protection of labor intensive industries is
noticeable. Additionally, industrial concentration and scale (collective action)
characteristics are significant intervening variables, explaining differences in protection
and support across sectors but, while the latter acts upon tariffs, the former influences
only subsidies. The theories that remark the importance of exporting interest, especially
in a regional integration framework, are also consistent with the tests. Factor use
variables can be considered exogenous, relating to long-run characteristics of economic
sectors, based on long-run factor endowments and technological determinants, while
competition and trade-related variables can be somewhat endogenous to the policies (the
reason why they were lagged in the models). Finally, the “globalization dummy” is an
extremely important variable to explain the variations in the policies over time, reflecting
the policy shocks of the 1990s and the importance of international commitments in
281
shaping tariff policy, but with no effect on industrial policy mechanisms. Finally, from a
methodological point of view, my interest in this section was to explain the changes in
the dependent variables over time and the variance in the benefits received by the
different sectors. The use of a simultaneous equation framework allowed me to tackle the
complementarities between the two policies – tariffs and state subsidies.

Section III – Brazil’s Trade Balance Structure and Destination (1990-
2005)
In this section, I elaborate on Brazil’s national trade strategy, adopting a more
descriptive approach. I discuss trade balance trends and Brazil’s destination from 1990 to
2005. I comment on the recent debate about the political economy of trade liberalization,
industrial policy and manufacturing exports. I also examine some macroeconomic
implications and I comment on how these trends relate to the trade strategy options for
the country. Finally, I relate the picture presented in this section to the econometric
results of the previous section.
---**---
Brazil’s trade openness and export performance have been improving in the 2000s
(figures 3 and 4, Chapter 1), providing growing trade and current account surpluses, and
building up financial stability.
112
Simply taken, the trade surplus can be credited to the
booming world economy, and in particular to the China’s demand for primary

112
Openness here should be narrowly understood as the share of imports plus exports in GDP. Hence, trade
flows have been increasing its weight on Brazil´s GDP since mid-1990s, as figure 4 shows. However, it is
worth remarking that Brazil´s share in the world trade in the 2000s is smaller than it was in the 1950s,
when the Brazilian export portfolio relied mostly on commodities (Abreu 2004; Abreu and Werneck 2005).
282
commodities.
113
In the more recent picture, influenced by the international financial
crisis, there are some not so positive trends, but overall the foreign trade of the country is
in good stance. Notwithstanding the good world demand, strategies aimed at expanding
foreign markets and diversifying exports should not be taken for granted. Bonelli and
Pinheiro (2007a) point to the importance of policy with respect to industries such as
aircraft and cell phones, which benefited from governmental support in the past and are
now standout sectors in Brazil’s recent export drive. These industries are characterized by
a high flow of components and outsourcing of services, contributing to the domestic local
economy. Hence, the positive aspect of increasing manufacturing exports relates to
industrial complementarities and technological spillovers. From this point of view, the
support to manufacturing industries paid off.
On the other hand, industrial policies have by no means been universally
successful. Ferreira (2005) argues that industrial policy per se is neither a necessary nor
sufficient condition for economic growth. He states that countries with high participation
of commodities in exports, such as Australia and Norway, have high income per capita.
These countries were able to climb the technology ladder and to add value to natural
resources based exports (CEPAL 2006, chapter 4).
114
He also points out that the
experience of East Asian Tigers, perhaps the most successful example of industrial policy

113
Bonelli and Pinheiro (2007b) present empirical results suggesting that world demand has been the major
force behind Brazil’s recent trade balance increase.
114
See McLean and Taylor (2003) for a discussion on and a comparison between the growth trajectories of
Australia and California (both developed and technologically advanced regions with an Anglo-Saxon
heritage), which relied on abundant natural resources in the initial phases of their economic growth. See
Subramanian and Roy (2003) for a comparative review of recent theories of economic growth. In that
review about the “Mauritian miracle”, the authors sustain that heterodox policies - industrialization,
combined with exporting strategies – contributed for a successful case of development. But
industrialization, they argue, was just one among several other variables that might have explained
economic development in Mauritius.
283
and export promotion, was accompanied by several other prudent policies, such as
macroeconomic and fiscal balance and educational upgrading. Abreu (2005) also draws
attention to the complementarities between macroeconomic policies – such as fiscal
balance, low inflation and favorable (not overvalued) exchange rates– and a successful
industrial strategy.
115

Historically, Brazil has adopted a piecemeal approach toward trade liberalization
using tariff protection and state support as complementary policies, similarly to what the
successful East Asian Tigers and China had done earlier. Yet, Brazil’s growth record, as
well as Latin America’s growth record as a whole, is decidedly inferior to that of the
Asian countries (figures 6 and 7, chapter two). The macroeconomic result of the country
in the 2000s was enhanced by a vigorous boost in foreign trade, contributing to price
stability and the accumulation of dollar reserves. Notwithstanding the macroeconomic
improvement, Brazil’s trade performance cannot be compared with that of more
successful countries. Lall, Albaladejo and Moreira (2007) describe the lackluster
presence of Latin American countries in international trade vis-à-vis East Asia and China
in the last two decades (1990s and 2000s), particularly in more knowledge-intensive
sectors. With the exception of Mexico, which benefits from a preferential trade
agreement with the U.S. and Canada under NAFTA, other Latin American countries were
not able to tap into competitive markets and to expand their portfolio of manufactured
goods. Brazil constitutes an intermediate point because it was able to climb the
technology ladder of its exports. However, as Moreira (2007) argues, Brazil is currently
experiencing a trend toward a return to natural resource-based exports after the

115
Along these lines, these Brazilian authors endorse the opinion of Rodrik (1996), see chapter 2.
284
“manufacturing export overshoot” in the previous decades, just like other Latin American
countries. In sum, after years of ISI and EOI policies in Latin America, declining export
dynamism causes apprehension on the part of serious commentators (Ocampo and
Martin, 2003: chapter 2).
In the last section, I explained the differences in policy treatment for selected
manufacturing sectors. As presented in figure 10, Brazil still has a relatively high level of
tariffs compared to other countries. There is also a high variability in protection among
economic sectors, as presented in figure 11
116
. However, it is worth stressing that these
differences in policy treatment are not an exclusivity of Brazil. Several successful world
trade players, such as the East Asian Tigers, do have smaller average tariffs than Brazil,
but the level of variability among the sectors is also high. Table 19 below, shows data on
Most Favored Nation (MFN) tariffs from selected Asian countries, emerging market
countries, and developed regions (U.S., E.U. and Japan) in 2005. The source is
UNCTAD/TRAINS, using the Harmonized Schedule classification, which includes 97
tariff lines. Average and variance in these 97 tariff lines are reported. Simple and import
weighted average tariffs are used
117
.

116
Variability should be understood in the statistical definition: variance. In statistical theory, the
variance of a random variable or distribution is the expected square deviation of that variable from its
expected value or mean.

117
A tariff average measures the average level of nominal tariff protection. There are two types of tariff
averages: a simple average and a trade weighted average. The example below illustrates how those two
types of tariff averages are calculated.
Tariff line number Duty rate Import value Duty collected
0101.11.10 50% 10 5
0101.11.90 10% 100 10
0101.19.10 0% 1000 0
0101.19.90 20% 100 20
Total 80% 1210 35
Tariff Averages:
SIMPLE = Sum of duties/Number of duties = 80/4 = 20%
285
The numbers show that some East Asian countries, those successful in
implementing industrial policies, have higher tariffs than Brazil in 2005 (Korea, Taiwan),
whereas other Asian countries (Indonesia, Philippines) and emerging markets (Russia and
South Africa) have lower rates. Poster child liberalizing countries, such as Chile, and
advanced countries have much lower tariffs than Brazil. But Mexico, which entered
NAFTA with the U.S. and Canada and is considered an example of a trade liberalizer, has
higher MFN tariff averages than Brazil and other South American countries (Chile). The
level of variance is strikingly high across the board: in some emerging market countries
(India, Indonesia, South Africa, and even Mexico), the variability is higher than in Brazil
and in Argentina. The table also shows the position of three developed countries/regions
and it is noticeable that, although their tariffs are much lower than those of developing
countries, there is also a high variability, especially in the U.S.
These differences in policy treatments might be explained by political economic
pressures and technological variation in each country. For instance, agriculture in Asian
countries tends to be protected due to limited land endowment and localized interests of
those groups connected to its production. The successful industrial promotion in several
Asian countries does not make them advocates of free trade; quite to the contrary,
selected protection in industrial sectors was used in the past and their agriculture is still
highly protected.

TRADE WEIGHTED = (Sum of duties collected/Total imports) X 100 = (35X100)/1210 = 3%
It should be noted that the trade weighted average is often lower than the arithmetic average. This is
because, theoretically, low duties carry more imports than high duties. Subsequently, in the trade weighted
average, low duties are given more weight than high duties, thus introducing a downward bias. In the
arithmetic average, each duty carries the same weight, whatever its level. Source: UNCTAD/TRAINS.
286
It is also important to mention that inside each one of the 97 tariff lines of the HS
system, although the average tariff might be low, there is an extremely high variance as
well. The most impressive numbers can be seen in agricultural products. For example,
line 12 of the HS system, comprising oil seeds, oleaginous fruits, miscellaneous grain,
seed, and fruit, has an average tariff of just 8.25 percent in the U.S., but a variance of
1,130 percent inside that tariff line. The same happens in Korea, considered a successful
trade liberalizer after years of industrial promotion: the tariff lines equivalent to
agriculture (7 to 12) have averages tariffs in the hundreds, with variance going up to the
thousands percentage points. India and China, for example, also emulate these
characteristics, with extremely high tariffs in agriculture and food products. The
agricultural sectors exert severe political economic pressures in these countries,
explaining in part the stalemate at the Doha Round/WTO.
Several of the countries Brazil opted to promote an alliance within the G-20
negotiation group (India, Indonesia, and Mexico) have extremely high agricultural tariffs.
This seems contradictory since Brazil is a very competitive agricultural exporter.
However, one main objective of this alliance, as mentioned previously in other parts of
the dissertation, was to create a coalition with countries with similar development levels
to avoid industrial goods liberalization proposed more fiercely by developed countries, in
line with Brazil’s policy tradition that protects the industrial sector vis-à-vis the
agriculture. In brief, differences in tariff protection are not an exclusivity of Brazil´s trade
policy.
287
Table 19: Average and Variance in MFN tariffs, Harmonized
Schedule, Selected Countries (2005), Continued.

Simple
Average
Weighted
Average
Argentina
Average 11.83 11.67
Variance 29.96 36.00
Brazil
Average 12.29 11.85
Variance 27.95 33.25
Chile
Average 5.97 5.93
Variance 0.09 0.24
China
Average 10.97 9.56
Variance 32.69 30.80
Taiwan.
China
Average 6.28 5.44
Variance 36.64 36.40
Colombia
Average 13.57 13.79
Variance 29.29 32.37
India
Average 20.84 20.54
Variance 197.40 238.97
Indonesia
Average 7.82 7.77
Variance 128.37 90.55
Korea.
Rep.(2007)
Average 16.68 21.14
Variance 1,212.46 2.621.53
Mexico
Average 16.06 16.91
Variance 86.53 155.57
288
Table 19, Continued.
Philippines
Average 6.99 7.16
Variance 19.26 24.95
Russian
Federation
Average 10.54 10.21
Variance 26.76 31.58
South
Africa
Average 8.45 8.50
Variance 81.88 88.19
Thailand
Average 14.86 13.52
Variance 164.52 175.94
Japan
Average 6.69 6.58
Variance 23.73 25.19
United
States
Average 5.69 4.41
Variance 496.08 74.65
European
Union
Average 10.25 5.43
Variance 28.96 22.18

Source: UNCTAD/TRAINS

289
Brazilian critics in certain academic and industrial circles defend that “de-
industrializing” trade liberalization, combined with privatization and deregulation,
weakened the capacity of the state to use policies to increase domestic competitiveness.
Structural reforms exposed industrial sectors to excessive competition, but the economic
benefits of these adjustments were small.
118
The recent upsurge of commodity exports
has triggered reactions from these groups, claiming that the country is experiencing a
process of “Dutch disease” – nominal exchange rate overvaluation harming
manufacturing exports competitiveness. The influx of dollars is caused not only by
booming world demand for commodities in international markets but also by high
domestic interest rates. As a consequence, Brazil and other Latin American countries are
said to end up specializing in commodity-based export economies. Although the
macroeconomics of Brazil are evidently in better shape than in the late 1980s, when
structural reforms started, this “commodity based” trade specialization would not be
suitable for the country because it would displace industrial economic sectors, causing
harsh economic adjustments.
The whole rationale toward avoiding deep integration commitments with advanced
markets, both at the WTO and at the regional (FTAA) and trans-regional (UE-Mercosur)
agreements, relies on the logic that liberalization is more beneficial to developed
countries and to certain domestic economic interests - those that export commodity
oriented goods, in which Brazil has comparative advantage, but not to the national
economy as whole, because the country would end up specializing in primary goods.

118
In fact, from 1990 to 2000, economic growth in Latin America stands at 2.9 per cent per year and at a
meager 2.8 in Brazil (WDI 2007).
290
Considering that industrialization is a much esteemed aim on its own, e.g. because
industrialized countries are more developed than agricultural ones, the government must
preserve mechanisms for industrial policy development. Trade policy, in general, should
be used as an instrument to protect and nurture industrial capacity. Hence, as part of a
broader trade policy, trade agreements that might adversely affect the domestic industrial
sector must be delayed or rebuffed.
Recent evidence, however, does not support the “de-industrialization” thesis and an
objective view of the recent trade balance must take into consideration several other
factors, including macroeconomic aspects and world economy developments. First,
Brazil has been a major exporter of manufactures since the late 1970s and it has a rather
diversified export portfolio, both in terms of factor and technology intensity of goods and
market destinations (Figures 15 and 16, data from CEPAL 2006). The numbers (not
reported) behind the graphs show that the country remains an important exporter of
manufactures, even after the neoliberal reforms of the last two decades and the recent
nominal exchange rate overvaluation. For instance, processed food and beverages,
vehicles, machinery and mechanical equipment, iron and steel, accounted for almost 50
percent of shipments, or almost US$ 58 billion, in 2005. The data from CEPAL shows
that the export portfolio of the country kept similar shares between 1990 and 2005, even
while experiencing a gradual trend toward technological upgrading.
119
For example,
middle technology goods constituted 25.7 percent in 1990 and 33.2 percent in 2005 of
total exports. The performance of high technology exports was also far from

119
In the graphs, I merge middle and high technology sectors in order to make series and results more
visible.
291
insignificant: the value of sales increased eight-fold, from US$ 1.3 billion to US$ 9.5
billion, from 4.3 percent in 1990 to 8 percent in 2005. It is also true that Brazil widened
its deficit in high-technology goods – from US$ 1.8 billion to US$7.1 billion– while
keeping its surplus in primary goods. During the 90s, this deficit was even wider and
included mid-technology goods. This segment reversed the trend, picked up by the end of
the period and experienced a surplus of 5-6 US$ billions in 2003-2005.
Figures 15 and 16 also portray important messages about Brazilian trade relations
with different countries and regions of the world. They indicate that, whereas Brazil is a
global player in primary goods, it is a regional player in industrial goods, including high-
technology exports. Brazil has experienced a trade surplus in mid technology and high
technology industrial goods with Latin America as a consequence of being one of the
most industrialized countries in the region and of the preferential trade arrangements
under the Latin American Development Association (ALADI) and with Mercosur
countries. It also reflects the fact that Brazilian industrial sectors do present some level of
competitiveness in the region. Brazil sells mid and high-technology goods (electronics)
and durable consumer goods (appliances and automobiles) to Latin America, while it
imports primary goods from the region, such as natural gas from Bolivia. Low-
technology industrial goods, such as textiles and apparel, are also an important part of the
country’s hemispheric exports. The same pattern applies to Brazil’s exports to the U.S.,
adding the fact that Brazil is a large supplier of high technology goods to that market,
selling items such as middle-size aircraft and machinery, while imports from the U.S.
comprise value-added goods, such as chemicals and pharmaceuticals, electronics,
machinery and parts. There is a large content of intra-industry trade with the U.S. as well.
292
In contrast, in its transactions with the European Union and the Asia Pacific 10,
which includes the highly competitive East Asian Tigers, Brazil experiences a deficit in
high-technology and mid-technology goods, although it has a small surplus in low-
technology with Europe and mid-technology with the Asia Pacific 10. Trade with Europe
happens along “neo-colonial” lines: Brazil exporting primary or natural resource-based
industrialized goods, while importing industrial goods. In the Asian markets, there is a
strong presence of mineral ore in the Brazilian export portfolio. The pattern of
transactions with China and Japan reflects this natural resource specialization: Brazil sells
primary goods (soy, iron ore), while it buys technological consumer goods, such as
electronics, but also low-technology goods, such as toys. Note the impressive upsurge in
the commerce with China between 1990 and 2005. The trade barely reached US$ 500
million in 1990, but climbed to US$ 11 billion in 2005. This surge is a consequence of
the China’s extraordinary growth during the 1990s, and its huge demand for raw
materials and commodities.
Brazilian foreign policy initiatives toward China and other “South” countries date
back from the 1960s and 1970s when the military government promoted an “independent
foreign policy”, to detach the country from the Cold War international order. In the case
of China, Brazil reestablished diplomatic ties in the 1970s. In 1988, the first Brazilian
civilian president after 20 years of authoritarian regime visited the country, symbolizing
this rapprochement. Hence the upsurge of these flows can also be viewed as a
consequence of foreign policy measures. Despite foreign policy initiatives, the flood of
low-technology manufactures from China and the constant trade deficits, might explain
why the “Labor intensity” variable in the econometrics tests presented a positive and
293
significant effect on “Nominal tariffs”. Besides, although Brazil recognized China as a
market economy in 2004, this country was recently subjected to several anti-dumping
investigations and measures under the Brazilian Trade and Industry Ministry (MDIC).
Transactions with the rest of the world – in the chart “Other” - are characterized by
a relative stagnation of industrial goods exports and by a steady increase in natural
resource-based goods since 2000. This group includes Russia – which is an important
buyer of processed agricultural products -, as well as African and MENA countries.
Regarding these last two groups, Brazil had a very active foreign economic policy toward
them during the 1970s-80s, seeking to sell manufactured capital intensive goods (e.g.
weapons, aircraft) and services (engineering). These countries were one of the first
outlets of Brazilian value-added exports. The 1980s debt crisis, the ensuing troubled state
budgetary balance in Brazil, and security problems in the region, such as civil wars in
Africa and the Gulf War in the Middle East, disrupted these connections. After years of
meager trade flows, Brazilian commercial diplomacy is seeking to reestablish political
and economic ties with these countries.
The bottom right chart in figure 16 “World”- aggregate trade with the entire world
– is very indicative. It expresses Brazilian comparative advantages and structure of
specialization in the world economy: due to factor endowments, the country is a main
exporter of primary and natural resource-based industrial goods, as well as of low-
technology industrial goods, and it has a small deficit in mid and high-technology goods
(300 million) in 2005. The well-established industrial exporting capacity does not prevent
a country from being a net consumer of high-technology goods, which is understandable
since several high-technology goods used as capital goods have been experiencing an
294
import boom since liberalization in the 1990s. The recent overvaluation of the nominal
exchange rate in the early 2000s has also been stimulating the purchase of these capital
goods by Brazilian firms. Commentators and authorities acknowledge this as a positive
tendency since firms are investing in productive capacity.
However, the apparent diversification of destinations conceals structural
shortcomings. Brazilian exports of high and middle-technology industrial goods are
confined to the Western Hemisphere, where they benefit from tariff preferences under
ALADI and Mercosur, while exports to the rest of the world are indeed “commodity
based” (Moreira 2007). In the technology segments, Brazil and other Latin American
countries have been losing market shares to China, both worldwide and in the Western
Hemisphere (Barbosa et al 2004; Schott 2006; FIESP 2007; Moreira 2007).
120

In short, although industrial exports are regionally concentrated because of tariff
preferences, there is degree of competitiveness and localization advantages. Overall, the
country maintained the participation of value-added goods in its trade portfolio. It is
worth stressing, however, that much of the industrial exports to North America are by
foreign-owned enterprises (with the exception of EMBRAER, the Brazilian aircraft
company), and intra-industry flows carried out by multinationals contribute to a big bulk
of the Mercosur trade.
There are some additional issues that must be addressed in order to clarify the
debate about trade liberalization and industrial exports. First, the high demand for
commodities coming from emerging economies is benefiting the Brazilian economy,

120
The example of Mexico is remarkable, as this country’s manufacturing exports, even possessing a FTA
with Canada and the U.S., have been substantially displaced by Chinese goods in the North American
market (Wise and Quiliconi 2007).
295
which has a comparative advantage in producing these goods. Trade among developing
countries is growing quite satisfactorily. For example, between 1997 and 2005, while
world trade grew at 6.6 percent rate, the growth rate of developing countries trade
reached 9.0 percent, surpassing advanced countries by 3.2 percentage points (WDI 2007).
Due to the high demand from large emerging market economies (China and Russia)
Brazil is benefiting from positive terms of trade gains in its products. Therefore, the surge
in commodity-based exports is a very good response to the world economy situation.
Secondly, there are some value-added and capital-intensive goods which stand out in the
recent export drive, for example, transport equipment. Third, some of the new
commodity-based exports do include a fair degree of value-added exports, such as
processed food, which despite being natural resource based manufactures, include several
integrated production chains.
Table 20 below presents a nuanced picture of the recent Brazilian trade balance
after the liberalization and reforms of the 1990s. It comprises four distinct periods and
fours groups of products.
121
According to the table, terms of trade per se are not the only
force behind surpluses. If one looks at the first period (93-94 to 97-98) despite relatively
favorable export prices, there were ubiquitous deficits lasting until the phasing out of
tariffs and overvalued nominal exchange rate. This period was also characterized by a
steep increase in domestic demand that deviated production to the domestic market.
Between 97-98 and 2001-02, in the aftermath of the Asian crisis, though export value was
influenced by steep downward price swings, the floating exchange rates were beneficial

121
The goods presented in the table are classified according to CNAE/IBGE; however, they differ from the
10 sectors presented in the regressions because I merged some sectors for data necessity. See Annex,
methodologies of construction of variables.
296
and the period was characterized by surpluses. From 2001-02 to 2005-06, despite the
relative overvaluation of the currency and the less favorable than expected terms of trade
(only a 1.9 percentage variation in the period) there has been a consistent surplus. The
exchange rate appreciation caused Brazilian products to become more expensive in world
markets and the low prices for Brazilian exports should shrink trade surplus margins. Yet,
the huge demand coming from international markets (China) benefited several Brazilian
products (mining and quarrying, especially, but also non-processed agricultural
commodities). Finally, in the last phase (2005-06 and 2007-08), a decrease in the rate of
growth of the surpluses is noticeable, despite the increase in the terms of trade (3.9
percent), probably already capturing the impact of the international financial crisis in the
second half of 2008. Out of this there would seem to be four distinct groups of sectors:
those with high surplus, new surplus, low deficits and high deficits. Among those
experiencing surplus, the traditional agrarian and natural resource-based good, in which
the country has a comparative advantage, can be found, but also some industrialized mid-
and high-technology goods such as transport equipment and electrical equipment, and
labor intensive textiles and furniture. Among deficit sectors, the predominance is of high
and mid-technology goods (pharmaceuticals, machinery, and electronics) as well as oil,
chemicals and related products. However, the deficit of the new surplus sectors is clear in
the last period.
Table 20 also explains the wide variation in figures 15 and 16. The swings are
related to variations in terms of trade and nominal exchange rates, which were
particularly acute in destinations where the trade portfolio depended on a narrow range of
297
products experiencing changes in relative prices, for instance, panels “Other” and “Asia
Pacific 10.”
Summing up, table 20 provides a more complex picture of the commercial balance
in which several capital-intensive manufactured goods are indeed experiencing deficits
but the country also presents surplus in new emerging sectors, besides the highly
competitive natural resources-based sectors. Hence, the idea of an export concentration in
agricultural and mineral commodities is not empirically verified. Furthermore, in addition
to comparative advantage, some sectors experiencing surpluses have indeed benefited
from domestic policies, namely, BNDES loans. Figure 14 in the annex shows that there
has been a steady influx of subsidies. Although the graph depicts figures with a higher
level of aggregation, food products, metallurgical products and transport equipments are
among the main recipients of subsides. Hence, despite the reforms of the 1990s, one can
not declare that industrial policy instruments disappeared in the period. Quite to the
contrary, figure 14 shows steady figures in constant U.S. dollars.

298
Table 20: Variation in Trade Balance and in Terms of Trade per sector,
selected years.

299
How do figures 15 and 16 and table 20 relate to the econometric results of last
section? First, it is important to stress the methodological differences between the 10
sectors used in the regressions and the classification of CEPAL (2006) and
Ribeiro/FUNCEX (2008). Besides, table 20 and figures 15 and 16 encompass agricultural
goods and non-processed minerals, which I do not include in the statistical exercise. Still,
some insights can be extracted from these comparisons. Overall, capital-intensive
industries have experienced deficits, but also some important surpluses (automobiles and
parts). These sectors are important recipients of state support. As the regressions showed,
the political economy of protection in Brazil tends to protect capital-intensive sectors,
despite liberalization in the 1990s. Competitive sectors, based on natural resources, do
not require as much protection but are also important recipients of state support, for
example, food products. Conversely, according to table 20, some labor-intensive
industries, such as “Plastics and Rubber” and “Clothing and Apparel” experienced
deficits in the period. Tariff protection was recently raised in these labor intensive
industries. These industries are suffering from trade liberalization adjustments and from
the competition with Chinese goods. This is the reason why my results showed the very
significant effects of the variable “Labor intensity” on the dependent variable “Tariffs”

122
. The causation might not be so recent because “labor intensive” industries account for
protection even with the results with data from 1988 to 1999. However, it was in this
period that “Apparel and Textiles” and “Rubber and Plastics” – labor-intensive industries

122
Although my tariff data did not comprise recent measures, in 2007 The Foreign Commerce Chamber
(CAMEX) proposed a modification to the CET to increase the protection of clothing and apparel, among
other labor-intensive industries. These segments now have applied rates of 35 percent.
300
– experienced a fivefold increase in import penetration, possibly triggering the protection
backlash in early 2000s.
I maintain that trade policies are explained more in terms of factors share
(technology) used by sectors and by political economic factors (collective action/market
power) rather than contemporary shifts in trade balance. Nevertheless, results in Model 2
showed a statistical relationship between trade shares and subsidies. Regional intra-
industry trade indexes seem to play a role in state support. Conversely, capital and
technology-intensive exports are regionally concentrated, as showed in figures 15 and 16.
These capital intensive sectors are included in the new surplus group in table 20. Hence,
there is a connection between the participation of these sectors in regional markets, their
trade surplus and the level of state support. The direction of causation, in my point of
view, is from intra-regional trade interests to subsidies.
Section IV - Conclusion
This chapter provides a quantitative picture of the differences among industrial
groups regarding trade policies, seeking to understand the political economic factors that
have been hindering further Brazilian trade integration with developed markets. It also
commented on some recent foreign trade trends of the country. The picture that can be
extracted from this exercise is that the political economy of trade policy is still
characterized by a level of “dirigisme” and “protection.” This posture partially explains
Brazil’s cautious trade liberalization proposals in world trade negotiations, particularly
when these commercial agreements involve surrendering domestic mechanisms to
support industrial sectors and integration with advanced markets.
301
Brazil has reaped important economic gains after the major push toward trade
liberalization and structural reforms of the 1990s, such as taming skyrocketing inflation,
correcting current account deficits and amassing dollar reserves. Microeconomic benefits
are also reported in the literature showing gains in productivity (Ferreira and Rossi 2003;
López-Cordova and Mesquita Moreira 2005). These real and supposed benefits were not
enough to convince social actors about the benefits of further trade liberalization and
integration. For the broad public, trade integration with advanced markets (the U.S. and
the E.U.) may not be associated with the alleged deleterious effects of globalization, such
as unemployment; but domestic constituents are not interested in and do not join the
highly abstract discussions about the trade strategy of the country. As a consequence,
policymaking discretion carries out the process of trade negotiation quite autonomously
and because this is influenced by long-standing worldviews, the deeper trade
commitments remained stalled. This absence of debate about further trade liberalization
also benefits protectionist interest groups. Economic and social actors may not regard
trade as a zero-sum game, but there are no influential trade liberalization oriented lobbies
in the country, a situation that contributes to maintaining the status quo (Bonomo 2006).
My regressions showed this position of economic sectors as, despite liberalizing
reforms during the 1990s, both labor and capital-intensive industries still lobby for
protection and support in trade policies. Finally, there is an offsetting effect of the
decrease in tariffs toward enhancing subsidies to capital-intensive industries. This is, in
my point of view, the utmost explanation for the cautions commitment of the country in
the FTAA and European-Union-Mercosur Agreements, and also at the WTO. I conclude
this dissertation commenting on the possible trade policy choices for Brazil in a situation
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of breakdown of the multilateral world trade negotiations, amid the world financial crisis
that might trigger widespread protectionist interests.
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Section V - Methodological Annex
Data Sources and Methodology for Construction of Variables
Data for the 10 manufacturing sectors identified in table 21 were obtained from the
Annual Industrial Survey (PIA) and from the Brazilian Institute of Statistics and
Geography (IBGE) in a two digit level categorization, National Classification of
Economic Activities (CNAE). CNAE is similar to the two-digit Standard International
Classification (SIC). For data equivalence purposes, I have merged some lines. For an
explanation of the classification of Brazilian manufacturing sectors and its equivalence
with U.S. classification (NAIC and SIC), see Professor Marc-Andreas Muendler web-
page (http://econ.ucsd.edu/muendler/) and Muendler (2001).
Exports and Imports by technological content – The graphs in figures 15 and 16
below use data from CEPAL (2006) and Lall et al (2007). Products classified according
to incorporated technological intensity, Standard International Trade Classification –
SITC, Version 2, are divided in Primary Goods, Natural Resources Based Manufactured
Goods, Low Technology Manufactured Goods; Middle Technology Manufactured
Goods, and High Technology Manufactured Goods.
Dependent variables:
Nominal Tariffs - This is a proxy for protection, it comes from Arruda de Almeida
(2004) and from the World Integrated Trade Solution (WITS), software developed by the
World Bank and the United Nations Conference on Trade and Development (UNCTAD)
(www.wits.org). From 1986-1988, I use data from Arruda de Almeida; from 1989-2005,
data comes from WITS. Sectors are in CNAE/IBGE classification and two digits
Standard International Classification (SIC). Effective Tariffs data is from Abreu (2004b),
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Kume, Piani and Souza (2000) and Kume, Piani and Miranda (2003). Effective tariffs
series were built by these authors using input-output tables for the Brazilian economy. It
is worth noticing that the Brazilian consolidated nominal tariffs are subjected to several
exceptions under the Mercosur Common External Tariff (CET), thus, at this level of
aggregation, effective tariffs would make more economic sense in order to gauge each
sector’s political economy differences. However, since this series is shorter I opted for
nominal tariffs.
State Support Share – This is a proxy for industrial policies. This series measures
subsidies in terms of loans of the National Bank for Economic Development (BNDES)
received by the 10 manufacturing sector, divided by value of production in each sector
from 1986-2005. Values for production come from FUNCEX/IBGE. Values for state
support are disbursements (loans) of the Brazilian National Bank for Economic and
Social Development (BNDES). These figures come from the Ministry of Finance, the
Ministry of Industry and Development, the BNDES itself and Batista (2002). This last
author is the only source for BNDES disbursements between 1986 and 1989. Values are
in constant 2005 US$ dollars.
Explanatory Variables:
Trade Orientation variables – Data source Center for Foreign Trade Studies
Foundation – (FUNCEX). Downloadable at www.funcex.com.br:
Export share - This series measure the share of domestic sector output that goes to
exports, in percentage points, using current US$ dollars, from 1986-2005.
305
Import share - This series measures the share of the domestic demand supplied by
imports, also called “import penetration”, in percentage points, using current US$ dollars.
It covers the period from 1986 to 2005.
Imported Inputs Share– Value of imported inputs by each domestic sector
divided by the production in each sector. Inputs comprise both primary and intermediate
goods. Data is in percentage points and in 2005 US$ dollars. This series covers only
1990-2005.
Intra-industry regional trade indexes – These series were built using the Grubel-
Lloyd index of intra-industry trade, which measures the amount of each sector’s
transactions within a given region, with data of imports and exports from FUNCEX. The
formula for this index is: 1 – [ |exports – imports| / (exports + imports)]. I measure
separately the exports and imports within Mercosur and within the Western Hemisphere.
Factor endowments variables.
Capital-Labor Ratio – I built these series to create a proxy for the relative
proportion of capital to labor in each industrial sector. They were obtained with data from
the PIA/IBGE. For labor, I use employed personnel per sector, end of year. For capital, I
use fixed assets (ativo imobilizado) per sector, which comprises real state, buildings,
machinery and inventories, etc. This is a measure of “capital stock”, end of the year.
There are substantial methodological differences throughout the years in the Brazilian
data. Data from 1988-1995 comes from table 2221 of the PIA; data from 1996-2005
comes from table 1732 of PIA. Muendler (2001) uses this same data from the PIA/IBGE.
Alternatively, I have data on the Capital-Labor Ratio for the USA, using the series from
the Bureau of Economic Research (BEA/USA): for capital, “Historical-Cost Net Stock of
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Private Fixed Assets by Industry”, capital stock in billions of dollars end of the year; for
labor, “Gross-Domestic-Product-by-Industry Accounts - Full-Time and Part-Time
Employees by Industry“. Since series for capital stock in Brazil were subject to these
methodological changes, I found more reliable to use the USA series.
Capital Intensity– This variable was built with data of the PIA/IBGE is the ratio of
fixed assets to industrial output in each sector. Data from 1988-1995 comes from table
2221 of the PIA; data from 1996-2005 comes from table 1732 of PIA, and they have
changes in methodologies. This variable is a ratio in decimal units. Both numerator and
denominator are in 2005 US$ dollars.
Labor intensity– This variable was built with data of the PIA/IBGE is the share of
expenses with wages to value-added in production process. Data from 1988-1995 comes
from table 2221 of the PIA; data from 1996-2005 comes from table 1732 of PIA, and
they have changes in methodologies. Numerator and denominator are in the Brazilian
currency of the time; thus, the number is a ratio in decimal units.
Skill Intensity– This variable, with data of the PIA/IBGE, is the share of wages to
total employment in each sector. Data from 1988-1995 comes from table 2221 of the
PIA; data from 1996-2005 comes from table 1732 of PIA, and they have changes in
methodologies. The numerator (wages) is in constant 2005 Brazilian R$, the denominator
is the number of employees, end of the year. The number is a ratio in decimal units.
Dummy for technology-intensive Sectors – This variable sets the value of 1 to
electrical and electronic equipment, transport equipment and chemical and
pharmaceuticals – sectors considered high-technology by international methodologies -
and 0 to all the other sectors.
307
Industrial Organization/concentration variables
Scale – Employment to Number of Firms– This series also comes from
PIA/IBGE, it depicts the share of employment end of the year to the number of
establishments in each of the 10 industrial sectors. I use only establishments with more
than 20 employees, which are considered middle-size companies in the Brazilian
methodology. Data from 1988-1995 comes from table 2221 of the PIA; data from 1996-
2005 comes from table 1732 of PIA, and they have changes in methodologies. Nicita and
Olarreaga (2006) use the same data of concentration for Brazil, in the Trade, Production
and Protection database, but their series cover only 1985-1995.
Concentration – This variable, following Olarreaga and Soloaga (1998), is
calculated as a ratio between firms in each sector to total firms in the 10 industrial
sectors. This variable uses the same sources and tables of Scale.
Herfindhal index - measures the market of share of firms in terms of sales. The
closer the number to 1, the more concentrated the sector is. I use data from Resende and
Lima (2005) calculated upon sales data, covering 1986-1998. They calculate the
Herfindahl concentration index - defined by H = Σis2i, where si stands for the market
share of the i-th firm.

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Section VI - Tables and Graphs
Table 21: Brazilian effective tariffs, manufacturing sectors (percentage).

Table 22: Summary statistics (all variables).

1986-1990 1991-2000
Non-metalic mineral products 50,44 14,34
Metallurgical products 38,64 15,21
Machinery 41,95 20,59
Electrical and eletronic equipment 58,72 25,84
Transport equipment 149,80 69,75
Paper, printing and publishing 36,73 11,44
Rubber and plastics 71,50 20,78
Chemical and pharmaceutical products 45,92 11,88
Textiles, clothing and leather 91,73 25,52
Food products
58,69 20,33
Average 64,41 23,57
Standard deviation
34,36 17,02
Source: Kume et al (2003)
Variable Observations Mean Standard Deviation Minimum Maximum
Effective Tariffs 130 31.103 28.373 6.100 197.850
Nominal Tariffs 180 21.092 12.513 7.977 72.883
State Support Share 180 2.968 3.367 0.290 22.870
Export Share 180 12.125 7.040 1.800 35.350
Import Share 180 10.257 9.503 0.800 48.955
Mercosur Intra-industry 180 0.458 0.303 0.000 0.983
Western Hem. Intra-industry 180 0.524 0.298 0.000 0.994
Capital Labor Ratio 180 72.979 50.968 7.520 278.160
Capital Intensity 180 0.190 0.156 0.020 1.171
Labor Intensity 180 0.154 0.052 0.062 0.303
Skilled Labor 180 0.279 0.112 0.079 0.522
Scale 180 111.702 49.480 56.100 291.100
Concentration 180 0.106 0.072 0.035 0.275
Share of Imported Inputs 150 6.590 5.462 1.190 30.951
Herfindal Index 120 0.155 0.118 0.024 0.680

Table 23: Correlation Matrix (variables used in Models 1 and 2).

Table 24: Co-linearity diagnosis (variables used in Models 1 and 2).

N o m in a l S ta te S u p p o rt E x p o rt Im p o rt M e rc o s u r W e s te rn H e m . C a p ita l L a b o r C a p ita l L a b o r S k ille d S c a le C o n c e n tra tio n
T a riffs S h a re S h a re S h a re In tra -In d u s try In tra -in d u s try R a tio In te n s ity In te n s ity L a b o r
N o m in a l T a riffs 1 .0 0 0
S ta te S u p p o rt S h a re -0 .1 0 6 1 .0 0 0
E x p o rt S h a re -0 .0 3 3 0 .6 0 4 1 .0 0 0
Im p o rt S h a re -0 .1 8 1 0 .1 8 1 0 .3 7 1 1 .0 0 0
M e rc o s u r In tra -in d u s try 0 .0 4 8 0 .2 6 1 0 .1 4 8 0 .2 9 3 1 .0 0 0
W e s te rn H e m . In tra -in d u s try -0 .0 7 7 0 .1 8 2 0 .1 9 2 0 .4 2 6 0 .4 1 1 1 .0 0 0
C a p ita l L a b o r R a tio -0 .0 9 7 0 .4 9 1 0 .4 0 1 0 .5 4 5 0 .1 8 1 0 .0 3 8 1 .0 0 0
C a p ita l In te n s ity 0 .3 9 9 0 .1 7 4 0 .1 2 1 -0 .2 5 3 -0 .0 5 5 -0 .0 0 6 -0 .1 7 3 1 .0 0 0
L a b o r In te n s ity -0 .0 8 6 0 .1 3 6 0 .2 9 5 0 .1 7 2 0 .1 3 0 -0 .1 2 5 0 .2 6 9 -0 .3 5 1 1 .0 0 0
S k ille d L a b o r 0 .0 3 7 -0 .0 3 6 -0 .1 4 5 0 .3 7 7 0 .1 8 3 0 .3 3 5 0 .3 6 4 -0 .0 9 5 -0 .1 6 5 1 .0 0 0
S c a le 0 .3 5 5 0 .1 9 1 0 .2 4 9 0 .1 5 7 0 .3 1 8 0 .3 5 5 0 .3 7 9 0 .0 9 0 -0 .0 9 4 0 .5 4 6 1 .0 0 0
C o n c e n tra tio n -0 .0 2 1 0 .1 3 2 0 .3 0 7 -0 .4 0 2 -0 .0 9 4 -0 .0 6 0 -0 .5 8 7 0 .2 9 1 0 .1 3 8 -0 .6 7 7 -0 .3 1 8 1 .0 0 0
Square Root R- Eigenvalue Conditional
Variable VIF VIF Tolerance Squared Index
Export Share 3.870 1.970 0.259 0.741 3.866 1.000
Import Share 4.910 2.220 0.204 0.797 1.841 1.449
Mercosur Intra-industry 1.560 1.250 0.642 0.358 1.604 1.553
Western Hem. Intra-industry 2.370 1.540 0.423 0.577 1.102 1.873
Capital Labor Ratio 4.610 2.150 0.217 0.783 0.792 2.209
Capital Intensity 1.470 1.210 0.681 0.319 0.607 2.525
Labor Intensity 2.450 1.570 0.408 0.592 0.461 2.896
Skilled Labor 3.380 1.840 0.296 0.704 0.362 3.269
Technology dummy 6.720 2.590 0.149 0.851 0.201 4.381
Scale 3.860 1.960 0.259 0.741 0.108 5.979
Concentration 6.580 2.570 0.152 0.848 0.058 8.198
Mean VIF 3.8
309

Figure 10 - Median Nominal Tariff for selected countries, 2005.

Source: UNCTAD-TRAINS

310

Figure 11: Brazil - nominal and effective tariffs, 2007 (percentage).
Source: Moreira (2008)
311

Figure 12: Effective tariffs, 1986-2000 (percentage).

Source: Kume et al (2000), Kume et al (2003)

0
50
100
150
200
250
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Average Chemical and pharmaceutical Eletronic and Electrical equipment Food products
Metallurgical products Machinery Non-metalic mineral products Paper, printing and publishing
Rubber and plastics Textiles, clothing and leather Transport equipment
312

Figure 13: Nominal tariffs, 1986-2005 - Sectors (percentage).
Source (Arruda de Almeida 2005, UNCTAD-TRAINS 2008)

0
10
20
30
40
50
60
70
80
90
100
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Average Chemical and pharmaceutical products Electronic and electrical equipment
Food products Machinery Metallurgical products
Non-metalic mineral products Paper, printing and publishing Rubber and plastics
Textiles. clothing and leather Transport equipment
313

Figure 14: BNDES Disbursements, 1986-2005 (constant US$ millions).

Source: BNDES, Ministry of Finance, Ministry of Development, Industry and Foreign Trade
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
5,000
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Chemicals and pharmaceuticals Electronic and electrical equipment Food products Machinery
Metallurgical products Non-metallic mineral products Paper, printing and publishing Rubber and plastics
Textiles, clothing and leather Transport equipment
314

Figure 15: Trade balance by category of products and market destinations, 1990-2005 (constant US$ billions).

Source: CEPAL 2006, based on official figures. Products classified according to incorporated technological intensity (Standard International Trade Classification –
SITC, Version 2)
315
Latin America
-6
-4
-2
0
2
4
6
8
10
12
14
16
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
United States
-8
-6
-4
-2
0
2
4
6
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
European Union
-15
-10
-5
0
5
10
15
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Primary Goods Ind Nat Resourc Low Tech Mid/High Tech
Asia-Pacific 10
-4
-3
-2
-1
0
1
2
3
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Primary Goods Ind Nat Resourc Low Tech Mid/High Tech
316

Figure 16: Trade balance by category of products and market destinations, 1990-2005 (constant US$ billions).
Source: CEPAL 2006, based on official figures. Products classified according to incorporated technological intensity (Standard International Trade Classification –
SITC, Version 2)
China
-4
-3
-2
-1
0
1
2
3
4
5
6
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Japan
-4
-3
-2
-1
0
1
2
3
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
World
-25
-20
-15
-10
-5
0
5
10
15
20
25
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Primary Goods Ind Nat Resourc Ind Low Tech Mid/High Tech
Other
-5
-4
-3
-2
-1
0
1
2
3
4
5
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Primary Goods Ind Nat Resourc Low Tech Mid/High Tech
316
317

Conclusion
This dissertation has probed the question of what determines trade policy in Brazil.
The analysis was conducted in light of the North-South trade negotiations that the
country engaged in during the 1990s and 2000s, both in the multilateral and regional
realms. I draw on political economy theories, interdisciplinary methods, including a
historical-comparative narrative and a domestic institutional-bureaucratic framework, and
econometrics tests in my attempt to explain Brazilian trade policy formulation.
The application of international trade theories to domestic trade politics highlighted
the fact that not all domestic sectors will benefit from trade liberalization and thus
lobbying will vary accordingly. Neoclassical international trade theory (the Heckscher-
Ohlin and Ricardo-Viner hypotheses), as well the new growth theories, were employed as
a way of capturing these nuances in the domestic political economy. It turned out that the
ideological world view of policymakers and their interactions with domestic constituents
and bureaucracies are essential components that shape policy outcomes. Apart from a
narrative that explicated policies in the context of domestic economic institutions, I
traced the ways in which globalization, anchored in an international political economy
theoretical framework, influenced Brazil’s domestic responses.

Specific Issues
My fundamental aim was to explain the ways in which trade tariffs have been
gradually liberalized in Brazil since the 1990s, while subsidies in some product lines are
still the norm. This dichotomous trend has evolved against the backdrop of a
predominantly mercantilist and protectionist discourse that has prevailed over this time
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period, which lingered even as the “Washington Consensus” recommendations of the late
1980s and early 1990s began to sink in. Brazil – along with other Latin American
countries –embarked on structural reforms meant to tackle severe macroeconomic
imbalances that ensued after the demise of the ISI model and the debt crisis of the early
1980s. Severe inflation, along with balance of payment and fiscal constraints, prompted
this reform effort, which also included unilateral trade liberalization. As I described,
developing countries anchored these reforms in trade integration initiatives, both at the
regional (Mercosur, Nafta) and multilateral (GATT/WTO) levels.
However, due to contradictory incentives determined by the domestic institutional
framework, Brazil resisted the deepening of the kinds of North-South trade agreements
that other developing countries had joined. Despite the stalling of multilateral trade
negotiations at the WTO, Brazil maintained an independent position and focused on
“South-South” negotiations. Why did Brazil opt for this strategy while other Latin
American countries (Mexico, Chile, Colombia, and Peru) sought market access to
developed countries? Brazil opted for an autonomous path, while also emphasizing the
multilateral WTO track, basically the size of its domestic market and its ranking amongst
the largest economies in the world enabled it to do so.
In addition to my qualitative discussion about the domestic institutional policy
framework, I captured how economic forces shape government decisions, through the use
of econometric methods. I inferred that tariff liberalization was largely a result of Brazil’s
increasing commitment to global trade integration under the auspices of the 1994
Uruguay Round agreement and the World Trade Organization (WTO), whereas the
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government’s maintenance of hefty trade subsidies reflects the continued resistance of
domestic producers to deeper levels of trade integration. Prompted by domestic political
and economic factors, these policies are also part of an institutional inertia – described in
chapter one, that continues to hinder Brazil’s entry into deeper trade commitments.
The breakdown of the Brazilian trade balance and its destination of trade provide
important insights into the country’s negotiating strategy at the multilateral and regional
levels. As a competitive exporter of primary and industrial goods, Brazil has important
stakes in the Doha round of the WTO. Thus, the country’s push for agricultural
liberalization and the alliance with the G-20 is understandable. Regarding regional
integration, Brazilian capital intensive exports to the U.S. and to Latin America, in
theory, would be an impetus for further trade integration. However, deeper trade
integration initiatives have been languishing through, not only because of Brazil, but also
because of the lack of interest on the part of the U.S. Mercosur’s institutional deepening
and consolidation, as well, has fallen on rough times, as I discussed in chapter two. As a
common market, Mercosur should have a cohesive trade policy, but, the lack of
institutional deepening is hindering this process.
The empirical results presented in chapter 4 suggest that capital intensive industrial
sectors are indeed able to exert pressure for compensatory policies in the form of
subsidies. The justification for this state support is based on the perception, advanced by
trade policy circles in the Brazilian diplomatic corps, in the Trade and Industry Ministry,
and in the business community, that the industrial sector would be harmed by the
eventual North-South integration under the WTO, the FTAA or an EU-Mercosur
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agreement. Despite the fact that some capital intensive industrial sectors are experiencing
surpluses, due to demand from regional (Latin America) and developed markets (U.S.), a
cautious position has prevailed. The alliance between the more “protectionist” forces in
the Brazilian state and these vested business interests has maintained piecemeal
liberalization. In short, Brazil has chosen a gradualist and heterodox path in its
international economic relations. This trend is epitomized in the maintenance and even
enhancement of subsides to special interest groups during the period analyzed (1988-
2005).
Which groups benefited more from protection and support? My results show that
H-O patterns shaped policies. However, while capital-intensive sectors have experienced
a drop in tariffs due to external pressures, there was an offsetting trend with the increase
of subsides to those sectors that faced adjustments. Conversely, labor, otherwise
considered the abundant factor in Brazil, is also receiving comparatively more protection.
As the country opened its economy to global trade, the competition with other labor
abundant countries created a backlash against liberalization. The protection of labor
intensive industries in Latin America is not new and it was the rule in the nineteenth and
early twentieth centuries, as Williamson and O’Rourke (1999) point out.
In this context, the regional integration path, and Latin American markets in
particular, could provide a logical and convenient outlet for Brazil’s value-added exports.
Mercosur, despite high levels of intra-industry trade, has not provided the stimulus for
trade integration with developed countries. In fact, Mercosur is riddled with exceptions to
the Common External Tariff (CET) – including a special regime for automobiles. As it
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continues to embrace some exceptions and protect industrial interests, Mercosur deviates
from the original idea of “open regionalism”. As my empirical results showed,
“concentration” is an important determinant of protection in Brazil and, by association, in
Mercosur. With the lack of domestic competition, industrial sectors have few incentives
to expand into foreign markets. However, my robust results for intra-regional trade in the
Western Hemisphere suggest that Brazil’s internationalized sectors could benefit from
closer ties toward continental trade and become a force to push deeper integration
initiatives forward.
The descriptive data in chapter four suggests that, despite the pursuit of heterodox
initiatives after the 1990s (e.g. industrial policy toward value-added exports), the country
is experiencing a trade balance more in line with its natural comparative advantage, with
deficits in capital intensive sectors but surpluses in industries related to natural resources.
This trend reveals the global competitive advantage of certain domestic industries and the
huge demand coming from world markets (China and Russia).
Since the advent of a Labor Party presidency in 2002, Brazilian foreign policy has
further emphasized political-diplomatic ties with Latin America and with non-traditional
partners, including large emerging markets such as China, India, and Russia. However,
negotiations among Latin American neighbors toward expanding and deepening South
American free trade areas have been stymied by mixed signals and delays. While there is
much rhetoric about expanding regional integration agreements, the existing ones still
lack solid rules. Conversely, there are some potential economic benefits to a South-South
strategy, because countries such as China and Russia demand goods for which Brazil has
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a comparative advantage. From a perspective of industrial goods, nevertheless, Brazil is
not a competitive exporter to these “non-traditional” markets.
Even though Brazil’s foreign trade policy has been used to complement domestic
industrial policy, and there has been an effort to promote competitiveness and seek new
markets for exports, my research suggests that the country still lacks a free-trade oriented
coalition. Policy circles and industrial sectors advocate state support to enhance the
competitiveness of Brazilian value-added exports. However, these same interests have
maintained a cautious approach toward further liberalization with advanced markets.
Some have gone so far as to support eventual tariff escalation, administrative measures
and exceptions to the Mercosur CET in order to avoid the penetration of foreign goods.
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Trade liberalization, under unilateral, regional or multilateral auspices presents
complex choices for policy-makers, who are constantly caught in a balancing act between
their constituents and domestic pressure groups. Even though trade liberalization
provides net welfare gains for the domestic economy, and a surplus for consumers, the
adjustment costs can be steep. For example, recent general equilibrium exercises for
Brazil suggest that low-skill and agricultural sectors would be the main winners in the
liberalization game, whereas industrial interests would bear steeper adjustment costs,
particularly under the North-South integration scenarios (Harrison et al 2005; Flores and
Watanuki 2008).
Summing up, I have argued that Brazil’s initial trade liberalization (tariff
reductions) was a function of policy discretion in the search to quell inflation and achieve

123
For instance, the use of antidumping measures has increased since trade liberalization and the end of a
pegged exchange rate in 1999 (Kume and Piani 2004; Bown 2006).
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macroeconomic stability (Rodrik 1994). This policy shift was reinforced by international
agreements, which tied the hands of policymakers, as in a two-level game model (Putnam
1988). Through this process the attitude of policymakers was partially changed,
prompting the reforms of the early 1990s. These reforms were further consolidated in
trade agreements such as Mercosur and the Uruguay Round (1986-1994), which were
decided by the government with little consultation concerning the positions of interest
groups. After the initial policy shock, these sectors organized and demanded
compensations, causing Brazilian policymakers to shirk from further agreements with
developed countries (FTAA and Mercosur-EU). In the name of trade policy autonomy,
one result is that subsidies have continued to be targeted toward special interests.
Therefore, while partially committing to trade reforms, Brazilian policymakers have
carefully preserved the policy space to foster industrial policies and protect the interests
of those displaced by earlier trade reforms. Acting within the loopholes of both regional
and multilateral commercial agreements, policymakers maintained certain instruments
while also avoiding deep liberalization in the form of WTO-plus agreements. Hence, my
focus on the complementary nature of the two key policies –tariffs and subsidies– in my
econometric results.
These policies reflect the country’s longstanding developmental ethos which holds
that domestic industrial sectors must be protected and fostered in Brazil’s effort to
achieve industrial autonomy and promote higher value added exports. Curiously, the
same technocratic worldview that influenced the reforms of the early 1990s defends these
mechanisms to support domestic economic sectors. This is one reason why the
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bureaucratic ranks –within the Central Bank, the Ministry of Finance and the Ministry of
Planning, and the BNDES–have no clear position on free trade. As a result, trade policy
is not a priority on the economic policymaking agenda, which privileges macroeconomic
and fiscal issues. However, although trade policy may be of less concern within
economic policymaking circles, it is still regarded as a highly strategic foreign policy
instrument for the country. Hence, the great weight of the Foreign Affairs Ministry
(MRE) in articulating and dominating Brazil’s policy stance on trade. Finally, domestic
constituents are basically disengaged from these highly abstract discussions about the
country’s trade strategy. As a consequence, state bureaucrats and interest groups drive the
process, leaving trade policymaking to the vicissitudes of long-standing foreign policy
worldviews and particularistic actions.
Prospects for the Future
From the perspective of epistemologies and methodologies applied to this research
problem, it is worth mentioning that the econometrics tests conducted here deserve
further elaboration. First, an increase in the number of industrial sectors used in the
regression would allow for the testing of the same hypothesis with a simpler OLS
framework. Second, the use of dynamic specification, which accounts for the change in
the dependent variable (trade policies), may offer more compelling explanations. I intend
to test these in the future. Finally, this kind of political economy research may suffer
from problems of omitted variable bias, multicausality, context-conditionality and
endogeneity (Franzese Jr 2006). Hence, my attempt to apply political economy tools to
the Brazilian case warrants improvement to the extent that future research would surely
cast more light on these complex problems.
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From the perspective of the substantial research problem, what are the prospects for
Brazil’s future trade commitments? The world economy is currently characterized by
severe macroeconomic stress. Whereas a strong protectionist wave has yet to appear in
the U.S. and in the EU, a deepening of the international financial crisis surely delays the
prospects for a successful conclusion of the multilateral trade agenda. The current
stalemates at the WTO and in several regional integration agreements cast doubt on the
extent to which short term trade liberalization is feasible, amid policies that tend to
compensate sectors mostly damaged by the downturn and which have the political
leverage to command support, such as the automobile sector (Brunel and Hufbauer 2009).
In short, the global economic imbalances of the early twenty-first century have further
clouded the prospects for multilateral trade liberalization.
Finally, regarding Brazil, these international macroeconomic trends have created
additional strains, while also fostering a cautious and lukewarm approach to further trade
commitments. As mentioned in chapter four, the sizable trade surpluses since 2004 can
be credited to soaring commodities prices in international markets. This boom helped
Brazil correct its current account deficit and amass large foreign reserves, which hit US$
150 billion in mid-2007. Yet, the weak U.S. dollar and over-evaluation of the Brazilian
currency has hurt domestic export interests. Despite the trade surpluses, business interests
often complaint about the domestic exchange rate. For now, the Central Bank is shielded
from pressure and carrying out a strict monetary policy, but there are critics even inside
the government that defend lower interest rates and limits to the currency appreciation.
Against this backdrop of a fairly orthodox financial and macroeconomic policy, trade
326

policy presents the possibility for heterodox and gradual positions. The ongoing financial
crisis can have dire consequences for Brazil’s trade surplus, which hugely benefited from
world demand in the 2000s. As I argued throughout this dissertation, trade policy in
Brazil is characterized by cautious and piecemeal approaches to liberalization, even in
moments of a trade upturn. Hence, the global economic downturn is an added factor that
contributes to this cautions approach and can potentially hinder Brazil from committing
toward integration agreements, especially those that involve a deepening of North-South
ties.

327

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Abstract (if available)

Abstract This dissertation discusses the political and economic forces, both external and domestic, that have shaped Brazilian trade policy in the 1990s and 2000s. Marked by concurrent multilateral and regional trade negotiations, the country has simultaneously embraced orthodoxy and liberalization of the past, while also falling back on protectionist practices. For instance, after implementing steep unilateral tariff cuts in the late 1980s and early 1990s, trade policy has subsequently undergone only piecemeal change

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Asset Metadata

Creator Oliveira, Glauco Avelino Sampaio (author)

Core Title The political economy of Brazilian trade policy: domestic determinants, world and regional strategies

School College of Letters, Arts and Sciences

Degree Doctor of Philosophy

Degree Program Political Economy

Publication Date 10/26/2009

Defense Date 05/14/2009

Publisher University of Southern California (original), University of Southern California. Libraries (digital)

Tag Brazil,European Union-Mercosur,FTAA,International trade,Mercosur,OAI-PMH Harvest,Political Economy,regional integration,trade and industrial policy,World Trade Organization (WTO)

Place Name Brazil (countries)

Language English

Contributor Electronically uploaded by the author (provenance)

Advisor Wise, Carol (committee chair), McKenzie, Roderick C. (committee member), Nugent, Jeffrey B. (committee member)

Creator Email glaucoav@gmail.com,goliveir@usc.edu

Permanent Link (DOI) https://doi.org/10.25549/usctheses-m2690

Unique identifier UC1187473

Identifier etd-Oliveira-2968 (filename),usctheses-m40 (legacy collection record id),usctheses-c127-276679 (legacy record id),usctheses-m2690 (legacy record id)

Legacy Identifier etd-Oliveira-2968.pdf

Dmrecord 276679

Document Type Dissertation

Rights Oliveira, Glauco Avelino Sampaio

Type texts

Source University of Southern California (contributing entity), University of Southern California Dissertations and Theses (collection)

Repository Name Libraries, University of Southern California

Repository Location Los Angeles, California

Repository Email cisadmin@lib.usc.edu