Brazil’s gradual rise, however, starkly contrasts with the story of its only major rival on the continent: Argentina



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Brazil’s gradual rise, however, starkly contrasts with the story of its only major rival on the continent: Argentina. Blessed with the temperate, fertile Pampas region and dominance of the Rio de la Plata river system, Argentina boasted all the tools it needs for rapid capital accumulation and subsequent economic development. Indeed, Argentina was ranked among the top five most prosperous nations at the beginning of the 20th century. A boom in European immigration and development between the end of the War of the Triple Alliance through the interwar peroid had Argentina competing with major industrialized nations in terms of GDP per capita. Standing in Argentina’s shadow, it is no suprise that Brazilians developed the tendency to be humble, unwilling to challenge their southern neighbor.

This boom created a relatively large middle class in Argentina. However, unlike in North America, there was never a wide distribution of land to individual landholders. Much like Brazil, Argentina began with an oligarchic landholder system that left most of the population economically dependent on a small handful of wealthy elite. When the backlash to this autocratic structure came, it was in the form of labor unrest that propelled to power the populist Peron regime. The legacy of Peron is that the tools of power remain consolidated under the control of a strongman -- or as in the case of the current government a strongwoman -- whose influence over the institutions of the state is near total. Other institutions are much weaker than the presidency, and as a result, policies in Argentina are highly dependent on the indivual in power at any given time.



An economic crisis in 2001-2002 placed a populist government in power which defaulted on the country’s debt. Freed of the need to make interest payments, the new government introduced mass subsidies on goods. High growth resulted, but the policies were only paid for by hollowing out the country’s capital stock and distorting the economy to the point where fundamental industries -- from cattle farming [LINk] to wheat growing [LINK] to natural gas production [LINK] -- have now begun to fail. High taxes combined with high consumption encouraged by subsidies and price controls have crippled business owners. Meanwhile, high subsidies have locked the government into increasing expenditures. Efforts to resuscitate domestic industry have led to spastic efforts at restricting foreign trade with major trading partners like Brazil and China. The net effect is that Argentina, while gifted with significant natural resources, is on a not-so-steady downward slide. Buenos Aires only weilds limited influence in South America, and little to none beyond the continent.
 
In stark contrast to Argentina's sharp rise and slow decline, Brazil has had a long slow climb, as it painstakingly built the infrastructure necessary to overcome its geographic challenges. Growth was boom and bust, with the booms causing runaway inflation which triggered the busts. In the mid-1970s the military government adopted a strategy of debt-led growth and promoted the targeted development of specific economic sectors. Many of those sectors failed, but some have become globally successful. Brazil’s ethanol, aerospace (Embraer), energy (Petrobras) and construction (Odebrecht) sectors are world class. This foundation plus the inflation controls adopted in the 1990s (discussed earlier) has led many in Brazil -- and beyond -- to believe that Brazil has finally arrived as a global player.
Perhaps. We do not mean to belittle Brazilians’ achievements to date. Taming their lands, taming inflation, and crafting a series of economic sectors fully deserving of international acclaim are no small fish. What strikes us at Stratfor as the most interesting about Brazil is the degree to which Brazilian achievements and stability are beyond their ability to control. The economy remains hooked on commodities whose prices are set far beyond the continent. After nearly two centuries of independence, the same issues -- insufficient infrastrcture, a shallow labor pool, and an unwillingness to challenge Argentina -- continue to define the Brazilian position. Even today Brazil’s rise to prominence has been less about things the Brazilians have done right as it is about the things the Argentines have done wrong.
For Brazil to truely emerge as a significant extra-regional power there is a lengthy list of internal and regional issues the Brazilians must first address. These include -- but are hardly limited to -- formalizing their dominant position in the border states, dealing with the legacy of slavery, moving beyond an oligarch-labor economic-political split that has hobbled them for nearly three centuries, and ensuring that Argentina will never again harm them. These are not simple things to do, and acheiving them will require a change in Brazil’s business as usual. But this is the price for being a master of own destiny, rather than simply accepting the results of Argentine (in)actions.

Brazil’s Geopolitical Imperatives


Typically Stratfor’s geopolitical imperatives nest: the second imperative is dependent upon the first imperative, the third upon the second, and so on. That is not the case for Brazil. Since Brazil occupies such a difficult geography, it has traditionally been a weak state that lacks the resources and institutional capacity to greatly impact the world around it. Its first three imperatives reflect this. As such the order in which those imperatives might be attained is largely determined by the status of Brazil’s near abroad rather than any decision-making process in Brasilia. Brazil can only push to achieve its imperatives as circumstances beyond its control allow it.

Imperative One: Protect the coast
The Brazilian southern coast contains the country’s core territories. However, the ruggedness of that coast and the disconnected enclave nature of the core territories mean that infrastructure linking the coastal territories together will be insufficient to ensure mutual defense. The only way in which Brazil can protect its core is to develop a naval force of sufficient strength to deter would-be predatory powers. Without such a navy Brazil would shatter into a series of -- likely mutually hostile -- city-states. And without a navy any Brazilian exports are utterly at the mercy of more maritime oriented entities.
Historically this has led Brasilia to seek alliances with whomever the dominant Atlantic power has happened to be in order to hold the traditionally more-powerful Argentina in check. Throughout the 1800s the Brazilians sought out a favorable relationship with the English. But the deeper expression of this imperative came from Brazil’s enthusiastic embracing of the United States’ Monroe Doctrine. Nearly alone among Western Hemispheric powers Brazil expressed its excitement for the American neo-colonial policy of barring European states from the Western Hemisphere, largely because it could not stand up to those powers without assistance.
Even today Brazil’s navy is unable to reliably patrol the Brazilian coastline much beyond the Brazilian core territories. And so even today Brazil maintains close -- if not exactly friendly -- relations with the United States as a hedge against potential threats.

Imperative Two: Selectively expand into the interior
Developing a navy is one means of protecting Brazil’s core. Another is to expand that core into new areas that are not so exposed to a hostile navy. In this Brazil faces no end of challenges. The coastal enclaves are not large enough to generate their own economies of scale, so reaching inland requires the expenditure of massive resources that Brazil simply does not have. As such Brazil’s inland expansion has been halting, slow and piecemeal and driven by an often badly coordinated mix of government and oligarchic interests.
Ironically deforestation has provided the most sustained means of expanding the Brazilian cultural and government footprint. Clearcutting requires a network of logging roads in order to harvest the lumber, and those roads provide a sort of artificial waterway that Brazilians have used to establish an economic life for themselves independent of both the state and the oligarchs. There is obviously a high environmental price, but deforestation-driven development has both expanded Brazil’s small middle class and laid the groundwork for Brazilian democracy.
On the negative side, however, there is the fact that the further Brazil’s population becomes from the coast, the more integrated it will naturally become into the capital-rich lands of the Rio de la Plata region to the southwest. Ironically, in achieving strategic depth, better economic opportunities and the basis for political liberalization, Brazil risks its territory becoming more fully integrated into its neighbors, as opposed to the Brazilian core.
Imperative Three: Expand into the Rio de la Plata region
The solution is to actively surge Brazilian influence to the south so that those territories ultimately answer to Brazilian economic and political decisionmaking. Like the first two imperatives, this requires decades of go-slow efforts to make any progress. It has only been in the past generation that Brazil has generated enough capital to encroach into the buffer states of Bolivia, Paraguay and Uruguay.
Brazil has invested heavily into Bolivia, with most of that country’s natural gas transportation and production under the direct management of Brazilian state owned energy company Petrobras. Brazilian natural gas demand is the lifeblood of the Bolivian economy, which is heavily dependent on energy income. In Paraguay, Brazilians have migrated in significant numbers, and are important investors in the economy -- particularly in electricity, as the two are partners in the Itaipu dam. Brazilian (and Argentine) cash fuels Uruguay’s vibrant financial sector, and trade and migration between the two is vibrant.
More broadly, Brazil is engaged with all three buffere states as well as Argentina in the Common Market of the South (Mercosur), a trade grouping that effectively serves to tie the five countries to one another economically and politically. Within the context of Mercosur, Brazil has been able to extend influence over Argentina as well as the buffer states, including through trade negotiations, security cooperation and in recent years has even been in a position to extend offers of financing to Argentina [LINK].
The next logical step -- and something the normally non-confrontational Brazilians are currently struggling with -- is what to do once economic control has been seized, but political control is not yet in place? For all practical purposes the three buffer states are now all economic satellites of Brazil, but none of them shirk from demanding better terms out of Brasilia. Uruguay charges steep fees on Brazilian cargo. Paraguay was able to recently triple the cost of electricity produced by the Itapau dam, Brazil’s single largest source of electricity. The Bolivian government regularly tramples on the rights of Medialuna landowners who are for all intents and purposes fully integrated into the Brazilian economy. If Brazil is going to make its gains stick, at some point it will need to devise a strategy for formalizing its control of the buffer states.
There also looms a much more significant competition. Brazil cannot be truly secure until such time that it at least controls the northern shore of the Rio de la Plata itself. That requires not only a de facto absorption of Uruguay, but also of select pieces of northern Argentina. If that does happen, however, Brazil’s interior would have direct access to the world’s most capital regions. The marriage of that capital generation capacity to Brazil’s pre-existing bulk will instantly transform Brazil into a power with global potential.

Imperative Four: Challenge the dominant Atlantic power
Should Brazil manage to consolidate control over Argentina, the game changes. At this point Brazil is no longer a vulnerable, enclave-based state facing extreme challenges to its development. Instead Brazil would control the majority of the continent, one of the world’s most capital rich regions and command broad swathes of easily-developed arable land. Instead of cowering in fear of regional naval powers, it would be the dominant regional naval power. With that transformation, Brazil would not see extra regional navies as angels, but as demons.
Obviously this imperative is well beyond Brazil’s reach in 2011. Not only is Brazil’s navy far smaller than that of states with one-third its population, but it is no where close to commanding the Rio de la Plata region. Until that happens, Brazil has no choice but to align itself with whoever the Atlantic’s dominant power happens to be. To do otherwise risks not simply the country’s exports, but the country’s overall economic coherence.
Contemporary Challenges: Escaping the Trap
While Brazil’s inflationary characteristics have always hobbled the country’s developments, a handful of poor decisions in recent decades have only reinforced Brazil’s structural challenges. Perhaps the worst policy is the trading agreement known as Mercosur. Recall that the Brazilian economy has long been dominated by an oligarchy that controls most of the country’s scarce capital and who enjoys a privileged economic and political position. Unlike most trade agreements -- which are negotiated by governments on behalf of the corporate world -- Brazil’s oligarchic background meant that Mercosur was negotiated by the oligarchs on behalf of the Brazilian government.
This abnormal process radically changed the end result. A normal trade deal removes barriers to trade and exposes companies in all the affected countries to competition from each other. In Mercosur’s case the various Brazilian industrialists were able to block off entire swathes of the economy for themselves and protect themselves from foreign competition. As such Brazil’s industrial sector is shielded from competition with outside forces -- even versus most other forces within the Mercosur block.
But then the Brazilian government granted preferential access to its internal market to Chinese firms, partly in order to get access to China’s ample credit, partly due to latent anti-Americanism (working from the theory that if it annoys the Americans it must be good). The result is that Chinese firms -- alone among the world’s companies -- actually have the ability to compete with Brazilian firms in Brazil. And because Chinese firms are more concerned with throughput and market share rather than profitability (link), they are deeply undercutting the sheltered Brazilian industrial base on its home turf.
That would be problematic enough under normal circumstances, but the success of Brazil’s anti-inflation policies have now come back to haunt it. Some of the policy planks of the anti-inflation program include well-capitalized banks that do not make risky loans, low government spending, reasonably clean government and low subsidies. These are all factors that international investors respect, and they have voted for Brazil with their money. Inward investment into Brazil is at historical highs, with the Brazilian Central Bank projecting the country’s 2011 FDI take at a stunning $60 billion. Much of that investor money is translating into credit, pushing up consumer demand, prices and so Brazilian inflation is toeing the government’s red line. But the real damage is to the currency. The capital influx has pushed the real up 50 percent the dollar compared to two years ago, and well over double the value of just eight years ago.
The stronger currency eliminates whatever competitive advantage Brazil’s sheltered industry might have at one point enjoyed. And the China trap is catching Brazil in three ways. First, direct competition for market share in Brazil. The Chinese yuan is de facto pegged to the US dollar so Brazilian goods are now less competitive versus Chinese goods on the domestic market. Second, China is engaging in indirect competition for market share by shipping goods into Brazil via Mercosur member states. Clauses in Mercosur allow the members to allow third party access. Third, the Chinese are among those international investors whose cash is pushing the value of the real ever upward. With every dollar the Chinese invest into Brazilian commodity production, the real goes just a bit higher and Chinese goods edge out their Brazilian counterparts just a bit more.
Resisting these reinforcing trends will require some clever and quick policy making. Partial solutions might include drastic education and immigration reform to build or attract the appropriate skills for the labor force, a scrapping of Mercosur and throwing open the Brazilian market to global competition to weed out uncompetitive firms. Such efforts would enrage the business elite and labor unions alike, and even if such reforms work they would by design gut much of the industrial base. Navigating such challenges requires a government that is fearless, experienced and nimble.
In order to accomplish such radical changes, the government will have to overcome major institutional inertia and inexperience. The country only started building its civilian institutions in 1985 with the end of military rule. The constitution did not enter into force until 1988. The currency only dates to 1994. And civilian-run Brazil has really only had one transfer between political parties: from Henrique Cardoso to Luis Inacio Lula da Silva in 2003.
The current president, Dilma Rouseff is a non-charismatic technocrat well known for demanding respect and results. It’s a good fit considering the nature of Brazil’s contemporary challenges. But success will require brutal and rapid changes in Brazil’s standard operating procedures -- changes that would undoubtedly come with serious political risks. 


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