assembling the world’s most expensive iphone briefing paper february 2015 !! 2! assembling the...

Assembling the World’s Most Expensive iPhone:

Global Value Chains, Industrial Policy and Electronics in Brazil

A BrazilWorks Briefing Paper February 2015

By Etienne Michaud With Mark S. Langevin, Ph.D.

BrazilWorks 1718 M Street, #356

Washington, D.C. 20036 USA

Tel. 202-744-0072 [email protected]

Copyright © 2015 BrazilWorks

BrazilWorksAnalysis and Advisory

www.brazil-works.com

BrazilWorks Briefing Paper February 2015

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Assembling the World’s Most Expensive iPhone: Global Value Chains, Industrial Policy and Electronics in Brazil

A BrazilWorks Briefing Paper

February 2015

By Etienne Michaud*

With Mark S. Langevin, Ph.D.**

Summary: In stark contrast with Brazil’s inward oriented industrial development since the end of World War II, the country has recently become a magnet for the foreign direct investment of electronics-producing MNEs since Dilma Rousseff took office in 2011. Notably, the world’s largest manufacturer of electronic components, Foxconn, started to produce Apple’s iPads in Brazil in 2011 and built its fifth manufacturing plant in 2012. The same year Microsoft started assembling the Xbox360 in Manaus and its competitor, Sony, began assembling its PlayStation3 two years later. Previously, these two companies only produced in China and/or Japan. The move to Brazil suggests a sharp shift in their supply chain strategy and shows the importance of Brazil’s growing electronics goods market. Yet additional policy reforms and industrial restructuring needs to be carried out if Brazil is to fully integrate into the electronics global value chain.

* Etienne Michaud is completing a Master in International Economics at the Graduate Institute of International and Development Studies in Geneva, Switzerland. He was a visiting student at the George Washington University in Washington D.C. in 2014 and previously worked for the US multinational firm Alcoa both in Switzerland and Brazil. He holds a B.S. in Economics from the University of Lausanne, Switzerland and completed coursework at the University of British Columbia in Vancouver, Canada. He can be contacted at: [email protected].

** Mark S. Langevin, Ph.D. is Director of BrazilWorks and adjunct Professor of International Affairs at The George Washington University-Elliott School of International Affairs. He can be contacted at: [email protected]


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Assembling the World’s Most Expensive iPhone:


One only needs to step into a mobile phone retailer in Rio de Janeiro to realize the peculiarity of Brazilian trade policies. In fact, the difference in smartphone prices between the United States and Brazil is so great that it may be cheaper to fly round-trip to Miami to purchase, say, an iPhone 6.1

This is largely a consequence of the stringent protectionism that hallmarks Brazil as one of the most closed emerging economies in the world.2 Brazil has largely maintained polices directed toward building domestic production networks whereas a set of countries – most of them in Asia – industrialized during the 1980s and 1990s by integrating through global value chains (GVCs) led by the advanced industrial economies.3 Internationally competitive manufacturing firms tapped into the comparative advantages found among dozens of nations around the world to produce finished goods while too many Brazilian industries fell far short of their market potential by focusing on the national marketplace rather than GVCs, especially in electronics. Today, Brazilian industry is often penalized by the high costs of imported capital goods and components as well as other dimensions of the so-called “Custo Brasil” (Brazil Cost).4 As a result, Brazilian exports of electronics fell by 32% and imports raised by 36% between 2007 and 2010,5 in spite of the high prices of imported devices. In some instances, the amount of taxes and tariffs paid by foreign electronics multinational enterprises (MNEs) selling goods in Brazil represents as much as two-thirds of the retail price.6

Graph 1: iPhone 5S Price and Average Wage

Source: author’s elaboration. Data from MobileUnlocked (2013), BBC and ILO (2012)7 1 Using Apple’s official online prices and the exchange rate of February 8th, 2015, the prices of the cheapest iPhone 6 differ by USD 609 between the United States and Brazil. The cheapest round-‐trip flights from Rio de Janeiro to Miami are sold for USD 548 for April 2015. 2 Canuto O., Fleischhaker C., Schellekens P. (2015), all. 3 Canuto O. (2014), all. 4 Langevin M. (2013), p. 5. 5 Sturgeon, T., Gereffi, G., Guinn A., Zylberberg E. (2013), p. 53. 6 “Gamers Brasileiros, nós ouvimos vocês”, PlayStation Blog, http://blog.br.playstation.com/2013/10/21/gamers-‐brasileiros-‐nos-‐ouvimos-‐voces/. 7 “iPhone 5S Price Index”, Mobile Unlock, http://www.mobileunlocked.com/iphoneprices.asp and “Where are you on the global pay scale?”, BBC News Magazine, 29 March 2012,

USA

BRA

CHI GER

IND LUX

MEX NZL RUS

TUR

UK

$0

$500

$1,000

$1,500

$0 $500 $1,000 $1,500 $2,000 $2,500 $3,000 $3,500 $4,000 $4,500

Price of iPhone 5S in USD

Average wage in USD (PPP)


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In stark contrast with Brazil’s inward oriented industrial development since the end of World War II, the country has recently become a magnet for the foreign direct investment (FDI) of electronics-producing MNEs since President Dilma Rousseff took office in 2011. Notably, the world’s largest manufacturer of electronic components, Foxconn, started to produce Apple’s iPads in Brazil in 2011 and built its fifth manufacturing plant in 2012.8 The same year Microsoft started assembling the Xbox360 in Manaus9 and its competitor, Sony, began assembling its PlayStation3 two years later.10 Previously, these two companies only produced in China and/or Japan.11 The move to Brazil suggests a sharp shift in their supply chain strategy and shows the importance of Brazil’s growing electronics goods market. This change also calls into question Brazilian industrial policy and whether it can advance greater manufacturing opportunities for Brazilian firms.

As it turns out, the decision of global electronics players to locate production facilities in Brazil has been motivated by GVC-oriented industrial policies reinforced under the umbrella of the Plano Brasil Maior (Bigger Brazil Plan).12 Brazil leveraged its huge domestic market to bring a modest functional subset of the electronics GVC inside the country’s boundaries, mostly for regional consumption, by offering substantial tax incentives conditioned on domestic assembly as well as local content and research & development (R&D) investment requirements.

It remains to be seen whether the presence of MNEs’ subsidiaries can foster domestic capabilities through knowledge spillovers and eventually allow Brazilian firms to climb up the value chain to the more sophisticated, value added stages, such as semiconductor design and production. Local content requirements (LCR) will likely create a policy-induced demand for increasing domestic capabilities, but such a discriminatory, non-tariff trade barrier may also violate Brazil’s obligations under the World Trade Organization’s disciplines and is currently challenged by the European Union (see page 10).

The GVC Revolution

To understand the formation of GVCs it is helpful to take a step back and consider the historical evolution of economic globalization. With respect to the development of global assembly lines, Baldwin points to the two “great unbundlings,”13 including the fall in transport costs that allowed for a greater distance between production and consumption and the subsequent telecommunications revolution of the 1980s which permitted cheap and reliable coordination and transfer of information between distant locations.

http://www.bbc.com/news/magazine-17543356. 8 “Foxconn to Build Fifth Brazil Plant”, Wall Street Journal, 19 September 2012, http://online.wsj.com/articles/SB10000872396390444165804578005722309270246. 9 “Microsoft confirma produção de Xbox no Brasil”, Valor Econômico, 27 September 2011 http://www.valor.com.br/empresas/1021170/microsoft-confirma-producao-de-xbox-no-brasil. 10 “Microsoft to produce Xbox 360 consoles in Brazil”, MarketWatch, 28 September 2011 http://www.marketwatch.com/story/microsoft-to-produce-xbox-360-consoles-in-brazil-2011-09-28. 11 “Foxconn 'mulls $12bn Brazil move' as it seeks expansion”, BBC News Business, 13 April 2011 http://www.bbc.co.uk/news/business-13058866 and “PlayStation 3 now being made in Brazil”, The Japan Times, 9 May 2013, http://www.japantimes.co.jp/news/2013/05/09/business/playstation-3-now-being-made-in-brazil/ and “Sony vai acelerar produção local do PlayStation 4 para reduzir preço”, Valor Econômico, 21 October 2013, http://www.valor.com.br/empresas/3311186/sony-vai-acelerar-producao-local-do-playstation-4-para-reduzir-preco&usg=ALkJrhiFl7KAYXlGhgMqqySGFbuJtWo9Gw. 12 “Plano Brasil Maior 2011/2014”, presentation of the Ministry of Development, Industry and Foreign Trade, 2011, slide 8, http://www.brasilmaior.mdic.gov.br/wp-content/uploads/2011/08/apresentacao_completa_final.pdf and “IT Law PADIS – semiconductors and displays”, presentation for Meeting with Taipei Delegation Brasília, MCTI and MDIC, October 25th, 2013, slide 4, http://investimentos.mdic.gov.br/public/arquivo/arq1383326246.pdf. 13 Baldwin R. (2006), all.


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Comparative advantages played a role at the industry level after the first unbundling and then developed as firm-based competitive advantages when the second unbundling allowed companies to distribute distinct stages of production and offshore specific tasks worldwide. A region or nation (and even municipalities) may now specialize in one task and provide it at a competitive price to all industries that rely on such a function in their respective value chains. As corporations seize these cost-saving opportunities, intermediate goods cross more borders and travel greater distances between each distinct production stage. Remarkably, since 2009, the value of intermediate goods trade is greater than that of final goods.14

The offshoring of labour-intensive activities such as functions driven by Information Technology (IT) and call center services to India (the “back office” of the world) or production lines to China (the “factory” of the world) are typical examples of the GVC revolution. On the one hand, quickly integrating GVCs through distinct, low value-added tasks can create learning externalities and other spillovers allowing emerging economies to upgrade to more skill-intensive tasks over time. On the other hand, MNEs carefully guard against excessive technological spillovers to local firms that could threaten their dominant status and control over production in emerging markets as a result.15 Such a strategy is especially relevant with respect to Brazil’s participation in GVCs and in particular, electronics.

The Electronics GVC

The electronics industry was initiated during the end of the nineteenth century, but “took off” after World War II. In recent years, sustained, transformative innovation in the sector created new, fast-growing markets and changed the way we work, communicate, play, shop, travel and so forth. Today, electronics is the most important goods-producing industry globally, creating more jobs and revenues than any other sector.16

A key characteristic of electronic goods is that they are made of a number of complementary components, most of which are either common to many different electronic end-markets or specific to one device but easily reproducible at high scales once developed. Thus, a final product can be distributed through a sum of intermediate goods that can be sourced through different firms in different countries. This high level of flexibility creates both product modularity (substitutability of components) and value chain modularity (substitutability of suppliers).17 The high value-to-weight ratio of those components also allows for a low per-unit transport cost.18 Consequently, the electronics industry developed through a global value chain dynamic that places a premium on increasing trade in components and services across borders. Trade in intermediate electronics goods is greater than all other sectors (43.3% of top-50 manufactured intermediate goods in 2006) and had the highest annual rate of growth between 1988 and 2006 (13.8% per annum).19

14 Sturgeon, T., Gereffi, G., Guinn A., Zylberberg E. (2013b), p. 2. 15 Sturgeon, T., Gereffi, G., Guinn A., Zylberberg E. (2013b), p. 1, 7. 16 Sturgeon, T., Kawakami, M. (2010), p. 2. 17 Sturgeon, T., Kawakami, M. (2010), p. 10. 18 Backer, K. D. and Miroudot S. (2013), p. 28. 19 Sturgeon, T., Kawakami, M. (2010), p. 4.


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Global Actors

Three main types of companies can be distinguished in the electronics GVCs; the lead firms, the contract manufacturers and the platform leaders. 20

Graph 2: The Electronics Value Chain and its Actors

Source: adapted from Sturgeon, Gereffi, Guinn and Zylberberg (2013), p. 48

The lead firms are the most well known to the general public as they often carry out the marketing under their name tags and bring the product to end-markets. They are at the source of the creation of the value chain, developing the original architecture of the device and sourcing different stages of their business model in a strategic way. Due to the dynamism of the electronics industry in recent years a large range of end products and varieties were commercialized, such as computers (HP, Microsoft, Apple); consumer electronics (Samsung, Sony, LG); mobile devices (Samsung, Apple, LG); video games (Nintendo, Sony, Microsoft); and products targeting other industrial sectors. As the names above suggest, most lead firms are located in developed countries such as the United States and Japan or late developing, but export oriented nations such as South Korea. There are only a few lead firms in developing countries that were able to gain a competitive position, mostly Chinese and Taiwanese firms such as Lenovo, Acer and HTC. Samsung and other companies remained almost fully integrated, designing and producing most of the components of the final product. Others like Apple and Dell outsourced many aspects of production to the second category of firms; contract manufacturers. 21

Global production networks in the electronics industry are characterized by two types of contract manufacturing: 1) electronics manufacturing services (EMS) that focus solely on production and 2) original design manufacturers (ODM) that also provide product design services. EMS firms pursue a strict standardization for productive processes that creates an integrated and coordinated platform for global assembly lines. This business model has been described as the McDonald’s approach to manufacturing.22 Lead firms and ODMs take advantage of the modularity of electronic devices to design the computer circuits, components and final product while transfering all the product characteristics and guidelines to the manufacturing platforms for production. 23 ODM firms are more vertically integrated but also narrower in the range of devices they design and produce. Taiwan is a hub for contract manufacturers and hosts seven out of the twelve major players, including the global leader Foxconn. The main challenger to the latter is the US firm

20 Sturgeon, T., Kawakami, M. (2010), p. 11. 21 Sturgeon, T., Gereffi, G., Guinn A., Zylberberg E. (2013), p. 49. 22 Lüthje, B. (2002), p.227 and 234. 23 Sturgeon, T., Kawakami, M. (2010), p. 13.


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Flextronics now based in Singapore. They operate on a global scale with production facilities located primarily in China, Vietnam, the Czech Republic but more recently Brazil. The high substitutability of this task coupled with the significant investments needed to produce and deliver huge volumes outsourced by lead firms led to a concentrated market with a few global firms operating at very low profit margins (2.4% for Foxconn in 2011).24 Much of their resources are internalized with little room for local suppliers in developing markets beside raw materials such as metals and plastics.25 Nevertheless, quantities are so large that the sourcing decisions of contract manufacturers can have a significant influence upon the industrial development of emerging economies such as Brazil.26

Select firms have developed cutting-edge expertise in specific technologies, allowing them to surpass their funcional roles related to EMS. These companies, called platform leaders, provide their components to be implemented in the final devices of lead firms. An instructive example is the operating system of a smartphone. Whereas Apple developed its own platform (iOS) and is therefore both a lead firm and a platform leader, Samsung outsourced Android to a platform leader; Google. Most electronic devices also function with integrated circuits made of semiconductors, materials that are extremely expensive to produce. The investment necessary for this technology is estimated to be from 1 to 10 billion USD. Those plants (referred to as fab or foundry) sometimes produce on behalf of many semiconductor design companies (fabless).27 The latter specialize in design, testing, assembly or sales of the integrated circuits. Other global firms conduct both design and production, in particular Intel and Samsung. Fabless activities represent an opportunity for developing countries because the capital investment required to enter the value chain is quite low. For example, the Taiwanese firm MediaTEK entered the market in 1997 and was able to adapt and maintain its position along the path of innovation from the CD to HDTV.28 Brazil has yet to complete such an ambitious path toward GVC based industrialization.

Brazil and the Electronics GVC

In high-tech industries such as electronics, Brazil and other emerging markets start with a comparative disadvantage in tasks that require technological capabilities and high-skilled workforce. They nevertheless have a clear comparative advantage over developed countries in low- and medium-skilled labor as well as raw materials.29 As discussed above, the second unbundling allowed countries to specialize in tasks rather than industries, in particular for goods with high relative modularity. Import-substitution industrialization (ISI) policies based on infant industry protection unleash a long and costly process of developing a country’s own capabilities along the value chain. This approach cannot reach the level of efficiency achieved by dividing the product into tasks and localizing each stage in a country with a related comparative advantage. Brazil’s ISI policies did not create or sustain export competitiveness in the electronics industry, whereas China welcomed FDI from electronics MNEs. In doing so, it benefited from an efficient integration of labor-intensive tasks throughout the value chain and was able to industrialize from the bottom-up. Ozawa referred to this new catch up model as “FDI-led take-off”.30 The disparity in policy approach between Brazil and China helps explain the

24 Sturgeon, T., Gereffi, G., Guinn A., Zylberberg E. (2013), p. 49 and Sturgeon, T., Kawakami, M. (2010), p. 14 25 Lüthje, B. (2002), p. 239. 26 Sturgeon, T., Kawakami, M. (2010), p. 43. 27 Sturgeon, T., Gereffi, G., Guinn A., Zylberberg E. (2013), p. 50. 28 Sturgeon, T., Kawakami, M. (2010), p. 14. 29 Ozawa, T. (2011), p. 2. 30 Ozawa, T. (2011), all.


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sharp deterioration of Brazil’s trade balance in the electronics industry, with a 36% rise in imports between 2007 and 2010 to 17 billion USD and a 32% fall in exports to 2.5 billion USD over the same period.31

GVC-Oriented Industrial Policies

In recent years, the Plano Brasil Maior reinforced pre-existing vertical (i.e. sector-specific) industrial policies in the electronics sector.32 This package of incentives is designed to attract the industrial know-how of MNEs and tap in the opportunities represented by fast-growing domestic and global demand. This approach differs from the ISI era in three ways. According to Gereffi and Sturgeon,33 it targets the FDI of global suppliers, focuses on specific low and medium added-value tasks, and holds out the possibility of achieving the objective of moving up the value scale over time.

1991 Informatics Law and Local Content Requirements

The broader Brazilian industrial policy relevant to the microelectronic industry is embedded in the 1991 Informatics Law. By raising taxes on imported electronic goods and components and offering exceptions for domestically assembled devices under a defined set of conditions, in particular local content and R&D investment requirements, the policy sought to increase FDI for the purpose of supporting its ISI policies.34 This policy orientation is also reflected in Brazil’s current local content requirements.

Graph 3: Tax Incentives for Devices Considered “Made in Brazil”

Source: author’s elaboration with data from Positivo Infomatica35

In order for a device to be considered “made in Brazil”, the Ministry of Science, Technology and Innovation (MCTI) and the Ministry of Development, Industry and Foreign Trade (MDIC) determine a Basic Production Process (PPB) that fixes the minimum share of each component that must be produced domestically, in a per-segment basis. For example, the PPB for a tablet in 2014 is that 90% of the motherboard, 80% of the wireless communications interface, 30% of the cellular access boards and 80% of the

31 Sturgeon, T., Gereffi, G., Guinn A., Zylberberg E. (2013), p. 53. 32 “Plano Brasil Maior 2011/2014”, presentation of the Ministry of Development, Industry and Foreign Trade, 2011, slide 8, http://www.brasilmaior.mdic.gov.br/wp-content/uploads/2011/08/apresentacao_completa_final.pdf and “IT Law PADIS – semiconductors and displays”, presentation for Meeting with Taipei Delegation Brasília, MCTI and MDIC, October 25th, 2013, slide 4, http://investimentos.mdic.gov.br/public/arquivo/arq1383326246.pdf. 33 Gereffi and Sturgeon (2013), p. 353-354. 34 Costa I., Robles Reis de Queiroz S. (2002), page 1431-1432.


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AC/DC converters must be produced in Brazil. The share for other parts varies greatly, with 10% in 2014, 60% in 2015 and 30% from 2016, a challenge for companies facing sticky retail prices.35

Research and Development Investment Requirements

Global firms investing in emerging economies often concentrate their R&D efforts in their home base and transfer previously developed technological capabilities to countries with cheaper labor. Workers learn how to use existing technologies, but do not develop the necessary skills for deeper innovation.36 Consider the comparable case of Argentina where the creation of knowledge in the subsidiaries of MNEs and their respective linkages to the domestic economy were shown to be important factors that generate positive spillovers.37 To tackle this challenge and unleash such spillovers, Brazilian policy makers added a second requirement to qualify a product for the tax exemption in the form of an R&D investment requirement. The minimum amount is determined as a share of gross revenues from the tax-exempted products; 3% for computers and tablets and 4% for mobile phones.38 Flexibility is given to companies in the allocation of these funds, but their use must seek to develop new technologies (innovation) or new skills (education). An example of this flexibility is the United States headquartered computer company Dell that decided to outsource R&D projects to a global contract manufacturer present in Brazil to comply with this requirement.39

The Manaus Free Trade Zone

Brazil also established export-processing zones specifically for the Amazonas region. According to the Ministry of Development, Industry and Foreign Trade (MDIC),

“The Manaus Free Trade Zone is a free import and export trade area where special fiscal incentives apply, set up with the objective of creating in the Amazon Region an industrial, commercial and agricultural center under economic conditions that allow its development, given local factors and the great distance separating it from its markets”.40

In addition to advantages granted throughout Brazil, the free trade zone-produced goods are fully exempted from the federal sales tax (IPI), the corporate income tax is reduced by 75% and land is available at a very competitive price (1.00 BRL per square meter) and includes the necessary infrastructure such as water supply and treatment, telecommunication networks, and transportation infrastructure. The conditions firms must fulfill include a basic production process, job creation and training of the workforce, and reinvestment of a share of the profit in the region.41 This policy was successful in creating an electronics hub, the Manaus Industrial Sector Science, Technology and Innovation Center (CT-PIM), with partnerships developing in different parts of

35 “Taxation in Brazil´s PC Industry”, Positivo Informática, http://ri.positivoinformatica.com.br/positivo/web/conteudo_en.asp?idioma=1&conta=44&tipo=21962. 36 Costa I., Robles Reis de Queiroz S. (2002), page 1431. 37 Marin, A. and Bell M. (2006), p. 693. 38 “Taxation in Brazil´s PC Industry”, Positivo Informática, http://ri.positivoinformatica.com.br/positivo/web/conteudo_en.asp?idioma=1&conta=44&tipo=21962. 39 Sturgeon, T., Gereffi, G., Guinn A., Zylberberg E. (2013), p. 49 and 55. 40 Manaus Free Trade Zone: Business Opportunity and Investment in Amazon, Ministry of Development, Industry and Foreign Trade, July 2008, http://investimentos.mdic.gov.br/public/arquivo/arq1272655278.pdf. 41 Incentivos, Suframa website, http://www.suframa.gov.br/zfm_incentivos.cfm and “Manaus Free Trade Zone”, The Brazil Business, 10 September 2012, http://thebrazilbusiness.com/article/manaus-free-trade-zone.


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the world such as Belgium, Germany, France and Portugal.42 The Zone produced as much as 35% of the mobile phones used in Brazil in 2008.43

Compliance with International Trade Law in Question

Brazilian GVC-oriented industrial policies initiated one of the most recent international trade disputes at the World Trade Organization (WTO).44 On December 17, 2014 a panel was officially established following a request from the European Union (EU). The United States, Japan and Argentina joined as third parties.

According to the EU, the tax incentives granted to the electronics and automotive industries discriminate against imported products, violating Brazil’s international obligations. A major claim is that inputs and equipment imported in Brazil are afforded less favorable treatment than like domestic products (Art. III:4 of the GATT). In fact, local content requirements (LCRs) are explicitly prohibited since the 1994 Trade-Related Investment Measures (TRIMs) Agreement.45

Prior to signing the latter, Brazil and India strongly advocated for more flexibility in the use of TRIMs, in particular to “promote domestic manufacturing capabilities in high value-added sectors or technology-intensive sectors” and to “stimulate the transfer or indigenous development of technology”.46 This effort was unsuccessful, but TRIMs continued to be used. It backfired in 1998 when the European Communities and the United States initiated a similar dispute with India over LCRs in the automotive industry. The WTO panel ruled against India and the LCRs were removed almost four years after being implemented.47 Is this enough time for Brazil to develop lasting domestic capabilities in electronics?

Semiconductor Production

Brazilian industrial policy has also targeted segments controlled by various platform leaders, in particular semiconductor design and other tasks conducted by fabless firms. This is a good example of a middle technology in which the added value fits between raw commodities and semiconductor fabs. The integrated circuit (IC) program was first established in 2005 with a twofold strategy. First, it selected five Brazilian design houses and provided them with various types of support, mainly grants, connections in the industry, technical support and workforce training. The program scope was later expanded to include more participating companies. Second, it sought to attract foreign well-connected design houses from abroad, notably through non-reimbursable support funds and low-interest loans from the Brazilian Development Bank (BNDES). However, the IC program and its strategy did not succeed.48 As a consequence the Support Program for Technological Development of the Semiconductor Industry (PADIS) was launched in 2007 and added fiscal incentives for semiconductor and display companies conducting R&D in Brazil. Eligible companies

42 CT – PIM, Suframa website, http://www.suframa.gov.br/invest/en-zona-franca-de-manaus-ct-pim.cfm. 43 Electrical and electronic appliances and information technology products, Suframa website, http://www.suframa.gov.br/invest/en-onde-eletro-info.cfm. 44 Dispute DS472: Brazil – Certain Measures Concerning Taxation and Charges, the status of the dispute can be followed at http://www.wto.org/english/tratop_e/dispu_e/cases_e/ds472_e.htm. 45 “WT/DS472/5 Request for the establishment of a panel by the European Union”, WTO, 7 November 2014, http://www.worldtradelaw.net/pr/ds472-5%28pr%29.pdf.download. 46 “JOB(05)/149: Flexibilities left in the TRIMS Agreement for Developing Countries”, Brazilian and Indian communication to Committee on Trade-Related Investment Measures, 12 July 2005. 47 Communication from India in India – Measures Affecting the Automotive Sector, WTO, 13 November 2002. 48 Vinhais Gutierrez R. M., Ribeiro Mendes L. (2009), p. 32.


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were exempted from income, value added, and import taxes.49 However these measures failed to convince international semiconductor companies to install capacity in the country.50 Brazil’s efforts to attract such production and R&D investments related to greater and higher-value-added GVC integration have not fully overcome the “Brazil Cost” and additional obstacles that stand in the way of accelerating Brazilian industry’s international integration, at least in electronics. Brazilian incentives and competitiveness must improve in order to attract greater FDI in the electronics industry and overcome the visible hand of other national governments interested in this segment of the GVC as explained below.

Managed trade in the Semiconductor Industry

The atypical organization of the global semiconductors industry may be one of the reasons why Brazil is facing difficulties in entering this stage of the GVC. The era of managed trade started with the 1986 Semiconductor Trade Agreement between the US and Japan. It introduced a voluntary export restraint (VER), a scheme in which Japan would monitor capacities and costs and set a firm-specific minimum export price to counter US allegations of dumping.51 In 1987, the European Communities obtained the establishment of a panel to rule on the compliance of this scheme with the GATT. The following year, the panel ruled out the VER52 and it was subsequently removed.

In August 1996, the US and Japan met in Vancouver to set up a similar scheme administered by industry representatives.53 The Semiconductor Council was established, with the U.S. Semiconductor Industry Association and the Electronic Industries Association of Japan as co-founders. The roles of the Council were notably to promote cooperation, gather data on trade flows and assess supply and demand. It led the New York Times to wonder; “A U.S.-Japan Chip Industry Council (Or, Is It a Cartel?)”.54 The US and Japan published a joint statement affirming “their attention to support industry-to-industry cooperative efforts, and [planning that] at least once per year the two governments will hold consultation to receive and review reports on data collected and analyzed (...), discuss the cooperative activities conducted (...) and government policies and activities affecting the semiconductor industries.” 55 Later, industry representatives from Korea and Europe were added and the organization was renamed the World Semiconductor Council. The Chinese and Taiwanese are the most recent members of the Council.56

The enrollment condition for new countries is the elimination of all tariffs or the commitment to do so. Current Brazilian GVC-oriented industrial policy is therefore incompatible with a request for membership. Brazil’s inability to formally cooperate with the semiconductor industry across all member-states of the Council significantly reduces the country’s potential to attract major semiconductor platform leaders and upgrade its participation in the electronics GVC.

49 IT Law PADIS – semiconductors and displays, Meeting with Taipei Delegation, Brasília, 25 October 2013, http://investimentos.mdic.gov.br/public/arquivo/arq1383326246.pdf. 50 Vinhais Gutierrez R. M., Ribeiro Mendes L. (2009), p. 32. 51 Irwin D. (1996), p. 10 (footnote) and Baldwin R. (1994), p. 137. 52 Panel Report on Japan – Trade in Semiconductors, GATT, 4 may 1988. 53 “Joint Statement by the Government of the United States and the Government of Japan Concerning Semiconductors”, Vancouver, Canada, 2 August 1996. 54 Pollack A.: “A U.S.-Japan Chip Industry Council (Or, Is It a Cartel?)”, New York Times, 6 August 1996. 55 “Joint Statement by the Government of the United States and the Government of Japan Concerning Semiconductors”, Vancouver, Canada, 2 August 1996. 56 Office of the United States Trade Representative, Semiconductors, http://www.ustr.gov/trade-topics/industry-manufacturing/industry-initiatives/semiconductors.


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Public Policy Considerations

As the policies tailored for Manaus and semiconductors suggest, taxation is only one of the factors companies consider in their localization decisions. Additional factors and public policy considerations, such as physical infrastructure, workforce development and access to credit also represent key variables that shape the evolution of a national industry or GVC. These variables are influenced by a wide set of public policies formulated to overcome the high cost of doing business in Brazil. In particular, physical infrastructure has lagged behind the efforts of Brazil’s competitors in the electronics industry. For example, the cost to export a container from Brazil surpassed that of all major emerging economies since 2005 and rose from $630 USD in 2005 to $2,323 USD in 2011.57 Brazil’s inadequate infrastructure increases transportation costs and thereby limits the gains from “unbundling” electronics goods and lowers the attractiveness of Brazil as a hub.

Also, the country requires greater educational achievement in science, technology and engineering to upgrade its position in GVCs such as electronics. By 2015, the demand for engineers is estimated to reach 330,000 and Foxconn has expressed doubts about its ability to attract the 20,000 engineers it plans to hire.58 The “Science Without Borders Program” is a notable policy response to this shortfall, providing scholarships for Brazilian undergraduate and graduate students to spend a year studying at European and United States universities.59

Additionally, broad support from the BNDES to Small and Medium-sized Enterprises (SMEs) and MNEs serves to mitigate the Brazil Cost and improve national competitiveness. The BNDES portfolio represents over 25% of the total loans outstanding in the country and an impressive 70% of corporate loans that mature in more than three years.60 However, the current fiscal duress and economic downturn undermine the conditions for continuing such state subsidized loan programs.

Analysis and Recommendations

Recent Brazilian government efforts have led to the installation of electronics assembly, but have not fully integrated the country’s economy and industrial capacity into the electronics GVC. Instead, successive Brazilian governments leveraged the large domestic market and preferential access to Mercosur to raise preemptive barriers to trade and force global players to replicate and scale down part of the GVC inside the country’s boundaries. As a result, Brazil’s participation in the electronics GVC is restricted to serving national and regional markets rather than the much larger global marketplace. Brazil’s efforts to attract electronics MNEs do create short-term benefits, including increased employment. Indeed, the Brazilian government projected that the Foxconn deal in 2011 would generate about 100,000 jobs, 25% more than the number of direct employees of Petrobras in 2010.61 Furthermore, Brazilian consumers also gain from the re-localization of production to Brazil with falling prices as a direct consequence of lowered tax burden for electronics producers. For example, the price of now domestically produced tablets is expected to fall by 10% to 15%,62 which contributes toward lowering inflation. Finally, falling prices may explain part of the decrease in the relative size of the grey PC market from 80% in 2004 to 21% by 2013 as reported by the largest computer manufacturer in 57 World Bank data: http://data.worldbank.org/indicator/IC.EXP.COST.CD. 58 “Why Foxconn's IPad Deal Is Wrong for Brazil”, Foreign Affairs, 27 Oct 2014, http://www.foreignaffairs.com/articles/136625/ronaldo-lemos/why-foxconns-ipad-deal-is-wrong-for-brazil. 59 Website of the Brazil Scientific Mobility Program: http://www.iie.org/Programs/Brazil-Scientific-Mobility/About. 60 “Brazil's BNDES crowding out private banks from loans, OECD says”, Reuters, 22 Oct 2014, http://www.reuters.com/article/2013/10/22/bndes-brazil-oecd-idUSL1N0I81RP20131022. 61 "Why Foxconn's IPad Deal Is Wrong for Brazil", Foreign Affairs, 27 Oct 2014, http://www.foreignaffairs.com/articles/136625/ronaldo-lemos/why-foxconns-ipad-deal-is-wrong-for-brazil. 62 Ibid.


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Latin America, Positivo Informática. Such a decline could partially compensate for lower government revenues associated with reducing the tax burden of electronics producers with manufacturing installations in Brazil.63

However, these positive outcomes do not directly increase Brazil’s competitiveness in the electronics GVC. Nor have Brazilian policies attracted a growing list of semiconductors firms. It is not apparent that current public policies are sufficient to rapidly improve national capabilities and comparative advantages, or lessen the overall cost of doing business in Brazil. These circumstances raise important questions.

Which public policy reforms and industry restructuring efforts are needed to deepen Brazil’s participation in the electronics GVC as President Dilma Rousseff begins her second term in office amidst a sluggish economy and a contracting industrial sector?

Can Brazil move from assembling final products to designing semiconductors to eventually hosting a lead firm, another “Lenovão” i.e. a success story similar to Lenovo in China?

Clearly the answers depend on the ability of national firms to closely interact with an increasing number of global companies now taking part in the electronics GVC and either producing in Brazil or considering relocating production tasks to Brazil in the coming years. All participating firms may indeed benefit from external economies of scale through direct partnerships and human capital creation.64 For example, global car manufacturers set up operations in Brazil in the 1950s and are now positioned as globally competitive exporters in the sub-sector of automotive electronics.65 The minimum R&D investment requirement may advance such an outcome in electronics, but Brazilian industry’s potential for positive spillovers may be dampened by the large productivity gap and the important market share of more advanced foreign MNEs.66

Because Brazil built a fence around its domestic electronics industry it is now a latecomer to the modern electronics GVC. Nevertheless, the high value chain modularity allows for international reorganization and affordable substitution of suppliers. Following the financial crisis, lead firms increased their offshoring and outsourcing efforts to reduce costs and diversify away from sluggish growth in the advanced industrial countries. Some firms in emerging countries jumped on this opportunity and built on the knowledge accumulated through low value-added tasks to upgrade their respective positions in the GVC and start innovating on their own.67 Similarly, Brazilian policy makers should craft industrial policies formulated to attract foreign leaders in middle-technology tasks of the electronics GVC rather than rely on the national or regional consumer markets as the major attraction for FDI.

Baldwin argues that the key factors to truly integrate a GVC are “reliable workers, a hospitable business environment, and proximity to an advanced technology nation willing to offshore some of its factories”.68 If Baldwin is correct, then current Brazilian policies are wrong.

In order to scale up Brazil’s value added contributions to GVCs, government officials and industry leaders must quickly formulate policies that prepare Brazilian workers to make the most of global manufacturing opportunities, to eliminate the most onerous costs and unproductive elements of taxation and

63 “Taxation in Brazil´s PC Industry”, Positivo Informática, http://ri.positivoinformatica.com.br/positivo/web/conteudo_en.asp?idioma=1&conta=44&tipo=21962. 64 Kokko A. (1994), p. 279. 65 Sturgeon T., Gereffi G., Guinn A., Zylberberg E. (2013), p. 53-54. 66 Kokko A. (1994), p. 290. 67 Sturgeon T., Kawakami M. (2010), p. 7 and 44. 68 Baldwin R. (2014), p. 324.


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regulation, increase productive physical infrastructure to ease the cross-border shipment of intermediate goods and components, and reform the national trade policy to promote fast paced integration into GVCs rather than protect the nation from them. Brazil holds significant comparative advantages, but these cannot be fully unlocked and leveraged unless government and business decide once and for all that Brazilians have more to gain through optimizing participation in higher value added GVCs than through protection.

Bibliography

Backer, K. D. and Miroudot S. (2013): “Mapping Global Value Chains”, OECD Trade Policy Papers, No. 159, OECD, 2013

Baldwin R. (2014), “Trade and Industrialization after Globalization's Second Unbundling: How Building and Joining a Supply Chain Are Different and Why it Matters” in Feenstra R. and Taylor A., “Globalization in an Age of Crisis: Multilateral Economic Cooperation in the Twenty-First Century”, University of Chicago Press, 2014

Baldwin R. (2006): “Globalisation: the great unbundling(s)”, prepared for the Economic Council of Finland, September 2006.

Baldwin R. (1994): “The impact of the 1986 US-Japan Semiconductor Agreement”, Japan and the World Economy 6 (1994) 129-152.

Canuto O., Fleischhaker C., Schellekens P. (2015), “Brazil's closedness to trade”, VoxEU, 11 January 2015

Canuto O. (2014), “The High Density of Brazilian Production Chains”, Let’s Talk Development blog, World Bank, 13 November 2014.

Costa I., Robles Reis de Queiroz S. (2002): “Foreign Direct Investment and Technological capabilities in Brazilian Industry”, Research Policy 31 (2002) 1431–1443.

Gereffi, G. and Sturgeon T. (2013): “Global Value Chains and Industrial Policy: The Role of Emerging Economies”, FGI, NTU and WTO, 2013.

Irwin D. (1996): “The U.S.-Japan Semiconductor Trade Conflict” in Krueger, A.: “The Political Economy of Trade Protection”, University of Chicago Press, January 1996.

Kokko, A. (1994): “Technology, market characteristics, and spillovers”, Journal of Development Economics 43 (1994) 279- 293, page 279.

Langevin M. (2013), “The Brazilian Capital Goods Market: Recent Development and Future Prospects”, BrazilWorks, April 2013.

Lüthje, B. (2002): “Electronics Contract Manufacturing: Global Production and the International Division of Labor in the Age of the Internet, Industry and Innovation”, Volume 9, Number 3, 227-247, December 2002.

Marin, A. and Bell M. (2006): “Technology spillovers from Foreign Direct Investment (FDI): the active role of MNC subsidiaries in Argentina in the 1990s”, Journal of Development Studies, Vol. 42, No. 4, 678–697, May 2006.


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Ozawa, T. (2011): “The role of multinationals in sparking industrialization: From ‘infant industry protection’ to ‘FDI-led industrial take-off’”, Columbia FDI Perspectives, No. 39, 6 June 2011.

Sturgeon, T., Gereffi, G., Guinn A., Zylberberg E. (2013): “Brazilian Manufacturing in International Perspective: A Global Value Chain Analysis of Brazil's Aerospace, Medical Devices, and Electronics Industries”, prepared for Brazil’s Confederação Nacional da Indústria (CNI), September 2013.

Sturgeon, T., Gereffi, G., Guinn A., Zylberberg E. (2013b): “Brazil in Global Value Chains: Implications for Trade and Industrial Policy”, article for Funcex Magazine, draft May 21, 2013.

Sturgeon, T., Kawakami, M. (2010): “Global Value Chains in the Electronics Industry: Was the Crisis a Window of Opportunity for Developing Countries?”, Policy Research Working Paper, World Bank, September 2010.

Vinhais Gutierrez R. M., Ribeiro Mendes L. (2009): “The Electronics Sector: Microelectronics Design in Brazil”, BNDES Setorial 30, September 2009.

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