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Aug 6th 2011 | SÃO PAULO | from the print edition

Brazil’s industrial policyDealing with the realThe government feels the manufacturers’ pain

A FEW lucky Brazilian businessmen are about to have their prayers answered: they will soon be paying lower taxes. From the beginning of October manufacturers in four labour-intensive industries—clothing, footwear, furniture and software—will see the main payroll tax, of 20%, abolished. The government will claw back some, but not all, of the 25 billion reais ($16 billion) the measure will cost it over the next 18 months by taxing turnover at 1.5% (2.5% for the software industry). If by the end of 2012 the scheme is deemed a success, it may be extended to other industries and made permanent.

The tax cut is the centrepiece of President Dilma Rousseff’s long-awaited industrial policy, announced on August 2nd. It also includes a promise to act more quickly where imports involve dumping, and stricter checks on the origins of goods (Chinese manufacturers are rumoured to be evading anti-dumping tariffs by shipping via third countries). A “Buy Brazil” policy will bend public-procurement rules to allow the government to pay up to a quarter more than the lowest price in order to secure a local supplier.

The aim is to protect Brazilian industry from an ever-strengthening currency. As Europe and the United States lurch from crisis to crisis, high interest rates are attracting capital to Brazil: its policy interest rate, at 12.50%, is the highest in real terms of any big economy.

Companies such as Vale and Petrobras, which export iron ore and oil respectively, are shielded by strong world prices for commodities. Both are turning in record results. Construction and services are boosted by strong domestic demand. But industry is struggling. Though overall unemployment is at a record low, manufacturers are laying off workers. Industrial production fell by 1.6% in June (see chart).

In some ways the new industrial policy amounts to the continuation by other means of the “currency war” declared last year by Brazil’s finance minister, Guido Mantega. Having previously increased a tax on short-term capital inflows and raised reserve requirements for banks’ currency trading, on July 27th he fired his latest salvo. Futures contracts that bet on further strengthening of the real are to be taxed at 1% of their notional value, and that rate could rise to 25% should the ministry deem it necessary. The announcement caused the real to fall by 2% against the dollar. But past experience suggests the reprieve will be short-lived.

Page 1 of 2Brazil’s industrial policy: Dealing with the real | The Economist

14/08/2011http://www.economist.com/node/21525439/print

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from the print edition | The Americas

Consumers may worry that curbs on imports will raise prices. And by giving special treatment to some industries, the measures introduce distortions. But the policy also suggests a new realism within government. Mr Mantega habitually refers to foreign “currency manipulators” as the sourceof Brazilian industrialists’ woes. Speaking in São Paulo on August 3rd Fernando Pimentel, the minister for industry, laid some of the blame closer to home. The strong real was likely to last for the foreseeable future, he said, and industrialists needed to learn to live with it.

Cutting payroll taxes for four chosen industries, he added, was just the start of a necessary updating of Brazil’s labyrinthine tax system. There is certainly room to do more. According to the World Bank’s annual “Doing Business” study, a hypothetical medium-sized business in Brazil loses41% of its profits to payroll taxes, one of the world’s highest rates.

Page 2 of 2Brazil’s industrial policy: Dealing with the real | The Economist

14/08/2011http://www.economist.com/node/21525439/print