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Stealing the Third World's nonrenewable resources: lessons from Brazil.

In a recent MONTHLY REVIEW article ("New Light on Dependency and Dependent Development," January 1983) Arthur MacEwan noted that while "Marxists have often argued that economic development would not take place in the capitalist periphery," in fact over the last few decades "in certain parts of the periphery capitalism was attaining some undeniable successes, at least in terms of economic growth and a degree of industrialization." And, as MacEwan concluded, "the new role being played by oil-exporting countries forms the most dramatic example of the insufficiency of the simple center-periphery view of imperialism. The rising economic strength of Brazil and a few other 'semi-peripheral' or 'newly industrializing' countries must also be taken into account." (p.25)

The purpose of the present article is to widen and deepen this kind of analysis by examining aspects of "dependent development" in the nonrenewable resource sector.

An analysis of Brazil's mineral strategy reveals how the multinational mineral companies, working hand-in-hand with industrial countries and international organizations and the Brazilian government, have developed an approach which benefits virtually everyone--except the Brazilian people. The present strategy is focused on two key projects in the Amazon: the Carajas iron-ore project and the planned complexes for development of the bauxite/aluminum industry. The Carajas iron-ore project is totally export-oriented, with plans to produce and export 35 to 50 million tons of iron ore per year. It involves an investment of about $5 billion, of which 60 percent is to be raised by borrowed capital (divided roughly equally between foreign lenders and local lenders). The remaining 40 percent of the capital will be the risk investment of Companhia Vale do Rio Code (CVRD), a largely but not totally state-owned enterprise, which is undergoing a considerable shift of ownership from the government sector to the private sector.

Quantitative analysis of possible future revenues and costs of the Carajas iron-ore project, prepared by the World Bank, indicates that even under relatively optimistic assumptions, the projected profit rate will not be very high--somewhere between 11 and 13 percent per year. And, if these optimistic assumptions turn out to be false, which seems to use likely in a world of increasing stagnation in iron-ore demand and growing supplies of ore elsewhere, the project, on which CVRD is paying an average interest rate of 11 percent per year, could turn out to be a big loser for the Brazilian public sector.

Nevertheless, an analysis of the likely beneficiaries from the project indicates why it is being pushed ahead. For one thing, part of the region debt financing is being provided by the World Bank, which is playing an increasingly important role in Western strategies of trying to increase the world supply of minerals and fuels on terms favorable to multinational companies and the industrial countries. The rest of the foreign capital is being provided by banks in Japan and Western Europe, the countries which will buy most of the iron ore from Carajas; also companies in these countries provide much of the capital equipment for the project. Additionally, the foreign lenders' loans are amply protected by various provisions, such as that CVRD and the government are responsible for overruns above cost estimates. Finally, since CVRD's 40 percent of risk capital does not receive any profit until interest and debt repayments are covered, there is much room for the project to fall short of its expectations without jeopardizing the lenders' position.

Thus the real risk of the Carajas iron-ore project is borne by CVRD. Although CVRD is widely viewed by foreigners, and even by Brazilians active in the mineral sector, as a state-owned company, the fact is that about one fourth of the company's capital belongs to the Brazilian private sector. Moreover, in a move that has escaped public attention, as part of the debt financing for Carajas local private capital has been given a golden opportunity to strengthen its present position in CVRD through issuance to the private sector of $250 million in bonds convertible into CVRD's stock. In effect these bonds give the Brazilian private sector an option to increase its ownership share of CVRD if in the future it is highly profitable, whether due to Carajas turning out to be a greater success than now envisaged or because these convertible bonds do not expire until 1990, the private sector can wait until Carajas has been operating for about five years before deciding if it wants additional stock in CVRD; and if not, it can just get its capital back as debt repayment.

Surely a better example of having your cake and eating it too would be hard to find.

In summary, what would appear to be taking place through the Carajas iron-ore project is that the state sector is taking most of the risk. The foreign multinationals and industrial countries plus the indigenous private sector will be the major beneficiaries, while taking on little risk. Finally, the project facilitates a quiet continuation of the process of "privatization" of the state sector which is a goal of the present Brazilian, which in theory is supposed to be the caretaker of the country's mineral resources.

On the other hand, the Brazilian aluminum projects, which involve a projected investment of $9 billion in the 1980s, appear to be much more profitable and much less risky. Yet here the "risk," such as it is, is being primarily undertaken by the foreign sector.

Thus, of three new bauxite/alumina-aluminium projects which were moving ahead in 1982, involving a total investment of $4.5 billion, foreigners will own about 60 percent, CVRD 38 percent, and local Brazilians about 2 percent. However, the private Brazilian sector could acquire a larger share later on, because as noted above, it could own an increasing share of CVRD.

Unlike the Carajas iron-ore project, the aluminum projects appear highly profitable. Taking a reasonable set of assumptions, quantitative analysis indicates that the projected profit rate appears to be about 20 to 25 percent per year, or twice the profit rate on the iron-ore project. The reason for this is that Brazil has low-cost bauxite supplies and cheap hydroelectric energy. Also, the aluminum projects probably have much less risk than the iron-ore project, because in contrast with iron ore the demand for aluminum is expected to grow virogously. Moreover, the aluminum market is more monopolistic than that of steel and iron ore, so that production and prices can be more effectively controlled.

Overall, from the point of view of private capital--both local and foreign--this pattern of financing for the iron-ore and aluminum projects in normal and logical. If a project is risky but does not have a high profit potential, it makes sense to supply only relatively safe loan capital; while if a project has little risk and high profit potential, it makes sense to provide equity capital. The problem is that from the point of view of the Brazilian people, if we can assume they are better represented by the state sector than the private sector, this investment pattern is a total misallocation of capital. It would make more sense for the Brazilian government to put its capital investment into the aluminum sector rather than the iron-ore sector.

Some have argued that this is not feasible because Brazil has neither the technology and organizational skills nor the capital and markets for a large-scale aluminum industry. In fact this is not true. Brazil has all the requisites for a successful aluminum industry. Here we simply want to examine how the present Brazilian aluminum strategy helps the multinationals and hurts Brazil.

The most important point is that because Brazil is not considered as "safe" politically (and certainly not economically) as the major alternative supply source for aluminum, particularly Australia and North America, the rates of profit which the multinational companies demand in Brazil are considerably higher than elsewhere. According to a recent survey of a large number of mineral companies, their minimum acceptable annual profits rates for investments in various categories of countries were as follows: (a) the United States--14 percent to 18 percent; (b) "safe" developed countries--16 to 25 percent; (c) "stable" developing countries--22 to 28 percent; (d) "unstable" developing countries--25 percent to 32 percent.

In recent years Brazil might have been characterized as a stable developing country, but with the increasingly shaky world debt structure it may now be considered to be an unstable developing country. In any event, the profit rates that we calculated for the aluminum projects are clearly higher than those required by the companies from the United States, and for the most part higher than those required from the "safe" countries.

This raises a very fundamental point for the question of whether Brazil, or any country, should finance mineral development itself or relay on foreign companies. The fact is that the differences between these minimum-target profit rates essentially lie in foreign companies' assessment of a "risk" which is not intrinsic to the project but is basically political, i.e., the risk that in the future the country will change either the terms of the contract or its tax regulations sufficiently drastically to hurt the companies' profits. What these numbers indicate is that a developing country has to pay 5 to 10 percentage points of profits more per year to a foreign company as a "premium" to compensate the company for the possibility that in the future the country will do something which might in fact be in the best interest of the country itself. And, in may opinion, it is absurd for a country to pay these additional premiums to ensure against what may be desirable or necessary in the future (e.g., because of changed circumstances, to raise overall tax rates or divert production for local consumption).

Moreover, the cost of these premiums is enormous and is not just measured by the difference between 15 percent and 20 or 25 percent (which would appear to be a difference of perhaps one third to two thirds in profit rates). This is because of the compounding effects of the accumulation of capital. Thus $1 invested today for 20 years at a 15 percent per year profit rate would yield ultimately a cumulative profit of $16. The same $1 invested for 20 years at a 20 percent per year profit rate would yield $38, or more than twice as much. Finally, the same investment at a 25 percent per year profit rate would yield $87, or more than five times as much as the cumulative profits with "only" a 15 percent per year profit rate. Hence, these "premiums" have the potential to do enormous damage to the country's economy, since sooner or later they are shipped back to the Western industrial countries in the form of scarce foreign exchange, thereby causing balance-of-payments problems and/or reducing the country's pool of capital available for other investment projects.

Incidentally, if we add the word "billions" to the numbers in the preceding example, the $87 billion which would be the cumulative profits of foreign investment is about the same as Brazil's present total foreign debt. Moreover, the 20-year time period used in the illustration is about the length of the economic policy favoring foreign investment which was launched by the military government in 1964. Obviously, however, all of this foreign debt is not due to foreign investment, because, among other things, profits from foreign investment are not just reinvested into the country but flow out as dividends.

Nevertheless, these examples do illustrate the inherent long-term irrationality of a policy which seeks to develop a country by means of large-scale foreign investment. In this sense, the image which is increasingly being used to describe the relationship between developing countries which now owe huge sums in foreign debt, and the foreign banks and international institutions which lent them the money--namely, the narcotic addict-pusher relationship--is not only apt but needs to be extended to include foreign nonfinancial multinationals as part of the "pusher" problem (including also among the pushers the third world government officials who supported the addictive use of foreign capital in the first place).

Brazil illustrates a tendency characteristic of third world countries where the state accumulates large amounts of capital namely, the tendency for private groups to use their control of the state to transfer this capital to the private sector. This problem is potentially most crucial in the natural resources area, becuase in most third world countries the state either directly or indirectly accumulates capital in its role as ultimate resource owner or as tax collector.

The fundamental problem for the private sector is how it can obtain access to this state controlled capital. In earlier times, it was usually possible for the private sector to appropriate directly what it coveted. In the modern era, however, when even very underdeveloped countries tend to have significant technocratic forces operating within the state bureaucracy, this transfer problem is no longer so simply accomplished. (Although outright looting and corruption still occur, as the case of the Shah's Iran shows. There a list of government officials who were sending money abroad in the capital flight of early 1979 revealed near the head of the list the president of the National Iranian Oil Company, who had sent out tens of million of dollars; this, of course, is small compared to the enormous wealth that the Shah and his family and associates accumulated and sent abroad.)

As the Carajas iron-ore project in Brazil illustrates, one way for the private sector to deal with this capital transfer problem is to be allowed to buy interests in the state sector. However, where this is not possible, as is often the case, another mechanism would seem to be even more important. This, ironically, is what may be called a process of "too rapid" economic development. This can occur because in order for the capital accumulating in the state sector to be appropriate by the private sector, basically it is necessary for the state sector to spend this money (preferably within the country). Thus for the private sector to profit from the state's accumulation of natural resource wealth, it becomes necessary that various investment projects be started within the country, and the more the better. Thus only by having the government issue contracts for road construction, housing, airports, steel mills, and so on, can the indigenous private sector then share in the wealth (while even a little of this may trickle down to the lower sectors of society).

What this structural situation implies is that in countries with large revenues from minerals and where there is prviate control of the state (either alone, or more usually, in cooperation with military and technocratic groups) investment of these mineral revenues is likely necessarily to be wasteful and inefficient, from the viewpoint of society as a whole. Thus, the usual criticisms of these policies, along the lines that these nouveaux riches countries are wasting their resources by trying to spend far greater amounts of money than their economies have a capacity to absorb, and hence money is wasted through inefficiency, inflation, and corruption, often miss the point. (For example, Saudi Arabia, where the government is spending many billions of dollars per year, mostly for large investment projects, with only a small and relatively untrained population).

The fact is, from the point of view of the indigenous private sector (as well as their collaborators at home and abroad who share in some of the "waste"), the more waste and inflation the better! By way of illustration, if a country has only a labor force and physical plant capacity to absorb $1 billion per year in investment at prevailing prices, and the government orders $3 billion worth of investment projects in a year, the natural result of market forces will be that those controlling the capital and the factors of production, i.e., the private sector, will bid up their prices so that the full $3 billion is spent; the private sector will then absorb $2 billion in "excess profits." (Since some of this inflationary pressure could result in higher wages, to avoid this the private sector will seek either a large surplus labor force or a repressive apparatus to control the workers and/or their trade unions--which prevail not only in Brazil but in many other oil and mineral rich countries.)

this pressure to "invest" too rapidly is reinforced by the fact that the ruling elites in oil and mineral exporting countries frequently have a relatively short time horizon because they don't expect to be able to stay in power in the long run. Therefore they have even greater incentive to transfer the resources from the public sector to private sector as rapidly as possible in order to get money while they can, and transfer much of it abroad for safety.

Indeed, inflation through this large and too rapid project investment is a near-ideal mechanism for shifting accumulated capital from the public sector to the upper levels of the private sector. For one thing, there is no need for outright "corruption," since market forces will siphon off the profits to private capital in an apparently "normal" way. This is particularly important because of the existence in most third world countries of modern trained bureaucrats who will insist on "honest" in government, and will struggle against and be in a position to expose outright corruption. Moreover, it is important for the efficiency of the state bureaucracies that corruption not be so widespread as to sap morale; again, too much outright corruption raises the danger of a coup within the country from anti-corruption forces, particularly within the military.

Furthermore, the multinational companies of the industrial countries, working hand in hand with their international financial institutions, also have found these inflation-generating project mechanisms to be very useful. this is because such large projects, insofar as they involve contracts for foreigners, rechannel the flows of wealth from the resource exporting countries back into the industrial countries (or more pertinently to the multinational companies controlled by these countries' own ruling elites). tHus, it is not surprising that the multinational comapnies, in such fields as engineering, construction, and provision of capital equipment for resource exporting countries, themselves recapture a large part of the accumulated surplus. Nor is it surprising that such organizations as the IMF and the World Bank move most strongly against countries which even to some small extent subsidize for the mass of people the basic necessities of life, e.g., Jamaica under the Manley government, while participating in schemes like the Carajas iron-ore project which is clearly for the benefit of the industrial countries and the private sector of the third world country in question, and not for the mass of people within the country.

Additionally, large-scale projects also harmonize nicely with the tendency of state bureaucracies to build bigger and bigger empires. By this mechanism they themselves obtain a large share of the state's accumulated surplus (even if it is very small compared to the private sector's appropriate), through higher salaries, perquisites, and so on, and also gain greater power and prestige within teh society. Thus, large-scale projects can be the unifying force between the indigeneous private sector, the foreign private sector, and the state technocracies

Finally, another benefit of this "project-generated inflation" mechanism of the transfer of the surplus from the state sector to the private sector is that it minimizes the amount which goes directly to the lower classes. Thus, if instead of a large steel mill or large highway project type of development the state used its natural resource surplus for items of greater value to the mass of the population, such as widespread education, health, housing, improvement of small agriculture, development of small scale industry, and subsidies for the basic necessities and comforts of life, then much less of the accumulated surplus would fall into the hands of the upper elites of the society. Given the realities of power in most of the third world, however, it is not surprising that the patterns of investment in most resource-wealthy third world countries follow an apparently "wasteful" but in fact wealth-concentrating investment mode.
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Author:Tanzer, Michael
Publication:Monthly Review
Date:Apr 1, 1984
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