From: Tarun Khanna and Santiago Mingo, Global Policy Innovations Program, More from this Affiliate
Published May 21, 2010 02:43 PM

Brazilian Lessons for Industrial Policy

Few economic ideas are more lauded and reviled than that of industrial policy. Proponents, such as those who studied the rise of the East Asian economies, swear by it. Opponents see red at its very mention. The former point to economic development; the latter maintain that tens, even hundreds, of billions of dollars have been squandered.

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One recent theatre of (dis)content is that of renewable fuels. Worldwide, $184 billion is being allocated in public stimulus investments to promote clean energy, led by the United States ($67 billion) and China ($47 billion). Of course, there is some progress—wind power meets 20 percent of the electricity demand in Denmark and about 15 percent in Spain and Portugal, for example—but the recipe for success remains elusive.

In this vein, Brazil's experience at promoting renewable fuels, beginning in the 1970s, is directly relevant to today's polarized views of industrial policy. A 10-year industrial policy program called Pro-√°lcool was crucial in the development of the industry. Today, Brazil is the world's most competitive producer of renewable fuels, based primarily on bioethanol. Ethanol accounts for more than 50 percent of current light-vehicle fuel demand in the country, and Petrobras—Brazil's energy giant and one of the largest companies in Latin America—expects this share to increase to more than 80 percent by 2020.

Our research shows that industrial policy was successful in promoting a competitive bioethanol industry in Brazil. A massive stimulus package, prompted by the 1970s rise in oil prices, gave rise to an entirely new industry. But it would not have worked without the crucial role played by competition.

Brazil was attempting to become energy self-sufficient in a manner similar to modern efforts by other countries. But, as opponents of industrial policy are right to remind us, freebies never lead to a good outcome. The aftermath was the key. As world energy prices collapsed, Brazil fortuitously turned off its subsidy tap, whereupon a brutal Darwinian free-for-all ensued. This competitive rationalization was the key to the policy's success.

The details of Pro-√°lcool involved providing incentives to several parties to participate, without which they would have sat on the sidelines. The Brazilian state offered low-interest loans and credit guarantees for the construction of distilleries, as well as tax incentives for the purchase of ethanol-powered vehicles. Ethanol prices were manipulated to make it an attractive alternative to gasoline. In addition, the government induced Petrobras to distribute the renewable fuel. Gas stations installed ethanol pumps. The government signed agreements with the major automobile companies to provide incentives to make vehicles that could run on 100 percent ethanol.

Article continues: http://www.policyinnovations.org/ideas/briefings/data/000166

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