VZCZCXRO7627
PP RUEHRG
DE RUEHSO #0692/01 1731515
ZNR UUUUU ZZH
P 221515Z JUN 06
FM AMCONSUL SAO PAULO
TO RUEHC/SECSTATE WASHDC PRIORITY 5299
INFO RUEHBR/AMEMBASSY BRASILIA 6396
RHEHNSC/NSC WASHDC
RUCPDOC/USDOC WASHDC 2497
RUEHRC/USDA FAS WASHDC 0619
RUEHMN/AMEMBASSY MONTEVIDEO 2042
RUEHBU/AMEMBASSY BUENOS AIRES 2315
RUEHSG/AMEMBASSY SANTIAGO 1771
RUEHLP/AMEMBASSY LA PAZ 2869
RUEHPE/AMEMBASSY LIMA 1024
RUEHCV/AMEMBASSY CARACAS 0345
RUEHBO/AMEMBASSY BOGOTA 1407
RUEHRG/AMCONSUL RECIFE 2997
RUEHRI/AMCONSUL RIO DE JANEIRO 7206
RUEHAC/AMEMBASSY ASUNCION 2639
RUEATRS/DEPT OF TREASURY WASHDC
RUEHC/DEPT OF LABOR WASHDC
RHMFISS/CDR USSOUTHCOM MIAMI FL

UNCLAS SECTION 01 OF 06 SAO PAULO 000692 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR WHA/BSC, WHA/EPSC, EB/IFD 
STATE PASS TO USTR FOR MSULLIVAN 
STATE PASS EXIMBANK 
STATE PASS OPIC FOR MORONESE, RIVERA, MERVENNE 
NSC FOR FEARS 
USDOC FOR 4332/ITA/MAC/OLAC 
USDOC FOR 3134/USFCS/OIO 
TREASURY FOR OASIA, DAS LEE AND DDOUGLASS 
DOL FOR ILAB MMITTELHAUSER 
SOUTHCOM ALSO FOR POLAD 
 
E.O. 12958:  N/A 
TAGS: ECON EINV KIPR PGOV ETRD BR
SUBJECT: BRAZIL'S BUSINESS ENVIRONMENT 
 
REF:  A) SAO PAULO 685; B) BRASILIA 1178; C) BRASILIA 1188 
 
SENSITIVE BUT UNCLASSIFIED - PLEASE PROTECT ACCORDINGLY 
 
¶1. (U) SUMMARY:  Viewed through the lenses applied by many business 
groupings, Brazil's "competitiveness" has been falling relative to 
its major emerging market peers, such as India and China.  Numerous 
surveys of business leaders and some studies, including by the OECD, 
show Brazil falling in various competitiveness rankings.  While 
there is no settled definition of what constitutes a country's 
"competitiveness" -- indeed, it is a concept which some economists 
believe to be flawed -- these surveys/studies do highlight a common 
set of problems with Brazil's business environment and investment 
climate.  These include: a high tax burden, onerous tax compliance 
requirements, excessive bureaucracy, insufficient infrastructure, 
middling economic growth prospects, corruption, convoluted labor 
legislation, high real interest rates and a lack of investment in 
education and innovation.  The reforms called for by these studies 
and surveys are legion, but tax reform stands out as a particular 
need.  END SUMMARY. 
 
IS BRAZIL A MAJOR EMERGING MARKET? 
---------------------------------- 
 
¶2. (SBU) The term BRIC (Brazil, India, Russia, and China) was first 
coined by investment bank Goldman Sachs in a 2003 paper asserting 
that these rapidly developing economies may eclipse most developed 
markets by 2050.  Since then, BRIC has entered into popular usage to 
refer to these four countries and their status as the leading large 
developing economies.  Although Brazil since 2003 has made 
measurable progress in many areas, particularly debt management and 
efforts to improve the functioning of financial markets, its GDP 
growth has looked paltry in comparison to India, China and Russia. 
Growth in the four years of the Lula administration is expected to 
average 2.86 percent.  Although better than the 2.34 percent 
achieved under former president Fernando Henrique Cardoso (FHC) from 
1995 to 2002, it stands in sharp contrast to recent Chinese averages 
of close to 10 percent and India's of around 6 percent.  World Bank 
figures show Russia's yearly growth since 2000 at around 7 percent. 
An early 2006 article in the "Economist" magazine on the importance 
of emerging markets showed three countries, represented as animals, 
circling the globe:  a dragon for China, an elephant for India, and 
a bear for Russia.  Brazil was notably absent.  Regarding Brazil's 
absence, newspaper columnist and former Finance Ministry official 
Roberto Macedo commented, "Perhaps the artist just couldn't think up 
an animal to represent Brazil.  But a monkey would be appropriate. 
Either way, it's time for Brazil to choose its own mascot before 
it's too late and we end up with a donkey, a sloth, or even a 
beached whale." 
 
COMPETITIVENESS SURVEYS 
----------------------- 
 
¶3. (U) HUMPTY DUMPTY:  Brazil slipped 8 places to 65th in the World 
Economic Forum's (WEF) 2005 - 2006 Global Competitiveness Survey, 
which represents business leaders' opinions on competitiveness in 
117 countries.  Brazil's fall from 57th to 65th was among the 
largest slide of any country.  Breakout data showed more surprising 
figures.  Brazil was 79th in macroeconomic environment, ranked just 
below Nigeria.  It was 81st in macroeconomic stability and 83rd with 
regard to inflation.  It was second to last in terms of interest 
rates.  And Brazil was dead last in the efficiency of its tax 
system.  On the positive side, the study showed a low terrorist 
 
SAO PAULO 00000692  002 OF 006 
 
 
threat index for Brazil, but its "cost of crime" index was among the 
worst in the world.  In terms of education, Brazil is in 97th place 
in the quality of its public schooling.  In terms of potential for 
growth, Brazil was 65th in the opinions of these business leaders, 
beaten out by Ghana and Kazakhstan.  The WEF report emphasized that 
it is not enough for Brazil to merely maintain its solid 
macroeconomic management.  "If a country wants to be competitive, it 
needs to be vigilant and attack on various [reform] fronts.  The 
government needs to respond quickly to important problems like 
education, infrastructure, and labor," said Augusto Lopez-Claros, 
Chief WEF Economist. 
 
¶4. (U) PERCEPTION OF CORRUPTION UP:  According to the WEF, the 
ongoing corruption scandals, allegedly involving influence peddling 
and vote-buying in Congress by members of the Lula Administration, 
sullied the image of the public sector with a one-two punch: 
undermining private sector confidence and distracting legislators 
from the important task of preparing the Brazilian economy for 
competition in the global marketplace.  The WEF ranking indicates 
that the largest slide occurred in business leaders' perceptions of 
the quality of public institutions.  In this category, Brazil slid 
20 places to 70th.  According to the study, government inefficiency 
is one of the major obstacles to business in Brazil.  With regards 
to the use of public funds, Brazil occupied one of the lowest slots, 
111th.  It ranked 62nd in terms of government corruption and 69th in 
terms of favoritism in government decisions.  Professor Carlos 
Arruda, Director of Development at the Dom Cabral Foundation and 
coordinator for the WEF study in Brazil, made the following 
observation: "Last year, whn we announced the results, we expected 
that Brazl would gain in the rankings on the strength of it sound 
macroeconomic policies.  But we fell in te rankings due t the 
private sector's loss of cnfidence in public institutions.  For 
2006, it'surgent that we find a solution to Brazil's institutional 
crisis."  Arruda confirmed that countries eperiencing institutional 
crises have historicall felt negative impacts on the macro and 
microecoomic fronts.  Business leaders had better perceptins of 
the level of corruption in China and India, which placed 49th and 
50th places respectively. Russia came in 75th. 
 
AN INTEMPERATE INVESTMENT LIMATE 
--------------------------------- 
 
¶5. () FROSTIER THAN DENMARK:  According to the Busines Climate 
Ranking released in March by the Economist Intelligence Unit (EIU), 
Denmark will maintainthe best business climate between 2006 and 
2010 (it was also first from 2001 through 2005).  Brazil, however, 
slipped three places to 45th among 60 countries.  The EIU's global 
business rankings model is applied to the world's 60 largest 
countries, which account for more than 95 percent of global output, 
trade, and FDI.  It measures the quality and attractiveness, 
adjusted for country size, of the business environment and its key 
components.  The model considers 70 factors across 10 categories 
important to business life, including political and institutional 
environment, macroeconomic stability, approach to entrepreneurs, 
foreign investment, funding, and infrastructure. 
 
¶6. (U) CHILLY FORECAST FOR FDI:  According to the Organization for 
Economic Cooperation and Development (OECD), this all adds up to an 
unattractive investment climate.  Per OECD Secretary General Donald 
Johnson, "The USD 18 billion that Brazil received in foreign 
investment in 2004 was more a function of the size of the country 
than of an attractive and favorable investment climate.  In Brazil, 
much remains to be done."  Johnson noted that with appropriate 
 
SAO PAULO 00000692  003 OF 006 
 
 
reforms, Brazil could overtake China as the number one destination 
for investment in emerging markets.  In 2004, Brazil received three 
percent of foreign direct investment (FDI), whereas China received 
10 percent of FDI.  Johnson specifically mentioned improvements in 
the tax environment, citing Brazil's "overwhelming tax burden.  It's 
not that Brazil has a hostile investment climate, but with 
regulatory reform and advances in Private Public Partnerships 
(PPPs), Brazil could receive much more than its already impressive 
USD 18 billion per year," said Johnson.  He continued, "Structural 
reforms need to be made so that the entire country can benefit from 
globalization."  This is also reflected in A.T. Kearney's 2003-04 
FDI Confidence Index (which measures 25 countries in terms of their 
attractiveness for FDI), wherein Brazil fell eight places. By 
comparison, in A.T. Kearney's 1998 study Brazil was the second most 
attractive country on the list; today it is 17th. 
 
DIAGNOSIS: PAUCITY OF INVESTMENT IN INNOVATION 
--------------------------------------------- - 
 
¶7. (U) LOW PATENT COUNT: Brazil trails behind China, India, and 
Russia in the field of research and innovation, according to a 
recent study by the World Intellectual Property Organization (WIPO). 
 The WIPO study showed that Brazil registered fewer international 
patents than the other three BRIC nations in 2005 and ranked 27th 
overall out of 128 countries.  In 2005, Brazil registered only 238 
patents with WIPO, an increase of 0.07 percent, or two patents, over 
the previous year.  Russia registered 500 patents with WIPO in 2005. 
 China increased its WIPO patents by 47 percent, with 2,452 
registered in 2005, up from 1,706 in 2004.  And India registered 648 
patents with WIPO last year.  The WIPO ranking is one gauge of a 
country's investment in innovation. 
 
¶8. (U) PRESCRIPTION FOR INNOVATION:  Brazil has a longstanding 
problem with moving university-based research, in which it does 
invest, out of the lab and into industry.  Concrete approaches to 
the problem, however, only came into being recently, first with the 
advent of a Patent Law in 1997, next with the establishment of 
sector funds for innovation and development in 1999, then with the 
introduction of the 2004 "Innovation Law," and most recently with 
Provisional Measure 252, passed last year, offering tax incentives 
to businesses that invest in technical innovation.  The government's 
hope is that these measures, in particular the changes introduced by 
the innovation law, will help to merge research from universities 
and public institutions with business and industry. 
 
¶9.  (SBU) Whether the Innovation Law will indeed enable Brazil to 
generate the research and investment needed to create wealth is an 
open question.  That measure encourages the public and private 
sector (particularly small and medium-sized enterprises) to share 
staff, funding and research facilities.  However, it takes a 
government-centric approach, charging newly-created federal, state 
and municipal agencies with management of the entire innovation 
system, i.e. selecting parties for technology licensing, helping to 
arrange terms for exclusive licensing for commercial exploitation, 
and ensuring that licensed technology is commercially exploited "in 
the public interest."  Once an invention or new procedure is 
created, instead of having the relevant innovation support agency 
step back from the process, the law contemplates that this entity 
would acquire a partial share - as opposed to ceding title in full 
to private industry.  Officials at one of the country's leading 
research incubation centers have told us that while the concept of 
an innovation law is nice, given the heavy government involvement 
(and, ironically enough, the lack of implementing regulations), they 
 
SAO PAULO 00000692  004 OF 006 
 
 
had no plans to take advantage of the law's provisions and would 
proceed on their own. 
 
¶10. (U) For others, greater cooperation between academia and 
industry is not really the solution.  One of the principal symptoms 
of weak industrial innovation in Brazil is the size of qualified 
workforce with advanced degrees dedicated to research and 
development.  According to Carlos Henrique de Brito Cruz, Scientific 
Director of FAPESP (Sao Paulo Research Foundation), "In Brazil, 
there is a mistaken assumption regarding the place of research in 
the university system.  In industrialized countries, more than half 
of research is conducted in the industrial sector, not at 
universities.  And this industrial research generates 90 percent of 
all patents."  For example, in South Korea, the developing country 
with the largest number of WIPO patent registrations, of 124,000 
professionals in the research sector, 60 percent are employed in 
industry.  In Brazil, only 18 percent are in industry.  Moreover, in 
Korea, 64 percent of those in industrial research have masters 
and/or doctoral degrees.  In Brazil, only 14 percent have graduate 
degrees.  Brazil's weak showing in international patent 
registrations is a symptom of broader problems in Brazil's ailing 
innovation sector. 
 
PRECIOUS PRODUCTIVITY 
--------------------- 
 
¶11. (U) REDUCED POTENTIAL:  Taken together, these business 
challenges redound in lower growth potential.  A report released in 
April of this year by Brazil's National Confederation of Industries 
(CNI) shows Brazil falling to second-to-last (22nd) place in 
productivity rankings of the 23 largest economies.  Between 2001 and 
2005, Brazil increased its average productivity by 1.3 percent, down 
from 6 percent between 1996 and 2000 (when Brazil ranked 4th) and 
also down from 7 percent between 1991 and 1995 (when it ranked 6th). 
 Italy, with negative growth, came in at last place in the CNI 
ranking.  According to the study, India experienced the greatest 
average yearly growth in productivity at 10.1 percent.  CNI points 
to Brazil's low productivity growth as a warning sign for future 
exports, saying, "A great part of our recent export growth is 
attributable to productivity gains during the 1990s; low 
productivity growth tends to compromise future export growth."  CNI 
attributes Brazil's decline in productivity to high interest rates 
and low investment.  The group advises that in order to regain 
productivity growth and secure future export growth, Brazil needs to 
raise its investment levels, especially investment in technological 
innovation.  Unfortunately, according to recent rankings, Brazil's 
investment climate is unattractive. 
 
THREE KEY REFORMS 
----------------- 
 
¶12. (U) TAX REFORM: The American Chamber of Commerce (AmCham) 
advocacy agenda recently has focused on three key reforms: tax 
reform, regulatory agency autonomy and intellectual property 
protection.  Brazil's infamously burdensome taxation system 
repeatedly has been cited by multinationals as the primary factor 
encouraging companies to draw down employment and/or move operations 
outside of Brazil.  Brazil's taxation system engenders widespread 
tax evasion and helps stimulate the prevalent informal or shadow 
economy.  According to AmCham, there are currently 40 measures 
within 27 different pieces of legislation that guide taxation of 
goods and services.  Other items closely related to needed tax 
reform include: combating tax evasion, encouraging businesses to 
 
SAO PAULO 00000692  005 OF 006 
 
 
enter the formal economy, and designing a better way for businesses 
to receive proof of tax credits with the federal government. 
 
¶13. (U) REGULATORY AUTONOMY:  Brazil's young regulatory agencies are 
in many cases struggling to find their feet.  For the last three 
years, AmCham has been working to influence policy-makers regarding 
the role of Brazil's principal regulatory agencies -- the food and 
drug administration-equivalent (ANVISA), the Electric Energy Agency 
(ANEEL), the National Telecommunications Agency (ANATEL), and the 
Council on Fair Competition (CADE)).  AmCham studies also point out 
that frequent changes in the regulatory framework legislation are 
problematic for long term investments, particularly in energy and 
infrastructure.  Furthermore, AmCham's most recent evaluation of 
ANVISA faulted its lack of internal norms regarding decisions 
(resulting in uncertainty when applying for pharmaceutical 
licensing, for example); its inefficiencies in the use and 
integration of information technology (contributing to ANVISA's 
average 5-year backlog for permit approval); its lack of internal 
training for permit-approving officials; and the absence of any 
measures to reduce its processing time.  A pharmaceutical executive 
at Eli Lilly remarked, "We have commercial operations in more than 
140 countries.  When Eli Lilly decides to invest, ANVISA's 
inefficiencies weigh against our investing here in Brazil." 
 
¶14. (SBU) INTELLECTUAL PROPERTY PROTECTION:  Internationally, 
concerns about Brazil's intellectual property protection have 
dampened the enthusiasm of some investors.  To its credit, Brazil 
has done much over the last two years to improve its copyright 
protection, in part due to concerns over potential USG revocation of 
Brazil's Generalized System of Preferences (GSP) benefits.  The GSP 
review, while shining a spotlight on copyright issues, failed to 
motivate similarly significant changes on the patent and trademark 
front.  While the GoB is working to improve the performance of the 
National Patent Institute (INPI), which has a tremendous backlog of 
unprocessed patent applications, the effort is nascent (ref C). 
Much remains to be done to emphasize the benefits of a strong patent 
and trademark regime, especially in terms of attracting 
high-technology investment and spurring innovation. 
 
BRAZIL: COMPETITIVE IN INEQUALITY 
--------------------------------- 
 
¶15. (U) THE RICH-POOR GAP PEER GROUP:  Brazil has long fared poorly 
in global rankings of income equality, such as the World Bank's 
World Development Index, frequently rating among the world's five 
worst countries alongside the likes of the Central African Republic, 
Sierra Leone, and Swaziland.  The United Nations 2005-2006 Human 
Development Index estimates that in Brazil, the richest 20 percent 
claim 85 cents out of every dollar earned, while the poorest 20 
percent earn 3 cents, leaving 12 cents to the middle 60 percent of 
the population.  Moreover, according to a February 2006 publication 
by the World Bank entitled "Poverty Reduction and Growth:  Virtuous 
and Vicious Circles," Brazil's highly concentrated wealth can limit 
growth potential by negatively impacting on such areas as education 
levels, longevity, skilled labor, and innovation.  The World Bank 
study also tied inequality to competitiveness, and stated that only 
with an active policy of reducing inequality can Brazil achieve 
sustained growth.  Stating further that Brazil will only be able to 
catch up and compete with China and the Asian "tigers" if it combats 
poverty in a more aggressive manner, the World Bank report linked 
key reform issues, such as access to credit and capital for the 
poorer classes, to the alleviation of poverty and inequality. 
 
 
SAO PAULO 00000692  006 OF 006 
 
 
------- 
COMMENT 
------- 
 
¶16. (SBU) Although Brazil is heading in the right direction, its 
pace leaves something to be desired.  Part of this is a question of 
emphasis.  By contrast with some of its major emerging market 
competitors, Brazil has invested time and resources over the past 
twenty-two years in building up its democratic institutions.  These 
often do not engage in economic reforms with tremendous speed, but 
they do give the system legitimacy.  The institutionalization of the 
fiscal responsibility law is a useful example.  But Brazil must do 
better if it is to address entrenched poverty and reduce inequality 
and if its institutions are to maintain legitimacy.  An important 
first step will be addressing the twin issues of fiscal and tax 
reform during the first year of the new administration, to be 
elected in October 2007.  END COMMENT. 
 
¶17. (U) This cable was coordinated with Embassy Brasilia. 
 
MCMULLEN