Friday, May 14, 2010

Green industrial policy in Brazil

Tarun Khanna and Santiago Mingo argue that the green industrial policy of Brazil worked.

What did they do?

Brazil’s experience at promoting renewable fuels, beginning in the 1970’s, 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% 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% 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 1970’s rise in oil prices, gave rise to an entirely new industry. But it would not have worked without the crucial role played by competition.

How did they do?

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 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% ethanol.

By the 1990’s, the major subsidies and policies were abolished, and the industry was deregulated. Our statistical analysis of the entry and exit patterns of entrepreneurs in the Brazilian ethanol industry shows that the more efficient acquired the less efficient. Most underperforming ethanol companies went bankrupt or were taken over by entrepreneurs who had successful track records in running efficient operations.

The government did not bail out the underperformers, allowing market forces to restructure the industry during the post-subsidy phase. Certainly, the beneficiaries of Pro-√°lcool’s subsidies lobbied the state to continue the protective policies even after their usefulness – inducing the development of the industry – had expired. Fortunately, the government was not persuaded.

Lessons from Brazilian IP exercise:

Brazil’s experience offers three important lessons for nations implementing renewable energy initiatives: (1) government policies must be consistent, simple, and long-lasting, providing assurance to would-be entrepreneurs that they can invest for the long haul; (2) picking winners, the familiar weakness of overenthusiastic bureaucrats, must be kept to a minimum; and (3) the state must have the discipline to dismantle subsidies when the need for them has passed.