A Strategy to Prepare Embraer for the Restricted Proex Financing System
An
Approach to End the Aircraft Subsidies Dispute
Saulo
Nogueira
Master’s
Project
Commercial Diplomacy
Monterey
Institute of International Studies
Advisors:
Professor
William Arrocha
Professor Geza Feketekuty
Professor Bill Monning
Edited
By Janell Jenkins
This paper was
researched and written to fulfill the M.A. project requirement for
completing the Monterey Institute of International Studies’ Master of
Arts in Commercial Diplomacy. It was not commissioned by any government
or other organization. The views and analysis presented are those of the
student alone. Names of people, corporations, businesses and governments
are used only as examples. in order to depict a realistic, albeit
fictional, scenario. This does not represent any knowledge of these
examples, nor does it in any way represent an endorsement by an
individual, corporation, business or government.
The general background and information related to the relevant laws,
regimes and agreements is factual, although students will need to
supplement the information on specific WTO agreements and cases through
their own research.
All
material in this document is that of me, and does not reflect the views
of anyone in the aircraft industry. This document is exclusively the
work of the author. The reproduction of any material within this
document is prohibited without the prior written permission of the
author.
Table of Contents
Scenario
Issue
Executive Summary
Introduction
Background
Dispute Over Proex Subsidies
Restructuring Proex
Pushing
for Tax Credit for Research and Development
Pushing
the Canadians to Reform Their Subsidies
Legislative Analysis
Legal
Analysis
Domestic
Laws
International
Laws
Recommendation
Domestic Strategy
Establish
a Legislative Coalition
Legislative
Strategy
Research
Strategy
Institutional
Strategy
Public
Relations Strategy
Building Domestic Consensus on the Proposal
Political
Coalition
Political
Opponents
Timetable
Budget
Appendix A: The Brazilian Political System
Appendix B: Proposal for a Tax bill promoting R&D
Appendix
C: Survey on Companies’ R&D investment expectations
Appendix D: Media Advisory
Appendix E: Acronyms
Bibliography
Scenario
For the purpose of this project, I assume the role of a strategic
planner of Embraer, a Brazilian regional aircraft manufacturer,
addressing the WTO subsidies dispute with Canada. After 5 years of
discussions and attempts to negotiate a solution regarding both
Brazilian and Canadian government subsidies to aircraft producers, the
CEO of Embraer assigned me with the task of finding an alternative
solution to move the negotiations along or settle the dispute of the WTO
Dispute Settlement Body (DSB) proceedings.
For the purposes of this
project, I assume the timeframe to be May 2001. As of August 2001, the
DSB Panel ruled Proex (Brazilian export financing program) to be legal
thereby changing the legality of my arguments. Thus, I assume my
analysis and recommendation to take place before this ruling.
Issue
On 14 April 1999, the WTO/DSB Panel ruled that Proex, the
Brazilian export-financing program, was illegal and had to be changed.
This ruling has been met with contention by the Brazilian
government. The Government of Brazil eventually made the required
changes to Proex; however, the Canadian government is not satisfied with
the extent of these amendments and is requesting further modifications
to be made to the export financing program. Meanwhile, Brazilian
government and industry are demanding that the Canadian government
modify the subsidies system benefiting the Canadian aircraft
manufacturer, Bombardier. The dispute intensified when, as a form of
retaliation, other Canadian interest groups adopted a ban on the import
of Brazilian beef to Canada and the entire NAFTA market.
The
aircraft subsidies dispute must be brought to an end for the following
reasons:
·
It is harming the image of both aircraft manufacturers, Embraer and
Bombardier;
·
The respective governments’ intransigence and failure to
negotiate an acceptable solution must be brought to an end before
further damage occurs to their diplomatic relation;
·
The contention may lead to other retaliation, as exemplified by
the ban of Brazilian beef to NAFTA markets;
·
Both governments are diverting significant resources to this
dispute, which could be otherwise be applied to other pressing trade
issues;
·
A solution to the issue of aircraft subsidies must be found
within the next few years before the two aircraft producers enter the
wider, more competitive global commercial aircraft market which will
present further complex and contentious issues for both companies;
·
To avoid a repeat of the case in which the Canadian government
overtly subsidized Bombardier sales to the American airlines. The reason
the Canadian government gave was ‘to counter the Proex system’. The
result was that Embraer missed the opportunity to win a significant set
of contracts for 125 jets and over 100 options, worth a total of US$ 4
billion
.
Executive Summary
To:
Mr. Maurício Botelho, President & CEO
of Embraer
Date: 24 April 2002
Issue
Embraer
is at a competitive disadvantage because the WTO Dispute Settlement Body
(DSB) has recently applied restrictions to the Brazilian
export-financing subsidy, Proex. Our
disadvantage is compounded by the fact that our chief rival, Canadian
aircraft manufacturer, Bombardier continues to receive illegal
subsidies. Since 1996, the Canadian and Brazilian governments have been
challenging each other’s subsidies to their respective aircraft
manufacturers. The tension of the dispute has escalated and led to
indirect retaliation, hurting Embraer’s performance and other sectors
of the Brazilian economy.
Embraer
needs to find a way to compensate for the burden from the new
restrictions. Proex accounts for the higher country risk interest rate for
purchasing charged by banks in Brazil.
By pushing for a research and development (R&D) tax
incentive, Embraer will be able to level the playing field with the
Canadians, and other competitors, while compensating for the higher end
prices resulting from using the new Proex. Economic estimates show that
Embraer has a price advantage over Bombardier's aircraft when no
government-backed financing programs are involved. Therefore, Embraer
should support the Ministry of Foreign Relations in reaching an
agreement by both Governments to restructure their aircraft subsidy
programs according to World Trade Organization (WTO) rules as soon as
possible.
Background
Canadians initially took the issue of Proex subsidies to the WTO
in 1996, when the Dispute Panels first ruled that the financing programs
of both Canada and Brazil be redesigned so as to satisfy international
lending standards. The Canadians have changed two programs to the
satisfaction of the DSB, but still have three programs under
investigation. It is
expected that the DSB will require the programs under investigation to
be restructured as well. Brazilians have changed Proex to fit with the Panel’s
specified international standards, yet the Panel still needs to confirm
that the changes comply with international standards. The Canadians are
not satisfied with the new terms of Proex (Proex III) and demanded that
an additional ‘exposure fee’ be added to the Proex loans, to account
for lender and country risks. While Embraer’s aircrafts are of high
quality, a special attraction to its customers has been Embraer’s
price, facilitated, in part, by the financing terms of Proex. The new
financing terms of Proex III would reduce the value of Proex financing
by 70%, raising the overall price of each airplane by approximately US$
1 million, compelling Embraer to seek out ways to compensate for the
negative impact to its competitive advantage.
Embraer’s
large R&D investments are an inherent part of competing in the
aircraft industry. However, there is a lack of government policy that
encourages R&D in Brazil making it an expensive part of business
operating costs. Canada, and many other developed countries have long
had tax incentives for investing in R&D. These policies encourage
companies to develop new technologies and products that bring benefits
to their performance and to other industries through spillover effects.
Another level where the Canadian’s context is noticeably better
than Brazil’s is the transportation infrastructure and costs. While
the Canadians can rely on efficient transportation infrastructure to
move their goods, Brazilian businesses are weighed down by high
transportation costs. Several government and private agencies have
recognized the importance of R&D in these industries, yet the
Government of Brazil fails to adopt policies to support R&D.
The symbolic status of Embraer as Brazil’s national aircraft
manufacturer, and the strong political ties to it, has turned the
restriction of Proex into a serious debate in the Brazilian political
scene. Being the biggest exporter since 1998, Embraer is revered by many
Brazilian politicians who admire its success in a sector that is so
technologically advanced for a developing country. The WTO Panel ruling
against Proex reinforced growing criticisms of the WTO, with the notion
that WTO rules only serve the developed nations. The Ministry of
Development (MDIC) designed Proex and has been especially reluctant to
concede to the mandated changes to the export subsidy. Unfortunately,
WTO pressure on the Ministry of Foreign Relations has restricted
Brazilian trade representatives’ negotiating options. Indeed,
Brazilian trade representatives have taken a very stern position on
Proex by delaying mandated restructuring of the export program.
These delays in turn provoked the Canadians to behave similarly
by delaying compliance with the Panel’s requests for data regarding
Canadian subsidies under investigation. Thus, there is an urgent need
for Embraer to find a way to compensate for the new Proex burden so that
Brazil’s trade representatives have more flexibility in negotiating
Proex with the Canadians.
Recommendation
Embraer
should campaign for a new tax law that grants tax credit to companies
investing in research and development. The law will be two-tiered: a
higher credit for the transportation industry and a lower credit for all
other industries in the Brazilian economy. Meanwhile, the government
will negotiate with the Canadians to push for reforms of their subsidies
to the aircraft industry, on condition that Proex is modified according
to the standards set by the DSB Panel decision.
Strategy
Domestic
Embraer should build a
business coalition of supporters of a tax bill that grants tax credits
for R&D expenditures in Brazil. This coalition will firstly approach
the Ministry of Development, Industry and Commerce to explain the
purpose of our proposal, and gain their support to introduce the bill to
Congress. Meetings will then be held with the other Ministries to gain
their full support. To expand our political coalition beyond the
executive level, we will demonstrate the benefits of the R&D tax
proposal to regional politicians who in turn the legislative members
will perceive the demand for the bill by their constituents and
political colleagues. A media campaign will then amplify the presence of
the R&D issue in Brazil. Meanwhile, our coalitions will be lobbying
the Deputies and Senators to approve the bill when the votes take place
at the different levels of Congress. Our action plan will have a
15-month schedule so that the President ratifies the bill at the very
latest by August 2002, a couple of months before the Presidential
elections.
International
Embraer should continue to
provide trade data regarding Proex to the Ministry of Foreign Relations
while also researching more on the Canadian EDC subsidies that are
benefiting Bombardier. We will also convince the Ministry to push the
Canadians to reform their subsidies according to future DSB Panel
rulings. In exchange, the Ministry can offer the Canadians that the
specific changes they want to see made to Proex III will be made, on
condition that these changes are removed if the Panel determines these
changes to be unnecessary.
Introduction
Since its privatization in 1994, Embraer , a regional aircraft
manufacturer, has become Brazil’s largest exporter.
The company’s success became evident in two ways: it developed
into Brazil’s largest exporter in a short period of time, and it came
to succeed in a hi-tech sector in which developing countries normally
fail. Indeed, the company has been glorified by key political and
business figures alike, both domestically and abroad. Brazilian
President Fernando Henrique Cardoso has repeatedly named the company as
a symbol of the quality of Brazilian products.
However, Embraer ’s success in the international aircraft
market has also led to its ongoing subsidies dispute with Canadian rival
Bombardier. Seeing its market share slipping away to Embraer ,
Bombardier decided to investigate possible areas of controversy in the
Brazilian company’s activities. Bombardier questioned a Brazilian
export financing subsidy called ‘Proex’. Bombardier requested its
government to meet with Brazilian negotiators to gain an understanding
of the use of Proex and attempt to negotiate the removal of Proex.
Bi-lateral negotiations having failed, Canada filed to open a WTO/DSB
Panel in 1996. The dispute continues to this day.
Background
Dispute
over Proex Subsidies
In
1991, the Brazilian Ministry of Foreign Relations set up an export
financing system called Proex, which offers foreign buyers of Brazilian
exports direct loans or interest equalization subsidies. Since 1994,
Embraer has used the latter type of financing on its sales of regional
aircrafts. Proex was created to account for higher interest rates
charged by banks over purchases made in Brazil, also known as ‘Brazil
Risk.’ Indeed, Proex has been interpreted by the Minister of Foreign
Relations, Luis Felipe Lampreia, as a means to level the playing field
with foreign companies. Embraer has used Proex on 85% of its exports,
totaling 726 aircrafts to date (Dec. 2000). The export subsidy is
available for exports of capital goods, automobiles and auto parts, and
consumer goods.
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