Letter IEDI n. 1017–Investment, Modernization and Digitization in Brazil
The COVID-19 pandemic affected countries' economies through several channels, one of which was the increase in uncertainty, originating both in the epidemiological behavior of the new coronavirus and in the unprecedented character of the crisis. As a consequence, investments are expected to register a significant setback in 2020, given their sensitivity to agents' state of confidence and expectations regarding the future.
Brazil should not be an exception in this context, even if the Q1/2020 GDP data, which only partially reflect the impact of COVID-19, showed that investment was still in the positive trajectory seen in the last two years.
Based on a study carried out by economist and professor at Ibmec/RJ Thiago Moreira, at the request of the IEDI, today’s Letter analyzes in detail the profile of investment recovery in Brazil between 2017 and 2019. The full version of the work is available on the IEDI website (in Portuguese), but we summarize its main results below.
How was the state of investment in Brazil before the pandemic? The answer to this question leaves no room for much optimism: it was at its worst and was showing signs of slowing down.
In 2019, the investment rate was only 15.4% of GDP, that is, not far from its historical trough reached in 2017 and below the level prior to the 2015–16 crisis. The growth rate of gross fixed capital formation had decreased from +5.4% in Q2/19 to -0.4% in Q4/19 in comparison with the previous year and, in the same period, from +2.5% to -2.7% in the seasonally adjusted series. The return to positive ground, hinted at in Q1/20, is unlikely to resist the coronavirus crisis.
This performance is part of one of the weakest and most incomplete recoveries of investment, according to Moreira. The author argues that in the last three episodes of investment crisis, in 1981–84, 1989–92 and 2014–17, the intensity of the falls and the duration of the downward phase were similar. The biggest difference is in the pace of reaction. In the first two years of recovery, the recent expansion was about 3 to 5 times slower than in previous episodes.
Moreira points out some aspects that make the recovery of investment before the pandemic unique and explain its weakness. The first is its incompleteness, since public investment as a percentage of GDP is much lower than it was at the end of previous recessions.
The second aspect is the permanence of high idleness in the productive park. In the case of the industry, the indicator of average installed capacity utilization was in 2017–2019 more than 6% below its historical average for the years prior to the 2015–2016 crisis.
The third aspect is the construction sector, whose weight in investment was 50% in 2017 and which haven't recovered yet, despite positive signs in the residential segment, especially in 2019.
In any case, even if slowly, it is undeniable that investment had been recovering in recent years, which had little to do with expanding production capacity, given the levels of idleness. What kind of investment, then, would be ensuring that dynamism? Moreira's study gathers evidence that modernization and technological updating projects contributed to the recent expansion of investment.
The Investment Announcements Report (RENAI), released by the Ministry of Economy, indicates that 34% of the projects announced in 2016–19 were aimed at modernization, 10 p.p. above the figure for 2011–15 and almost three times the one for 2004–10.
In addition to the search for productivity and competitiveness, investments in modernization are also associated with the advancement of digitization in the world, which companies know they need to keep up with despite the low economic growth in Brazil. In the case of the industry, surveys carried out by CNI in 2017 and by Fiesp in 2019 had already pointed out that between 1/5 and 1/4 of the companies in the samples planned to incorporate 4.0 technologies in the subsequent years.
With the latest methodological update of the National Accounts (reference 2010), Moreira is able to identify the performance of the part of investment linked to new technologies and digitization, seeking to estimate it for the most recent years. In the new methodology, gross fixed capital formation started to incorporate intellectual property products, which include investments in R&D and digital or information technology services (software and database).
In 2017, investments in digital services and systems development were 124.1% higher than in 2010 and investments in R&D 26.1% higher. Moreira's estimates point to an additional 21% rise in digital services between 2017 and 2019, increasing their share of total investments from 4.3% in 2010 to 7.8% in 2019.
A modernization effort with digitization as an important axis can also be gauged from the performance of investment in capital goods, that is, roughly speaking machines and equipment, despite its drop in participation in total investment in the last decade (from 39% in 2010 to 35.6% in 2017).
Moreira argues that investments in equipment for information, communication and telecommunications (ICT) and, to some extent, in electrical machines and equipment can be associated with a digital modernization process as they constitute the physical infrastructure (hardware) linked to digital services.
Between 2010 and 2017, it was electronic and electrical equipment that gained space in the demand for capital goods, going from 19.8% to 26% of this type of investment. Moreira estimates a positive performance in the biennium 2018 and 2019, but one fundamentally based on imports: +8.4% for ICT equipment and +15.1% for electrical equipment. Their domestic production, in turn, registered -0.8% and -3.5%, respectively, in the period.
This relative disconnect between investment in digital services and the national production of the necessary hardware reduces the potential benefits of the digital modernization process. This is because it can make an important contribution to the improvement of the supply conditions of our economy, helping to increase productivity and competitiveness, but, by stimulating national output in a limited way only, it does not accelerate economic growth in the short term as much as it could.
In leading digital transformation countries, such as the USA, Japan, Germany and China, there is an explicit search for a symbiotic relationship between their capital goods industries and information technology services, which have jointly expanded in recent years, at least until the shock of the COVID-19 pandemic.