Regional Development Challenges in Brazil: Assessing State-Level Variation in Foreign Direct Investment Inflows

Abstract

Brazil is an immense nation with high levels of economic inequality between its twenty-seven Federative Units, which include twenty-six states and the Federal District. The total GDP of the wealthiest state is comparable to the GDP of the Republic of Indonesia, while the GDP of the poorest state is lower than that of the Kingdom of Swaziland. Foreign direct investment inflows have increased substantially to Brazil in recent decades, although variation in these inflows has likely exacerbated regional inequalities. Foreign investors have typically favored the more-developed states in the Southeast and South Regions of Brazil as the targets of their investments, bringing the many benefits associated with FDI to these already-prosperous regions and further hindering the economic growth of less-developed states in regions such as the Northeast. Developing an understanding of variation in FDI inflows is essential to mitigating inequalities between states. While a significant body of the development literature is devoted to explaining the determinants behind international FDI flows, less research exists on understanding regional variation in FDI flows. That said, most theories can be adapted for the purposes of a state-level analysis. The neoclassical model of growth, which holds that capital will flow to areas where it is scarcest due to diminishing returns on capital, is largely unable to accurately predict capital flows. Explanations focused around agglomeration-externalities effects are supported by a sizeable amount of real-world evidence, although are unable to explain capital flows in all instances. Arguments based around differences in the quality of institutions serve as causally sound and empirically defensible explanations for capital flows. In this thesis, I assess the above theories in an attempt to arrive at an explanation for significant state-level variation in FDI inflows to Brazil, placing the pertinent components of the extensive body of research on this topic in dialogue with one another in an analytical framework. When applied to FDI inflows in Brazil, a neoclassical model fails. A simplified agglomeration-externalities theory, where FDI flows more heavily to more economically developed states, explains much of the state-level variation in Brazilian FDI distribution, although there are a number of outliers. These outliers are the focus of this thesis. I examine three states as case studies: Bahia, Minas Gerais, and Santa Catarina. In 2005, these states displayed better-than-expected, as-expected, and worse-than-expected (respectively) levels of FDI stock per capita. I find an argument based around differences in institutional factors, specifically state government policy, to serve as a convincing explanation for these outliers. My case studies demonstrate that state government policies have been instrumental in creating pro-business environments in Bahia and Minas Gerais through offering tax abatements to foreign investors (in particular, reductions in ICMS, the state value-added tax) and providing publicly-financed infrastructural improvements and land grants to foreign firms. In contrast, the state government of Santa Catarina has failed to provide incentive programs, leading to the development of an unattractive investment environment and resultantly low levels of FDI.