GM 6030 A3 Regional Business Environment: Latin America MIDTERM EXAM

The success of any business venture in Latin America depends on the ability of the company to find a country that will provide the right amount of incentives and benefits but that will also have a continued political stability and guarantees for property rights and investment security. Our analysis will evaluate the probability that Brazil and Argentina, as the possible site selections for K-FIT, will have this kind of business friendly environment and will enact market oriented reforms. We’ll evaluate the aspects in both countries that make them adequate or not to invest in them. We’ll also provide a recommendation of which country and region within them we see as the best option to set up operations. Argentina Argentina is a democratic republic organized as a Federation of 23 provinces and the Capital City of Buenos Aires. It has a total population of 42.19 million and has an area of approximately 1.07 million sq. miles in the southernmost part of America (Buckman, “The World Today Series 2012 Latin America” p. 35). To understand the current business environment in Argentina and the prospects of market friendly reforms going forward, we have to understand its cultural legacy and the way its society is structured. Since its beginnings as a nation, and even before it got its independence from Spain in 1816, Argentina’s society has been polarized between the “people from the Interior” that lived in the inland provinces and the “Porteños” or people from the city of Buenos Aires located in the eastern coastal area. The “interior people” are predominately Indian and Spanish descents that subsist from agricultural and cattle raising activities. Most of them are poor peasants that work in huge land extensions known as “Estancias” owned by powerful landowners. The “Porteños” are predominately European descents that established a society dominated by an elite class of entrepreneurs that seized power after the industrial revolution in the early XX century (Buckman, “The World Today Series 2012 Latin America” p. 37). This accentuated division in the Argentinian society grew into a conflict between a dominant group of wealthy “Porteños” and landowners, versus the poor peasants from the interior provinces and the Buenos Aires’ Working Class. This conflict reached a peak when the 1930’s world crisis hit Argentina. The

Military, an interest group on its own, decided to intervene to “restore order” and prevent further civil unrest. (Buckman, “The World Today Series 2012 Latin America” p. 38). Then, after the end of WWII, Juan Peron rose to power. An ex-member of the military that served as Secretary of Labor, and a gifted orator who understood the power of the masses, he practiced a populist policy that inspired millions of people that named him “The Leader”. With his highly popular, but irresponsible, economic policies of increasing salaries and out of control fiscal spending, he gained the unconditional loyalty of the Labor Unions that by now had become a powerful force representing millions of middle class and poor workers. After the inevitable consequences of the ill devised populist policies manifested themselves throwing the country into economic despair, the military once again stepped in to “put order”. The now empowered poor social classes and Labor Unions adopted a leftist view that didn’t sit well with the powerful Military class or the rich “Porteños”. For the past 4 decades, the power struggle between the leftist Labor Unions, different factions claiming to represent the true legacy of Peron’s political party, right wing oligarchs from Buenos Aires, the Military, some Paramilitary groups, Local subversive groups, and other interest groups, have submerged the country into a vicious circle of turmoil, bloody confrontations, a few years of relative stability that is followed by a painful burst after the short term and egocentric policies put in place by whoever is in power reach their inevitable outcome and throw the country again into confusion and hopelessness. The recent economic history of Argentina denotes the power struggle taking place in a fractured and corrupt political system. After the senseless act of military stupidity in the Falkland Islands in 1982 left the country demoralized and in bankruptcy, the Military dictatorship gave way to a civilian government. The massive debt burden inherited from the Military regime, along with inadequate economic policies; put Argentina in an acute economic crisis with a destructive hyperinflation (Buckman, “The World Today Series 2012 Latin America” p. 42). A temporary bonanza came during the 90’s after an aggressive privatization campaign and a peculiar foreign exchange regime that pegged the Peso to the USD at a 1 to 1 exchange rate. This proved to be yet another failed attempt at fixing economy’s structural problems. It all crumbled when several crises in other international markets destabilized the economy and prompted the default of the Government on its debt obligations. The fall out of this crisis left a peculiar power couple managing the destiny of

Argentina. The Kirchners, Nestor and Cristina, politicians from one of the interior provinces, swooped into power after other more traditional political leaders failed to convince the voters. Nestor implemented economic policies that put him at odds with the IMF and the Argentinian external debt bondholders. Although some of his policies had a positive effect allowing the economy to grow again. He aligned with the left axis formed by Venezuela, Ecuador and Bolivia and forced many creditors to a bond swapping arrangement intended to lower the debt amount significantly. Nestor died in 2010 leaving Cristina in power. She has proven to be a very fierce authoritative politician. She had silenced her detractors using clever excuses to shut down newspapers. She had issued a series of executive decrees that could be considered bad economic policy like limiting the independence of the Central Bank. She is also in a bitter battle with the bondholders of the defaulted debt that didn’t accept the swap her husband forced on many of them. (Buckman, “The World Today Series 2012 Latin America” p. 50-52). Also, under the pretext of nationalism, she had seized control of the operations of foreign companies like the Spanish capital company Repsol and has escalated again to the international scene the Falkland Island conflict. All these measures intended to exacerbate the patriotism and rally the people behind a single cause are mainly a smoke screen to hide the fact that inflation is spiraling out of control thought to be 25% instead of the official 10% numbers and that the GDP expected growth rate is subpar when compared with some of its neighbors and expected to decrease after a short bonanza period caused by the increase on some of its agricultural harvests (that the absurd foreign exchange controls that her administration is implementing are alienating any type of Foreign Direct Investment into the country (EIU Argentina Forecast, January 2013, page 10). If we review the Argentinian case using the Packenham Model we can see how the different factors in the analysis point in a similar direction. First, the Political Party system is much fractured, with the Justicialists (Peronists) divided in several factions with very dissimilar interests and allegiances. There’s also a weak and poorly organized opposition, some Center-right groups, some Communists, etc. Cristina Fernandez retains power governing through executive decrees, but this is an unsustainable model that will sooner or later crumble and leave a much disorganized landscape. The political credentials of President Fernandez are very questionable. Her home province in the Interior of the country gives her some credibility with the poor working social classes. But still her clientelism and rampant corruption makes her be very prone to sudden swings in allegiances.

The President has ample manipulative skills, although they’re not strictly leadership skills, they help her get what she wants. Her combative demeanor makes most of her opponents fold out. The Political consensus as explained before and demonstrated in several aspects of Argentina’s political history is simply nonexistent. Not even within the same party (Justicialismo) their participants can agree in which policies truly represent the spirit of Peron’s legacy. The other parties in the political life spectrum are simply not united enough to present a cohesive argument together. Based on these aspects we can conclude that Argentina will not have a business friendly environment for the foreseeable future. The current economic, political and social realities in Argentina are not compatible with the enactment and sustainability of market-oriented economic reforms. We DO NOT recommend setting any kind of manufacturing or retail operation in the country. Brazil Being the biggest country in South America, Brazil’s 3.28M square miles territory is an exuberant combination of virgin tropical jungle with endless beaches and huge metropolis. As the only country in America to have been a Portuguese colony, Brazil’s cultural legacy is very different from that of all its neighboring countries. It has an enormous reserve of natural resources, and a multitude of ethnic and cultural groups that make it a powerhouse in the region. Becoming an independent nation in 1822 it went through a long period of relative political stability with Pedro II as emperor of the young nation. This helped Brazil develop into a Federal Republic without going through much of the cruel dictatorships other neighboring countries had to endure in their early years (Buckman, “The World Today Series 2012 Latin America” p. 76). After some turmoil in the first decades of the XX century, the country went through a period of prosperity with the Government of Getulio Vargas in 1930. His progressive views, like empowering the women and effective administration lead to a sound management of the economy and a period of industrialization (Buckman, “The World Today Series 2012 Latin America” p. 77). But the following civil administrations were unable to do a similar good job and the country started to slip off the path to civil unrest. This lead to a military coup in 1964 that established a military regime that lasted for 2 decades. During the period of the military dictatorship, the main objective of the controlling military junta was to advance Brazil in the industrialization path and foster economic development. They did have a

significant advance in economic growth estimated in 56% in 10 years (Buckman, “The World Today Series 2012 Latin America” p. 78) but that was in sharp contrast with the serious deterioration in individual rights, income distribution equality and education expansion. The Military Government was also brutal in their dealings with adversaries recurring to torture, intimidation and murder. It was only after a gradual transition to democracy that the first elected president assumed office during the mid 80’s. The end of the military dictatorship also meant the start again of labor groups mobilization that created civil unrest. Also a series of hard natural conditions plunged the economy into a recession that forced the country to default on its debt in 1987. The result: 1700% inflation rate in 1989 (Buckman, “The World Today Series 2012 Latin America” p. 82). Two more presidents were elected after this event and none of them was able to mend the economy until Fernando Enrique Cardoso, a Marxist influenced economist, created a new currency that he pegged to the US Dollar and brought down the inflation from 2500% to double digits in 1995 (Buckman, “The World Today Series 2012 Latin America” p. 83). Cardoso was able to put Brazil in the path of economic development. This was interrupted after the financial crisis in Asia and Russia forced Brazil to devalue its new currency and lose the peg with the US Dollar. The Real now was let lose to float in the market which brought a huge devaluation that in the end actually helped Brazil’s exports to become more competitive. In 2002, the Labor Union leader Luiz “Lula” Da Silva was finally elected president after 3 previous attempts. The new colorful president from the left caused turmoil in the market given the uncertainty of his economic policies. But to the tranquility of the economic analysts, Lula continued the sound economic policies started by Cardoso and actually abandoned his extreme leftists views from before to adopt a more center left posture that fitted well with the financial market expectations while at the same time enacting policies that favor the poorest social classes. With masterful negotiation skills he was able to pass a major reform of the pension system to allow it to have economic viability and also he was able to overhaul the complex state and federal tax systems which were significantly simplified. (Buckman, “The World Today Series 2012 Latin America” p. 86). Although being a president with a clearly Leftist inclination, Lula distanced himself from the radicalization portrait by Venezuelan president Hugo Chavez and his entourage, Evo Morales, Rafael Correa and Daniel Ortega. He was able to maintain a cordial relationship with them although not as close as the outspoken Chavez would have liked. Based on the prudent economic management and the boom the Brazilian economy showed during his first term, Lula was re-elected to a second term in 2005 and he pledged a new development plan for his

second term based on developing first world infrastructure and cutting down criminality in the main cities like Rio and Sao Paulo. Lula was also able to raise the international profile of Brazil to a first world country that was selected for the 2 most important sport competitions in the World, the Soccer World Cup in 2014 and the Olympics in 2016. Lula’s second term ended in 2010 and his successor was his Chief of Staff Dilma Rouseff. Although not sharing the same poor upbringing and worker class background as Lula, Dilma has also an interesting story having formed part of a guerrilla movement during the Military Regime and having been tortured for her involvement in that movement. She is a strong and smart leader that during her first years as President has continued the same solid economic policies that Lula followed. Her main concern is the eradication of poverty and diminution of crime. In the diplomatic front she will continue to play both sides in the international arena pledging no allegiances to neither the US nor its enemies like Iran, but certainly entertaining cordial relationships with both. Corruption seems to be plaguing Dilma’s

administration with several scandals. She has been firm and had fired several of her ministers because of these scandals. (Buckman, “The World Today Series 2012 Latin America” p. 92) In the economic front Brazil is the world’s 6th largest economy with a large reserve of minerals, oil, huge agricultural capacity and a vibrant industry. It has done so well in recent years that it repaid everything it owned to the IMF in 2005 (Buckman, “The World Today Series 2012 Latin America” p. 95). It has also allowed for social mobility putting a huge percentage of its population out of the poor social class and allowing them to now be considered meddle class. As a member of Mercosur it has been able to export a greater amount of its production and the forecasts for the coming years is a continued healthy growth of 3.5% of GDP, controlled inflation and public spending and low unemployment, Brasil is posed for even greater things during the coming years. (EIU Brazil Forecast January 2013, page 5) Using the Packenham model to determine the sustainability of market-oriented economic reforms in Brazil we can see that all factors point to a continued open and vibrant economy. The political party system, although having multiple parties, is now majorly favoring Dilma’s political party, the PT and they are well in their way to obtain a significant win in the next 2014 elections with a majority in congress as well.

Political Credentials of the President are very good given her previous position with Lula who is seen as a man of the people. She is also seen as humble and down to earth. She can connect with people and that helps her pass legislation easier. Her leadership skills are unquestionable. She has been firm with the scandals that have come out during her years as president but without losing credibility. Finally, the political consensus regarding the continuation of the market friendly approach is almost unanimous in Brazil. The social mobility experimented by such a large portion of the population to be in a better economic situation has allowed for a favorable climate regarding the openness and benefits of the free trade policies in which Brasil still has much more to benefit from. In conclusion, after analyzing the factors present in Brazil, their current situation and forecasts we can recommend to select Brazil as the site to open the new manufacturing and retail operations. There are certain aspects that require special attention like the complex tax system and the foreign exchange controls. But with the help of the proper experts these things should be manageable. We recommend setting shop in a metropolitan area where the total available market of consumers is much bigger and where the purchasing power is greater. Sao Paulo, Brazil’s main industrial city is a good choice, but we would even recommend going to a smaller but still large city like Curitiba which is still close to Sao Paulo but has a much better situation in terms of traffic, crime and contamination.