Cartes may have something to teach Rousseff. 

Photographer: Evaristo Sa/AFP/Getty Images

Brazil Needs to Pay Attention to Paraguay

Mac Margolis writes about Latin America for Bloomberg View. He was a reporter for Newsweek and is the author of “The Last New World: The Conquest of the Amazon Frontier.”
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Poor, hot and wedged between giants, Paraguay is easily overlooked. The landlocked country is still stained by its reputation as a smuggler's paradise and the home of the late Alfredo Stroessner, the generalissimo who ran one of Latin America's nastiest dictatorships for 35 years.

And yet capitalist perks, cheap overhead and a new enthusiasm for rules-based democracy have converted a patch of tropics that makes up just 0.05 percent of the global economy into one of the fastest growing and most business friendly spots in Latin America. The International Monetary Fund expects Paraguay to expand 3.8 percent next year, in a region set to grow only 0.8 percent.  

Brazilians have taken note: As their own economy swoons, they're turning to their diminutive neighbor as a source of low-cost manufacturing. The better bet might be to look at their neighbor's rise as inspiration for badly needed reform at home.

Brazilian direct investment in Paraguay grew more than fourfold between 2007 and 2014, reaching $641 million, and bilateral investment has increased by 276 percent over the last decade. Forty-two Brazilian companies in sectors ranging from footwear to auto parts set up shop in Paraguay last year and another 400 have sent scouting missions since 2014.

"The interest has been intense," said Sebastian Bogado, Paraguay's commercial attache in Brazil, who has been sprinting between road shows for companies eager to pour money into his country.

Paraguay's rise is remarkable in a region where just a few years ago Brazil was catching all the stardust. Now, Brazil's economy is set to shrink 3 percent this year and another 1 percent in 2016. Foreign direct investment has been falling since 2011, and Brazil tumbled 18 places -- more than any other country -- to place 75th out of 140 nations on the World Economic Forum's latest competitiveness ranking.

The slowdown in China and the world commodities bust are partly to blame for the country's struggles, but so are homemade woes like unchecked public spending and a top-heavy bureaucracy, which cost taxpayers a bundle, stifle private initiative and welcome graft. Indeed, a sprawling corruption scandal has hobbled public works.

Unlike Brazil, tiny Paraguay decided it needed to reach out to grow. The country’s free-market leanings date back to the days of Stroessner's rule (1954-1989), when the dictator worked to keep Paraguay safe from communism and its borders open to amigos with deep pockets. Brazilian grain farmers answered the call in the 1970s, and these Brasiguaios -- as the migrants are known -- have turned their adopted country into the world's fourth largest soybean exporter.

Eager to climb the value chain, Paraguay rewrote the rules for industry in 1997, offering incentives to foreign companies willing to assemble low-end factory goods for the world market. Investors balked at first, given the country's lingering penchant for political turmoil; the 2012 ouster of President Fernando Lugo didn't help.

Enter Horacio Cartes, a tobacco magnate who was elected president in 2013 on the promise of converting Paraguay into a stable democracy with a streamlined economy. Cartes signed a fiscal-responsibility law designed to keep government debt in check. Prior to his election as president, Cartes also backed a bill passing an income tax (Paraguayans had never had one) to pay for public services and rein in the vast off-the-books economy, which fed contraband and corruption.

The result: Paraguay rates higher than Brazil on the World Bank's scale of ease of doing business. A study by Brazil's National Confederation of Industry found that labor is 21 percent cheaper in Paraguay and electricity is 64 percent cheaper. Foreign direct investment to Paraguay grew by 230 percent between 2013 and 2014, compared with a 2 percent drop in Brazil. (Indeed, Paraguay stands out in a region where overall FDI fell 16 percent in 2014 and will probably retreat by as much as 10 percent this year.)

One of Paraguay's biggest draws is the trifling 1 percent value-added tax on goods for export that are processed or finished in Paraguay. The country also boasts the lowest corporate tax rate -- 10 percent -- in Latin America, compared with Brazil's rate of 34 percent. "Every time government has a problem, it raises taxes," said Carlos Tilkian, head of Brinquedos Estrela SA, Brazil's top toymaker, who is weighing investing in Paraguay.

Brazil would do well to take a cue from the boom next door. In a more sluggish global economy, the contest for capital will be sharp, and investors will probably go where the obstacles are least daunting. Paraguay has shown it's open for business. Brazil, caught in recession, and cash-strapped with crumbling infrastructure, should do the same.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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