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«Industrial policy and the creation of new industries: evidence from Brazil’s bioethanol industry Santiago Mingo*,y and Tarun Khanna** Downloaded ...»

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In addition to the attraction of a significant number of entrepreneurs with different levels of innate ability, an industrial policy period generates a protective environment in the industry that can also have long-term implications for the firms created during this time. Environmental conditions at founding can determine the future success or failure of an organization (Stinchcombe, 1965; Boeker, 1989;

Carroll and Hannan, 1989; Marquis, 2003; Johnson, 2007; Geroski et al., 2010).

Based on their empirical analysis of 100 high-technology firms, Hannan et al.

(1996) infer that initial conditions at founding have strong effects in shaping the evolution of firms. Zaring and Eriksson (2009)’s empirical study of Sweden’s information technology industry reports that conditions at the time of founding imprint organizations with persistent characteristics that can affect their future probability of closure.

More formally, according to the “organizational imprinting hypothesis,” organizations are imprinted for life by the technological, economic, political, and cultural context at the time of founding (Stinchcombe, 1965; Marquis and Tilcsik, 2013). The founder usually plays a crucial role during the imprinting process because he or she is S. Mingo and T. Khanna 6 of 32 the most important link between the environment and the young organization. The concept of organizational imprinting involves two processes: (i) the process through which the founding context shapes the organization during its foundation; and (ii) the reproduction process of the characteristics acquired at founding, or in other words, the persistence of these characteristics during the life of an organization (Johnson, 2007). Environmental conditions at founding can have an important effect on organizational growth and survival (Romanelli, 1989; Eisenhardt and Schoonhoven, 1990; Tucker et al., 1990; Swaminathan, 1996; Dobrev and Gotsopoulos, 2010). As Kimberly (1979: 438) puts it, “just as for a child, the conditions under which an organization is born and the course of its development in infancy have important consequences for its later life.” Downloaded from http://icc.oxfordjournals.org/ at Harvard Library on July 10, 2014 The set of public policies implemented during an industrial policy program is an important part of the institutional and business ecosystem faced by firms in the target industry (Guillen, 1994, 2001; Haveman et al., 2001; Russo, 2001). Thus, the environmental context associated with industrial policy can imprint the cohort of firms—and their entrepreneurs—created during the policy period (Boeker, 1988;

Swaminathan, 1996). In other words, industrial policy can affect the future prospects of an industry through its imprinting effect. For example, lobbying and influencing the public sector decision-making process can be crucial in an environment where discretionary government decisions play a significant role in the allocation of large subsidies and incentives (Mahmood and Rufin, 2005; Holburn and Zelner, 2010). A firm founded in an environment like this one can become imprinted with a preference and ability to generate rents through political means (Henisz, 2000; Delios and Henisz, 2003; Garcia-Canal and Guillen, 2008). In short, firms founded during a period of industrial policies develop abilities, routines, and organizational structures that, after becoming imprinted, can have important implications for the future survival and success of the firm.

2.1.2 The aftermath of industrial policy After an industrial policy program is terminated, a period of changes and restructuring occurs. The end of the program can lead to a significant shakeout in the industry (Klepper and Graddy, 1990; Mitchell and Mulherin, 1996; Klepper, 1997). During the post-industrial policy period, firms experience a large number of changes in strategy, ownership, and governance (Kim and Prescott, 2005). Many firms owned by lowability entrepreneurs will not be achieving their true potential because they are poorly managed. In other words, these firms would be more valuable if owned by other entrepreneurs. Naturally, high-ability entrepreneurs are in a better position to provide good management and take advantage of synergies and economies of scale.

Acquisitions can be an important mechanism of adjustment during the turbulent post-industrial policy period (Mitchell and Mulherin, 1996). We argue that, during the post-industrial policy period, high-ability entrepreneurs will acquire mismanaged Industrial policy and new industries 7 of 32 firms that are in financial trouble, thereby selecting out some of the low-ability entrepreneurs.

Summarizing, we propose three main mechanisms:

(i) First, during the industrial policy period a high number of entrepreneurs of varying abilities are attracted into the industry.

(ii) Second, a protective environment imprints companies founded during the industrial policy period. This imprinting process can affect the future capability of these firms to compete.

(iii) Finally, the end of the industrial policy program leads to significant changes in the industry. For instance, we can observe a high number of acquisitions where the most successful entrepreneurs grow by acquiring troubled firms.

–  –  –

3. The Brazilian bioethanol industry and its industrial policy program The Brazilian economy grew quickly during the late 1960s and early 1970s. The “Brazilian miracle” was fueled by investments in infrastructure, cheap oil prices, and foreign direct investment (Gordinho, 2010). This period of growth ended abruptly with the onset of the 1973 oil shock, which tripled the cost of oil imports.

During that time, oil imports constituted about 80% of domestic oil consumption.

In 1975, Brazil’s military dictatorship—under the presidency of Ernesto Geisel— initiated an industrial policy program called Pro-alcohol in response to the oil crisis (Mathews, 2006; Gordinho, 2010). The objective of the program was to create an industry capable of supplying significant amounts of sugarcane-based ethanol to be used as transportation fuel,1 with the final goal of making the country less susceptible to the economic downturns associated with international oil crises. Some sources also mention the creation of an additional market for Brazilian sugar producers as a secondary objective of the program (Walter and Cortez, 1999).

The role played by the government in the emergence of the Brazilian bioethanol industry was crucial (Moraes, 2000; Mathews, 2006). Many experts agree that this industry would not have been able to take off without the public policies implemented by the government from 1975 to 1985. What happened in other countries at that time shows how critical this program was. Nations like India and Thailand also have favorable geographical and natural conditions for sugarcane growth. As in In Brazil, bioethanol is produced using sugarcane. Other feedstocks can also be used to produce bioethanol. For example, in the United States corn is the main input used to manufacture this fuel.

Currently, the cheapest way to produce bioethanol is using sugarcane.

S. Mingo and T. Khanna 8 of 32 Brazil, their sugar industries were quite developed and their economies were highly dependent on foreign oil in 1973. However, the governments of India and Thailand never implemented industrial policies to develop the industry. Intriguingly, bioethanol industries did not emerge in these countries.

Coordination failure is the most probable reason that explains why the Brazilian government had to intervene in order to induce the development of the bioethanol

industry. Everything else seemed to be in place for the emergence of the industry:

(i) Brazil has always been among the best places in the world for the cultivation of sugarcane because of its climatic and geographical conditions; (ii) the Brazilian sugar industry is among the most competitive in the world, and this was also the case at the time the government started the ethanol fuel program. Therefore, these plants could Downloaded from http://icc.oxfordjournals.org/ at Harvard Library on July 10, 2014 easily start producing bioethanol if the business prospects looked promising; and (iii) the automobile industry in Brazil has played a very important role in the economy for more than 40 years (Shapiro, 1994). The auto industry has enjoyed a level of development and sophistication that is rarely seen in less developed countries. Thus, a domestic auto industry that could potentially supply ethanol-compatible vehicles was in place before the start of Pro-alcohol.

Despite these ideal conditions, government intervention was needed to offset coordination failures. Potential bioethanol producers were not going to invest in ethanol production if vehicles capable of running on ethanol were not produced, automobile producers were not going to manufacture these vehicles if the fuel was not widely available at gas stations, and consumers were not going to buy ethanol vehicles if a reliable distribution network for this fuel was nonexistent. The development of a distribution network for ethanol required the coordination of multiple actors.2 The bioethanol program involved a mix of government policies. The program initiated mandatory blending of ethanol in gasoline, extensive ethanol distribution at service stations, and the introduction of vehicles running on pure ethanol (Gordinho, 2010). Also, the state offered low-interest loans and credit guarantees for the construction of distilleries and the development of new sugarcane plantations.

These attractive loans persuaded incumbents—who were already in the sugarcane business before the start of Pro-alcohol—and new entrepreneurs to invest in industrial units to produce bioethanol. For example, Pro-alcohol attracted landowners and farmers without any experience in sugarcane planting (Gordinho, 2010). As a result, the construction of bioethanol facilities and new sugarcane plantations flourished.

Some of the industrial facilities were attached to existing sugar factories; other units produced only bioethanol.3 The government signed agreements with the major automobile companies in the country to produce vehicles that could run on 100% ethanol—a fundamental A similar situation is currently taking place in the electric vehicle industry.

Facilities that produce only bioethanol are typically called “autonomous distilleries.” Industrial policy and new industries 9 of 32 partnership was forged with the automotive industry. There was a reduction in the Tax on Industrialized Products (IPI4) for ethanol cars. In 1978, the industry started doing research to develop ethanol cars. The lower tax made it possible to sell an ethanol vehicle for the same price as a gasoline-powered model. Additionally, the government established tax incentives for the purchase of cars fueled by ethanol, such as a lower rate of the Road Tax (TRU5). It also manipulated and subsidized bioethanol prices, making it cheaper than gasoline even after accounting for ethanol’s lower energy content—on average, ethanol fuel has 30% less energy content than traditional gasoline. The price of ethanol was controlled through the creation of the “Alcohol Account,” which operated as a compensation tax. Through this mechanism, the government guaranteed bioethanol producers a price that provided a reasonable Downloaded from http://icc.oxfordjournals.org/ at Harvard Library on July 10, 2014 profit. At the same time, ethanol was sold to final consumers at a more competitive price than that of gasoline. According to an executive of the Brazilian Sugarcane

Industry Association (UNICA6):

At the beginning of the program the government set the price (of ethanol) above production costs so that it was highly profitable, and also made the pump price highly competitive. So, the first decision of the government was that ethanol should cost approximately 50% of the price of gasoline. The government created all these conditions for the market to exist. They gave the producer a good price;

they gave the consumer a very attractive price; and they gave the distributor a tax advantage. The government created this whole favorable environment and the program really took off. (Gordinho, 2010: 79) The government also funded R&D programs to improve agricultural and industrial techniques used to produce sugarcane and ethanol. In addition, the government mandated that Petrobras—at that time Brazil’s state-owned oil monopoly—distribute the alternative fuel. Finally, the government required gas stations in every town of at least 1500 habitants to install ethanol pumps. Interestingly, ethanol could be sold every day, whereas gasoline pumps were closed (by government order) on weekends.

These measures and incentives generated a lot of changes in the Brazilian sugarcane industry. Many established entrepreneurs in the traditional sugar industry invested in the construction of annexed distilleries and started selling bioethanol.

Drastic changes in organizational structure and business strategy were implemented.

The equipment, supporting systems, and procedures in these new “integrated

plants”7 had to satisfy the demands of customers coming from two different markets:

Imposto sobre Produtos Industrializados.

´ ´ Taxa Rodoviaria Unica UNICA is the largest organization in Brazil representing sugarcane producers.

The term integrated plant is commonly used to refer to plants that have the infrastructure to produce both sugar and bioethanol. These plants have a sugar factory and an annexed distillery for the production of alcohol.

S. Mingo and T. Khanna 10 of 32 food and fuel. On the other hand, new entrepreneurs entered the emerging industry mainly through the construction of autonomous distilleries that were initially focused only on the production of bioethanol—some of these distilleries were transformed into integrated plants later on.

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