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Revista de Economia e Sociologia Rural

Print version ISSN 0103-2003On-line version ISSN 1806-9479

Rev. Econ. Sociol. Rural vol.40 no.3 Brasília  2002 

Regulation and behavior of firms in Brazil's natural rubber agro-industrial system between 1997-2000



Augusto Hauber GameiroI; Cássia Barbosa SarettaII

IMS in Applied Economics, University of São Paulo. Email:
IIMS graduate student, University of Campinas. Email:




The need for regulation of Brazil’s natural rubber agro-industrial system (SAG) is evident. Since the middle of the 20th century, when the country began importing rubber, many governmental efforts have been made to promote the sustainable development of Brazil’s natural rubber productive sector. In 1997, the Brazilian government created a direct subvention policy to assist rubber producers. Given the structure of Brazil’s SAG, the international rubber market, and imperfect regulation by the Federal Government, it would not be unexpected to find signs that Brazil’s largest natural rubber consumer, the domestic tire industry, has begun to abusively exercise its market power. Using the theoretical structure of Industrial Organization, this paper tries to show evidences of this abuse.

Key words: public regulation, behavior of firms, natural rubber.



1. Introduction

In 1939, Mason published his work analyzing price and production policies in great companies. This analysis has become one of the theoretical bases of industrial organization (IO). The main example used in his analysis was the case of Firestone in the commercialization of tires with Ford. The present work also has the "pneumatics" industry as its focus

Studies by the São Paulo State Federation of Agriculture (FAESP) show that there were indications that the Brazil’s pneumatics industry adopted an opportunist "depressed price" policy in 1998 and 1999 to reduce the purchase price of Brazilian natural rubber, a main raw material in the manufacture of tires (Informe Projeto Borracha, 1998/1999). This policy can be considered a case of price discrimination as the term is used in the Theory of the Industrial Organization (Viscusi, 1997; Tirole, 1988).

According to FAESP, for most of 1998 and 1999, the Brazilian pneumatics industry paid lower prices for Brazilian subsidy benefited natural rubber than for imported natural rubber, after consideration of all importation costs. This wouldn’t have been a problem if Brazilian rubber prices were dictated by market forces; however, Brazilian rubber prices are supposedly controlled by a legislated price setting mechanism. The central objective of this paper is to present evidence that the effective prices paid by the tire industry for Brazilian natural rubber were below those that would have been negotiated had the legislated price calculation methodology been employed..

Mason’s important contribution concerning the influence of a firm’s "administrative profile" on its price policies will be used in this work. As will be shown, there are indications that "internal conflicts" within tire firms have been a decisive factor depressing raw material prices.

There are of 12 large multinational pneumatics firms and 16 tire production plants in Brazil. The country’s pneumatics industry is very concentrated, with the four largest tire companies (C4) responsible for 89% of production (BNDES, 1999). Domestic demand for natural rubber significantly surpasses Brazil’s production capacity.

Because of natural rubber’s economic relevance as a raw material for Brazilian industries and intense competition from Southeast Asian natural rubber producers, several government policies to improve the chances of Brazil’s natural rubber production sector’s survival have been developed (Della Nina, 1999; Oliveira et al., 1999; Sampaio-Filho, 1999; and Gameiro et al., 1999). In 1997, a direct subvention policy was created by the Brazilian government to assist rubber producers. Unfortunately, this natural rubber support policy has encountered serious problems: subsidy payments to the producing sector are frequently delayed and the mandated method used to determine the support level has not been followed.

The present work analyzes the relation between Brazil’s natural rubber sector subvention policies and the behavior of the pneumatics industries. The subvention policy mandated the application of a specific, fair method to determine prices paid for Brazilian natural rubber; unfortunately, the government has never applied this method. Instead, the Brazilian pneumatics industry has been able to set the country’s natural rubber prices at a level below the mandated level, a case of the pneumatics industry’s abuse of market power. The strong depreciation of Brazil’s currency, initiated in January 1999 when the country’s currency controls were lifted, makes the problem caused by the tire producers’ market power, oligopsonic power in this case, even more evident.


2. Methodology

Briefly, Brazilian Law # 9.479 of August 12th, 1997, created a subsidy to cover the difference between the international natural rubber price (lower) and the domestic price. This policy was intended to equalize the prices paid for Brazilian rubber with the prices paid in the international marked, allowing the tire and devices industry to purchase domestic rubber for the same price as imported rubber. The difference between the international price and the domestic price would be paid to Brazil’s natural rubber producers by the government.

The Law establishes a maximum subsidy payment of R$ 0.90/kg for Granulated Dark Brazilian rubber (GEB, the rubber used for manufacturing tires) to assure domestic rubber producers a maximum of (included the subvention) R$ 2.58/kg. The total value received by domestic GEB sellers is formed in the following way: PT = RP + SB, where PT is the total value received by Brazilian rubber producers for one ton of benefited rubber; RP is the reference price; and SB is the subsidy paid by the Federal Government. The reference price (RP) corresponds to the value that Brazilian rubber buyers would pay for rubber bought in the international marked and imported to Brazil. Brazilian law calls this price the "price of the product same type" (3rd Paragraph, 2nd Article),

The subvention policy is regulated by Decree 2.348, of October 13t, 1997. The Decree’s 1st Article, 1st Paragraph establishes that the references prices be formed by the following:

"a) the arithmetic average closing quotations for Standard Malaysian Rubber nº 10 (SMR 10), corresponding to Granulated Dark Brazilian nº 1 (GEB-1), in the commodity exchanges of Singapore, Kuala Lumpur and London over the fifteen days prior to the reference price’s publication, converted to United States dollars;

b) the conversion from US$ to the Brazilian currency (R$) will be based on the closing dollar quotation from the day before publication of the RP;

c) the cost of Brazilian taxes and duties, security, freight, additional freight, storage and other costs that can be verified at the time of publication of the RP."

One of the most important points of this Decree is that the Brazilian Ministry of Agriculture (MAA) is responsible for publication of the value of the subvention: the "Ministry of Agriculture and Supply, being responsible for the payment of the economic subvention, will publish the subvention’s value per kilogram of each type of rubber" (1st Article, 1st Paragraph).

It is clear that the subsidy’s value is determined by the reference price, with the reference being determined by the Brazilian Ministry of Agriculture using the methodology mandated by the Decree. Unfortunately, the Ministry of Agriculture has never used the prescribed formula to determine the value of the reference price, leaving that determination to a negotiation between the pneumatics firms and the Brazilian natural rubber producers. As the value of the RP is determined through negotiation with the pneumatics firms, it is clearly affected by these firms’ "administrative profile."

The basic hypothesis of this work is that pneumatics industry firms producing in Brazil are abusing their market power, paying less for Brazilian natural rubber than was mandated by Brazilian law. The Brazilian government, through its Ministry of Agriculture, has opened the door to this abuse by putting in place a price setting mechanism for Brazilian natural rubber and then ignoring that mechanism. This allows the pneumatics industry, not the international market, to determine the price for Brazilian natural rubber.

d is considered the abuse of market power, where:

d = PR PP (I)


RP = the reference price, as previously mentioned; and

EPP = the effective price paid by pneumatics industries to Brazil’s natural rubber producers.

The evidences of the pneumatics industry’s oligopsonic power over natural rubber processors are verified by d > 0. A value for d greater than zero would also indicate price discrimination because the Brazilian price would be below the cost of importation and purchase in the international market. Although the emphasis in literature is on price discrimination by suppliers, this work considers price discrimination caused by consumer demanders of raw materials; the reasoning is practically the same.

Pigou discerns three types of price discrimination: first, second, and third degrees (Tirole, 1988). The situation analyzed in this paper matches third degree discrimination, found when a firm is able to divide its suppliers into separate groups based on the external features that differentiate them and pays different prices to each group (Viscusi, 1997). The groups in this case are the Brazilian market (national processors and producers) and the international market.

The possibility of establishing discriminatory prices is related to an absence of price arbitration (Tirole, 1988). Prices in the Brazilian natural rubber market should be formed through arbitration between the country’s rubber producers and the domestic pneumatics industry, the domestic rubber devices industry, and international buyers; but two of the possible arbiters have limited relevance. The Brazilian rubber devices industries’ demand for natural rubber is limited (approximately 25% of the total produced); therefore, the rubber devices industry provides a restricted market. The Brazilian natural rubber export market is constrained by stiff competition from Southeast Asian rubber producers, especially when selling into the large Asian market, and the cost of transportation. On the buyers’ side, the domestic pneumatics industries hold sway.

Losses resulting from the pneumatics industry’s behavior will now be analyzed. The values of d will be obtained by using market information for each month between February 1998, when the subvention policy effectively began, and November 1999.

As established by law, the reference price must be formed by three variables:

RP = f(PI,C I,C A) (II)


PI = rubber price in the international market;

CI = product nationalization cost (the cost of rubber imported into Brazil); and

CA = the exchange tax.

The nationalization cost (CI) presents the following form:

CI = f(PI, QT, SE, II, R, FM, AF, P, AR, FR, DA, SD) (III)


PI = rubber price in the Malaysia Commodity Market (Kuala Lumpur);

QT = the amount of imported rubber;

CA = the exchange tax;

IF = insurance tax for carrying the product;

II = rubber importation cost;

CR = brokerage tax charged on the transaction;

FM = the value of maritime freight costs for one ton of rubber;

AF = Brazilian Merchant Navy Tax, charged on the value of the maritime freight;

CP and AP = costs of brokering movement and storage in port, respectively;

FR = road freight from the port to the plant; and

DA and SD = costs of customs forwarding and the dispatchers union respectively.

Only PI, QT, and CA will be considered as the effective variables of the nationalization cost (CI). The other variables that make up CI are considered fixed parameters in this analysis because they didn’t vary significantly over the period analyzed. The amount of imported rubber (QT) will also be omitted from the model. Calculations suggest that this variable does not influence the formation of nationalization costs per product unit.

The function of nationalization costs now assumes the following form:

CI = f(PI, QT, CA) = f(PI, CA) (IV)

So, in this study,

RP = f(PI, CA).

The method used to obtain expression for RP is presented in the appendix. Only the reference price’s final expression per metric ton of GEB is relevant at this time:

RP = (1.0465*PI + 90.75)CA + 58.75. (V)

The expression above gives the estimated reference price for one metric ton of GEB purchased from Brazilian natural rubber producers if the government’s methodology were applied.

Using the government’s mandated methodology, the calculated RP should determine effective purchase price (EPP) for Brazilian natural rubber. However, because RP has never been calculated, the Brazilian natural rubber market has adopted a historically accepted method to determine EPP; and this EPP determines RP, exactly the opposite from what was envisioned in Decree 2.348. It is important note that the historic method of Brazilian price formation is a "negotiation" process suggested by the pneumatics industry.

To determinate the relation between the RP calculated using the mandated method and the EPP for Brazilian natural rubber, three cases will be considered. Case 1 was constructed to analyze the problem of market power. Cases 2 and 3 are exercises that can help in the understanding of price formation. The results from analysis of the three cases are shown in Table 1.


Table 1 - Click to enlarge


For all cases, the EPP values for 1998 and 1999 shown in Table 1 were ascertained using data provided by FAESP. The calculated RP for month "i" is the average of the natural rubber daily closing prices in the Kuala Lumpur commodity market for the period between the 21st day of "i-2"month and the 20th day of "i-1" month (period "a"); adjusted by the average exchange tax between the 26th day of "i-2"month and the 25th day of "i-1" month (period "b"). This method of price calculation is effectively the same as the method mandated by Decree 2.348, and is represented mathematically as,

RPi = f(PI (a), CA (b))

Case 1 compares the average effective price paid (EPP) to Brazilian natural rubber producers over a specific month to the RP value that would have been calculated for that month if the Brazilian government’s mandated method were employed.

In Case 2, the reference price is established by the minimum closing values that could be obtained given conditions in the Kuala Lumpur market. The RP for that day would be based on "excellent importation," with the importing firms following Neoclassical Microeconomic Theory by behaving as costs reducers.

Case 3 considers a situation that is the opposite of the one considered in Case 2. In Case 3, it is assumed that the firm closed its import purchases when the international market was the least favorable. The importing firm would then have paid the market’s maximum purchase price for the product.

It is important to remember that prices from the "excellent day" considered in Case 2 can be verified but not previously determined. This is because RP, EPP, and the exchange tax are determined by their daily closing prices, which are unexpected information. The importance of this situation is to consider that when a firm buys a product in "excellent" conditions, it may be unintentional. The same holds true in Case 3. The buyer cannot predict that his purchase will be made at the least advantageous price. The equations used to determine RP for Cases 2 and 3 are shown below.

Case 2 RPi = Mín [ RP = f(PI(i-1), A(I-1)) ] (VII)
Case 3 RPi = Máx [ RP = f(PI(i-1), A(I-1)) ] (VIII)

3. Results

The percentile difference between the reference prices and the effective prices paid makes clear the pneumatics industry’s "power of market" (d ).

In Case 1, it is observed that the RP and the EPP were similar through February 1999, and included some small negative differences (-d ). However, the differences become very significant and positive after February 1999. From March 1999 to November 1999, the EPP is from 10.7% to 26.1% lower than the RP. Because the RP is a direct reflection of international prices and the EPP is the price paid to Brazilian natural rubber producers, the consistent, significantly lower value for EPP after March 1999 confirms harmful and discriminatory pricing behavior by the pneumatics industry.

In Case 2, it is observed that between March 1999 and November 1999, even under the assumption that the RP was calculated during a time of "excellent conditions" for natural rubber buyers in the international market, the calculated RP was still higher than the EPP. This supports our hypothesis that price discrimination is being practiced by pneumatics firms,

Figure 1 presents the results from our analysis of Brazilian retail tire price behavior. Domestic tire prices are considered proxies for the prices negotiated by the pneumatics industry for Brazilian natural rubber. The prices shown are the average monthly prices of two types of tires in Greater São Paulo’s retail market.



At the beginning 1999, strong depreciation of the Brazilian currency (R$) resulted in an increase in Brazilian tire prices. Between January and February 1999, the average Brazilian price of truck tires increased 13.5% while car tire prices increased an average of 12.6%. These prices remained relatively stable over the following four months, then rose again as the Brazilian currency continued to depreciate.

This behavior is explained by a R$ increase in the cost of tire manufacturing. In early 1999, the price of imported raw materials used to manufacture tires, such as synthetic rubber, increased in Brazilian currency terms. Tire manufactures were forced to increase Brazilian tire prices to maintain their margins. However, since passing all manufacturing cost increases to the final consumer is difficult, directors at different stages of the tire production process within the same firm were also obliged to reduce costs. This causes what Manson (1939) calls "internal conflicts" and increases pressure to further reduce raw material prices.


4. Conclusions

This analysis of the natural rubber market found that pneumatics firms using Brazilian natural rubber adopted behavior harmful to the country’s natural rubber production sector in 1999.

The Brazilian government’s 1997 subvention policy to aid the country’s natural rubber production sector created legislation to assure that Brazilian natural rubber prices directly reflect international market prices. Due to the Federal Ministry of Agriculture’s inability, for whatever reason, to execute the government’s own policies, tire firms producing in Brazil have paid lower prices to the country’s natural rubber producers than those mandated by the government’s policy.

This behavior, called "price discrimination" in the Theory of Industrial Organization, is permitted by the structure of the natural rubber agro-industrial system in Brazil, a structure shaped by the tire industry’s oligopsony power.



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The expression for the price reference, already considering the cost of nationalization and the tax of exchange, was gotten by the following formula:

PR = PI. CA. [( 1 + SE ) . ( 1 + II + CR )] + FM. CA. [ AF + ( 1 + SE ) . ( 1 + II + CR )] + CP + AR + FR

The values or percentages used in the formula had been gotten with the customs brokers of the city of Santos (SP) during the year of 1999.

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