Financial Times, October 28, 2014
On October 26, 108m Brazilians voted in the second and final round of the country’s presidential election. Incumbent Dilma Rousseff defeated challenger Aécio Neves by a slim but definitive margin (52 per cent to 48 per cent) and she will now remain in office until 2018. The results suggest that this election was not about change but rather the continuation of helping Brazil’s new middle class pursue upward mobility.
Over the last 20 years, Brazil has taken crucial strides towards achieving its weighty, if elusive, economic potential. Finance minister (later President) Fernando Henrique Cardoso’s Real Plan established a stable macroeconomic foundation in the 1990s, which allowed his successor, President Luiz Inácio Lula da Silva, to implement social programmes that lifted upwards of 40m people out of poverty in the 2000s. Strong growth gave Brasília fiscal leeway during the global financial crisis; an aggressive stimulus package in 2009 led to claims that Brazil was the last country in and first country out of the Great Recession. Investment poured in and many wondered if a new day had finally dawned for the perennial “country of tomorrow”.
Since 2011, however, Brazil’s burgeoning middle class has faced growing pains. For tens of millions of nouveau stable, simply participating in the country’s economy is no longer enough. They seek continued access to opportunity and they fear a return to poverty. A stagnating economy spurs disquiet. Growth, which averaged 4.5 per cent annually from 2004 through 2010, has averaged 1.6 per cent since. When hundreds of thousands took to the streets to protest in 2013, and when 108m visited the voting booths on Sunday, they demanded improved efficiency, transparency and, above all, a return to growth. Here are five ways to accomplish that:
1. Fiscal Rebalancing – Fiscal policy is at the heart of the current Brazilian malaise. Sustainability is key to an environment conducive to growth and investment, yet Brazil’s fiscal balances have eroded over several years. Rebuilding them will likely require a similar amount of time. The country’s public spending (close to 40 per cent of GDP) far exceeds that of other upper-middle income countries. This spending includes world standards in terms of efficiency such as theBolsa Família, but also plenty of pork worth cutting.
The new administration must set a direction early, ideally with a multi-year plan of fiscal consolidation that begins with a focus on transparency. Since 2011, Brasilia has leaned on various accounting measures to manipulate headline fiscal results, making the reported numbers increasingly irrelevant. A significant tax reform — as debated since the 1990s — would be a crucial second step. Such reform could lower growth-dampening compliance costs while remaining revenue neutral. In the long term, pension reform could defuse a fiscal time bomb while encouraging saving, which remains chronically low.
2. Stabilize the Macroeconomic Foundations – Brazil fought hard for macroeconomic stability. That effort must not go to waste. At 6.75 per cent, inflation is currently above the country’s upper target-rate limit and has been near it for several years, creating environment of tolerance and de-anchoring inflation expectations. Perhaps most perniciously, this approach has reduced the perception of central-bank autonomy. While above-target inflation may be unavoidable in the near term, the central bank should be guaranteed the operational autonomy to restore the targeted 4.5 per cent in the medium term, even if this requires further interest rate hikes. Over the long term, lower inflation and enhanced central-bank credibility should allow for lower interest rates — especially if fiscal conditions improve.
3. Closing the Infrastructure Gap – From unpaved streets in the northeast to the overburdened ports of Santos, Brazil’s infrastructure deficit is ubiquitous and costly. Brazilian fields produce grain twice as fast as those elsewhere but getting that grain to port can cost
almost half its value. Meanwhile, vast mineral deposits remain buried deep within the earth (and vast numbers of people remain buried deep in São Paulo’s traffic) for want of better transportation. At roughly 2.45 per cent of GDP, investment in Brazilian infrastructure is below the emerging market average and barely enough to keep up with depreciation.
The good news is that addressing infrastructure can provide large gains. Given fiscal constraints, most of this investment must come from the private sector. Fortunately, investors worldwide have shown keen interest in Brazil, as demonstrated by continued FDI inflows. Securing this investment will require an improved framework for public-private partnerships and the removal of procedural burdens that slow projects (the infamous custo Brasil).
4. Educating a 21st-Century Workforce – Brazil’s Lula-era momentum can partially be attributed to a series of one-off events: the rapid rise of China, the commodity super-cycle and the lifting of millions out of poverty. To sustain this momentum, the country must develop a workforce with expanding skill sets and productivity potential.
Brazil has made impressive progress in universalizing access to primary education, yet the quality of education and achievement remains poor by international standards. Moreover, the quality of education students receive depends greatly on where they live and their racial and socio-economic backgrounds. The country must improve the quality of education not just by investing more but also by systematically evaluating the effectiveness of government programmes from pre-school to university.
5. Trade and competition – Under President Rousseff, Brazil has adopted an increasingly defensive trade policy. Through tariff and non-tariff barriers, the country has protected domestic industry, reflecting policymakers’ belief that the domestic market is large enough to sustain growth. Just as in the 1970s, this approach has created inefficiencies and economic distortions: the quality of the Brazilian product may not be up to snuff, while the imported product may be too expensive.
Elements of the Brazilian private sector have good reason to advocate for the more liberal approach of the Pacific Pumas. Opening to world markets would provide Brazilian firms with an incentive to expand and offer access to technology and inputs. Successful Brazilian firms could compete on quality rather than hide behind sectoral benefits and trade protection.
Moving Forward
These recommendations are not easy to implement and do not translate into growth overnight. They may not appeal to Latin American policy-makers who all too often pursue short-term growth at the expense of long-term reform. Their approach, however, has resulted in cycles of boom followed by the inevitable busts, and centuries of unfulfilled promise. Brazil’s impressive progress means it can no longer stimulate growth by helping families afford a refrigerator—they have one now and do not need another. Brazil’s new middle class needs better jobs, more skills and a dependable economy. By implementing these recommendations the second Rousseff administration could kick-start the process.
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