OCTOBER 28, 2014 A slightly modified version of this piece was published in the Financial Times' beyondbrics blog.
FIVE STEPS TO KICKSTART BRAZIL by Samuel George and Cornelius Fleischhaker On October 26, 108 million 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 percent to 48 percent), and she will now remain in office until 2018. The results suggest that this election was not about change but the continuation of helping Brazil’s new middle class pursue upward mobility. Over the last twenty years, Brazil has taken crucial strides towards achieving its weighty, if elusive, economic potential. Finance Minister (later President) Fernando Enrique Cardoso’s Real Plan established a stable macroeconomic foundation in the 1990s, which allowed his successor, President Lula da Silva, to implement social programs that lifted upwards of 40 million people out of poverty in the 2000s. Strong growth in the naughts afforded Brasilia fiscal leeway during the global financial crisis. An aggressive stimulus package in 2009 led to claims that Brazil was the last country to enter — and first country to exit — 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 dire poverty. Growth, which averaged 4.5 percent annually from 2004 through 2010, has averaged 1.6 percent since, and a stagnating economy spurs disquiet. When hundreds of thousands took to the streets to protest in 2013, and when 108 million visited the voting booth yesterday, they called for improved efficiency, transparency and, above all, a return to growth. There are five ways the second Rousseff government can meet the electorate's demands: 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 (40 percent of GDP) far exceeds that of other upper-middle income countries. This spending includes efficient social-welfare programs such as Bolsa Familia, 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 incentivizing savings, which remain chronically low. 2. Stabilize Macroeconomic Foundations - Brazil fought hard for macroeconomic stability. That effort must not go to waste. At 6.75 percent, however, inflation is currently above the country’s targeted upper limit after having been near it for several years. This has created an environment of tolerance and raised inflation expectations. Perhaps most perniciously, this development has reduced the perception of central-bank autonomy. While above-target inflation may be unavoidable in the near term, the Central Bank of Brazil should be guaranteed the operational autonomy to aim for a 4.5 percent inflation rate, the center of the targeted range, 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 a vast number of humans remain buried deep within São Paulo traffic) for want of better transportation. Overall, at roughly 2.45 percent 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 for large gains. Given fiscal constraints, most of this investment must come from the private sector. Fortunately, investors worldwide have demonstrated keen interest in Brazil, and continuing FDI inflows demonstrate this. Securing this investment will require an improved framework for publicprivate 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 socioeconomic backgrounds. The country must improve the quality of education not just by investing more, but also by systematically evaluating the effectiveness of government programs 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 and do not translate into growth overnight. They may not appeal to Latin American policymakers who all too often pursue short-term growth at the expense of long-term reform. Their approach, however, has rendered 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 kickstart the process.
Samuel George is a project manager specializing in Latin America at the Washington, DCbased Bertelsmann Foundation. He is a co-author of "Brazil and Germany: A 21st Century Relationship", a Bertelsmann Foundation – Getulio Vargas Foundation collaborative study. samuel.george@bfna.org Cornelius Fleischhaker is a junior professional associate specializing in Brazil at the World Bank. The opinions expressed here are his own and do not reflect those of the World Bank. cornelius_f@hotmail.com
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