In this blog, I have generally tried
to paint a picture of Brazil that is cautiously optimistic, emphasizing the
major challenges the country is facing while suggesting possible approaches to
address them. In this post, however, I will present the pessimist’s case. Despite
the immense progress that Brazil has made in the last twenty years, there is a very
real concern that such gains will ultimately prove illusory, just as the famous
“Brazilian
Miracle” of the 1970s led to a massive debt crisis and a lost decade of
economic stagnation. Looking at the ongoing situation in Southern Europe, it is
difficult not to draw parallels with Brazil.
By now, the troubles of Greece,
Italy, Spain and Portugal have been well documented. The countries had long
been plagued by similar problems: underlying competitiveness
issues in businesses and labor markets due to weak productivity growth, a large,
entrenched bureaucracy that soaked up government spending while inhibiting
the private sector, entrenched corruption
and tax evasion issues that led to inefficient spending and revenue
collection, and overly generous salaries and pensions in the public sector that
grew exponentially with the demographic aging of the population. While
economies suffering from such flaws would normally be expected to stagnate,
Southern Europe actually boomed over the last decade due to the adoption of the
euro and the governments’ ability to borrow money at cheap interest rates. People
excitedly talked about the “convergence”
of the Eurozone, and Greece, Spain and Portugal became part of a handful of countries to cross the threshold from middle- to high-income status. Now, of course, that story is quickly unwinding, and Southern Europe
looks set to struggle with economic hardship for many years to come.
Brazil suffers from many of these
same underlying weaknesses. It has a very large, bloated public sector whose
salaries and pensions take up most of government spending, and federal spending
continues to rapidly outpace the overall expansion of the economy:
(Source: The Economist)
Furthermore, Brazil already
spends more on pensions than any major country in the world save Italy, despite
having a much younger population. This means that as the population ages, the
problem is expected to get significantly worse, resulting in an explosion of
costs for the government:
(Source: The Economist)
These problems, combined with an
underlying lack
of competitiveness and poor
productivity growth, point to serious structural problems facing the
Brazilian economy. Like the nations of Southern Europe, these issues have
plagued Brazil for a long time. Whereas Southern Europe’s problems were
camouflaged by the adoption of the euro, Brazil’s problems were camouflaged by
a massive commodity boom due to China’s industrialization. The dangers have not
yet become as acute in Brazil as they are now in South Europe, but as the
population ages it is clear that the country is walking toward a major fiscal
crisis.
Yet there are reasons to be
hopeful that Brazil will not necessarily go down this path. Brazil learned
about fiscal mismanagement the hard way after crises in 1982, 1998 and 2002.
Long a poster child for out-of-control spending and hyperinflation, the country
is now considered to be fairly fiscally prudent. It has regularly run a fiscal
surplus, boosted
its foreign currency reserves, brought down its debt-to-GDP
ratio, maintained rigid
inflation targeting through monetary policy controlled by an independent
central bank, and seen its sovereign
debt rating rise over the last few years. Furthermore, unlike its
Southern European peers, it has strengthened its tax collection agency, referred
to locally as “The Lion”, which has successfully
cracked down on evasion and adopted aggressive revenue collection tactics that
are lauded internationally. The adoption of these policies under President
Cardoso and their continuation under President Lula has been the hallmark of
Brazil’s success, and the reason that the country was able, for the first time
in its history, to adopt
counter-cyclical measures in 2008 and 2012 to stimulate the economy and shield
it from the effects of the global financial crisis. This was a major step
forward for the country.
But this sound fiscal management
in itself will not be enough over the long term to avoid an economic crisis.
With the economic tailwind from China fading and the population aging (the
worker-retiree ratio is set to
fall from 8.51 in 2010 to 2.89 by 2050), the government cannot rely
indefinitely on a commodity boom and a demographic dividend
to buoy its finances. Major structural reforms will be needed to avert a Southern
Europe-style catastrophe.
The ruling PT’s record of
leadership is not encouraging on this front. President Lula established a
reputation as a free-wheeling populist, generously spending government funds on an
assortment of development projects. While many of these programs achieved very admirable social goals, others simply expanded the political patronage machine
and bloated the government payroll. President Rousseff has changed course
somewhat, staring
down striking public workers, fighting
congressional patronage machines, publishing bureaucrats` salaries
to promote public shaming, and successfully passing a first-step pension
reform program. But there are some worrying signs that she is letting
Brazil’s fiscal rigor slip: pressuring the central bank to continue to reduce interest rates despite rising inflation concerns, and reducing the primary budget surplus in order to stimulate growth. (However, these moves may end up being
wise over the long run, as falling interest rates and new tax cuts could
improve competitiveness, providing inflation can be kept under control.)
Overall, it is clear that
President Rousseff is moving the PT toward more prudent fiscal policies. There
is hope that, like the
Socialists in France, economic realities will force the leftist party to
restrain its big-spending instincts and move to a more moderate position in
the long term. The danger, however, is that Brazil’s problems are not as
immediate as those of Europe, and its political leaders can probably get away
with putting off major reforms for some time to come. Ms. Rousseff has taken a
few steps in the right direction, but she has not been bold enough. To avoid
becoming the next Greece, Brazil will need to be much more aggressive in
radically reorganizing its bureaucracy, improving its spending efficiency,
simplifying its tax code, and promoting productivity gains in the private
sector. The major worry is that Brazil, like its Southern European cousins,
will ignore the problem until it is too late. Courageous leadership will be
needed to save the country from becoming the next Greece.
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