Livre Digressão: Brazil economics: the off-road trap

Yes, let’s switch to English and talk about Brazil.

I’m all for using the public apparel to mitigate inequality and spur economic growth, which we have done in the last decade or so.

However, apparently, the force that was pushing the country forward have reached some sort of ambiguous boiling point.

The outlook is hardly bright, inflation is grinding against its target ceiling (6.5% a year) (4), GDP growth has stalled (possibly negative last year) (1), in 2014 the primary surplus target had to be extraordinarily revised down to keep our commander in chief out of jail (maybe not jail, but some accountability) and there is no perspective of improvement in a foreseeable future. Notwithstanding all of it, the unemployment rate is at its lowest level ever (9) and Government net debt as a share of GDP is very low by historic standards.

To sum up, the economy is somewhat overheated, the macro tripod have a single strong leg left (exchange rate is still floating) and Brazil have lost its thunder, we're no longer that 2010 shining star that was rising unscathed above the international crisis at a 7.5% annual growth rate and was about to host the next world's major sports events (World Cup 2014 was OK and there's still the Rio Olympics 2016, but I'd say nobody is impressed).

Let's call it the off-road trap. But how did we get here?

In one of his classic papers, Dr. Rodrik argues that “igniting economic growth and sustaining it are somewhat different enterprises” and (damn!) the man is right.

The 90s were a time when we finally managed to put an end to a long period of high inflation (not real hyper though - if you know any history you know the hyperinflation was staged to force the transition to the new currency and apparently The Economist doesn't) and do some long overdue reforms - including putting the macro tripod in place (inflation target, floating exchange rates and public primary surplus target) -, paving the way in a fashion that would allow us to put the pedal to the metal, right? Well..., for awhile we had a pretty decent ride I'd dare to say.

At the end of Lula's first term, inflation expectations were anchored, the exchange rate was stable and GDP was actually growing at a good pace (3%-4%), partially because the world was cruising blue skies. But it wasn't until the appointment of Ms Rousseff to the Ministry of Casa Civil (June/05) that we started to boldly step on the gas. And, as soon as the last quarter of 2006, the policy lurch was already gathering momentum, a steeper upward trajectory was kick-started for the minimum wage (5), the Brazilian Development Bank - BNDES was given new guidelines that would double its loans within 4 years (8), the primary surplus target was fairly reduced (7) and the welfare programs expanded.

Have I mentioned that Ms Rousseff ran the Planalto like a bulldozer, even before being elected President? To get the World Cup works done in time, gross exceptions to the Public Tender Law (Lei 8.666) were created, to approve the environmental license of a very controversial hydroelectric plant, the UN Champion of the Earth Marina Silva was led into resignation, to improve the feasibility of infrastructure projects, BNDES was induced to reduce rates and offer longer financing periods, just to name a few examples.

As a result of the social programs, people whose incomes belong to the lowest 7 deciles saw their earnings increase faster than the national average rate (older post), therefore biting a bigger slice of the pie. That's one of the reasons why private consumption was the major driver of output growth in the last decade, since it grew faster than government spending and steadier than private investment (3).

As anyone who can rock simple Kaleckian models would tell you, if there is outstanding inequality (in Brazil, the top 5% earn 30% of all income), the mere improvement of income distribution can make the national pie significantly larger, as income is transferred to the poorest classes, which tend to spend a higher fraction of its earnings, thereby increasing overall effective demand. In addition, credit availability boosted consumption as well, which explains why household debt to income ratio have soared (10).

Off course, investment was an important driver too. At the time, China was still strongly fueling international demand for commodities, which - in conjunction with the huge amount of BNDES financing - created incentives to add capacity through capital spending. Moreover, the Federal Government infrastructure program (PAC) that encompasses World Cup stadiums, roads and airports concessions, sanitation work and so forth also magnified investments.

All of it amounts to a GDP CAGR (Compound Annual Growth Rate) of roughly 3.3%, between the 1st quarter of 2003 and the 3rd quarter of 2014. If you look at figure 3, since the indexes are discounted by GDP growth, if there's an upward slope it means that the variable outpaced GDP and - as we can see - that's what happened with investments and consumption. Government spending, however, presented an overall pace below GDP growth, despite the ordinary primary surplus reductions (7). And, in fact, we had a declining net public debt to GDP ratio for most of the period (6), only recently it started to go up mostly due to low economic activity, since a big chunk of public resources goes to social security - a GDP inelastic expense - while tax revenues are highly GDP-elastic.

So, if the public finances outlook is not as catastrophic as the Brazilian press likes to report it (we didn't save any money to service the debt for the first time in 14 years (2), so what?), why is the market so passionate when it comes to defending the harsh austerity measures - spending cuts and public prices/tax hikes - that we're currently witnessing? I don't have a final answer to this question, but I'd guess it is the usual.

In Brazil, there's a belief that governments can hardly do any good, even though they are expected to do almost everything. So, basically, people think most public institutions are either corrupt or incompetent and the ongoing investigation of Petrobras kind of corroborates that notion. Unfortunately, though not completely wrong, this image of governments overshadows the fundamental role it had in our economic history and prevents Brazilians from demanding an effective development strategy from politicians.

Thus, if Governments are no good, we should minimize it and let the 'animal spirit' of entrepreneurs roar, right? That's the understanding that prevails amongst the middle class and the market in general, which is why the stocks plunged and the exchange rate spiked when Mr. Neves - an advocate of small Governments - lost the presidential election to Ms Rousseff last year.

However, Brazilian entrepreneurs have shown only a 'pet spirit' throughout the history, instead of leading and taking risk, they have often waited for the Government to break new grounds or at least take them by the hand. That was the case in most of the major economic sectors - mining, steel, automotive, energy (oil and electricity), telecommunications, transport/logistic infrastructure (roads, civil aviation, airports, railroads, ports), capital market, etc. Commonly, a public company would be set up to jump start a sector (before Petrobras there was no oil sector, for example) or a subsidies scheme would be enacted to get the private players in the game (that's how we get the car companies to come here in the 50s).

You may be tempted to point out that the tax burden is too heavy (~35% GDP) and the State is too meddlesome, which I can't deny, but it is a relatively recent circumstance. In figure 12, you can see that the tax burden stayed below 25% of GDP up until the beginning of the 80s and even through that decade it remained unstable and lower than that for most of the time. Well, I've already pointed out that the State had to take charge of the economy and build most of the strategic sectors from scratch, so before that there was not much to be nosy about. In addition, right after the privatizations of the 90s, it could be argued that regulation was pretty lax and stayed that way up until Ms Rousseff had it her way. So, I don't see a plausible excuse for the lack of 'animal spirit'.

Just to be clear, this isn't a critique of the Brazilian capitalist class. I'm not saying they should be bolder and take risk. I'd even argue that the 'animal spirit' is a myth, but that's the subject of a different digression. The point is that we simply cannot count on the private sector to take the lead.

Nevertheless, I'm not sticking my neck out to defend the Rousseff Administration, I disagree with most of the meddling, because I believe they are just meant to exert control (Ms Rousseff is a notorious control freak). I'd argue that the welfare policy that was juiced up by Lula and Ms Rousseff is fair and necessary, but Brazil still needs a master plan. In the past, for instance, we had the 'Plano de Metas' of president Juscelino Kubitschek that brought the car industry in the 50s and the militaries designed two National Development Plans (PNDs) that intensified the industrialization based on Import Substitution in the 60s and 70s (in case you're wondering, I'd oppose any kind of military intervention). The 80s is still called 'the lost decade', because that's when our struggle with high inflation started and GDP stuck. And, in our long fight against inflation, we lost our ability to plan.

The reforms of the 90s did prepare the country for the wave of growth I mentioned. Nonetheless, it seems that the paved stretch of the road is out reaching its limits and the ride is getting bumpier by the minute. Moreover, sticking to the metaphor, we know where we wanna go but there are only a few poorly connected pieces of the map. What I mean by that is that our country have no comprehensive development strategy. All we have is a bunch of unconnected packages of poorly executed investments and actions intended to solve immediate problems.

There are at least two waves that are heading toward us and if we're not strong enough to paddle we'll probably miss them. One is Green Energy and the other is Big Data. In the first front, because of our hydroelectric plants, Brazil rely on fossil fuels for roughly 60% of its energy consumption, while this number is around 80% for the World as a whole. In the second front, Brazil have 107.8 millions of Internet users, what makes it the 5th biggest Internet market in the world by that standard. Then, there are favorable circumstances that we could rely on to construct a new national development plan, so we could surf both waves magnificently. But, if the State don't step up, we're going to paddle out one more time.

Let's take Medina as a role model then :)

(Don't mention our football/soccer team, please)