487: Politics and Economics of Development
BRAZIL
Prepared by:
Abeer Bhatia
Zarina Kosinovsky
Kaya Pai-Panandikar
Eric Wang
Adrian Zak
" We would like to express our gratitude to our sponsors Deutsche Bank, Diamond Technology Partners, Pfizer and CNA Financial "
"....Brazilians are finally discovering that we are big, strong and important in the world. We are not a country of just Coffee, Soccer, Carnival and Amazon. We are a rich country, diversified, compound and deeply creative, capable of being one of the big examples to the whole world".
Fernando Henrique Cardoso, President of Brazil
Brazil’s 500th aniversary, April 23, 2000.
Introduction
We believe that Brazil has the capability for high economic growth and development. However, the country faces several challenges. This study will examine specific issues that are pertinent to the development of the country. Our analysis includes:
i)A discussion of current reforms
ii)An analysis of the political system and leadership
iii)An examination of the education system
iv)An assessment of the privatization process
v)An analysis for possible outcomes / conclusion
Brazil has made tremendous progress in efforts to tame inflation, stabilize its currency, the Real, and alleviate its enormous fiscal deficit. Furthermore, the advancement of the privatization process has contributed to a large increase in FDI (foreign direct investment). As a result of this increase, prospects for economic growth are indeed realistic now. Yet, a plagued political and inadequate educational system along with some of the worst income inequalities in the world, creates specific problems that may negate many of the gains achieved. The interdependent nature by which the ills of the educational system affects the democratic process and long-run economic development of Brazil are far-reaching and indeed require a credible commitment by the government to rectify. The long-term implications of an uneducated workforce particularly affect productivity, an essential input for growth. Thus, even though Brazil’s short-term prospects for growth appear positive, unless educational issues are seriously addressed, the country may find itself with a workforce unable to meet its needs.
Snapshot(Please see appendix 1 for relevant graphs)
Brazil is the largest country in South America comprising half of its land mass and population. Its vast geographic expanse, cultural diversity and economic potential make it one of the most powerful and influential players in the “Latin” world. Brazil’s relations with its neighbors are cordial and there are no significant territorial disputes outstanding. An interesting fact about Brazil is that it is the only non-Spanish speaking country on the continent except for the Guyanas. Brazil is home to the biggest rainforest in the world, the Amazon. Brazil’s official GDP, is about $520 billion (approx. $650 billion including the informal sector), representing approximately 35% of the total Latin American GDP. However, its GDP per head is lower than that for other South American countries like Argentina, Uruguay and Chile. Brazil’s population of 165 million is unevenly distributed across the country. The south and south-east, including Rio de Janeiro and São Paulo, hold 58% of the population, the north-east 28% and the rest of the country including the huge Amazon region, only 14%. In terms of GDP per region, the imbalance is even larger, seeming more like two economies within one country. The south and south-east produce 74% of the domestic product while the north-east and the rest produce 13% and 13% respectively. Brazil’s current President, Fernando Henrique Cardoso, who was recently re-elected for a second term has been at the forefront of reforms in Brazil and so far has proved to be reasonably popular.
Reforms
There are some reforms commonly believed to be essential if Brazil is to start a high-growth development process, such as fiscal, tax, judicial, political, and pension system reforms. Starting with the implementation of the “Real” stabilization plan in the mid-90s, the Brazilian government has been taking some of these measures, including ending most state monopolies, which is linked to the privatization process.
As macroeconomic stability is achieved, the focus has shifted to other reforms. The past macroeconomic fluctuations forced companies to focus more on financial management than on real productivity. For example, the CFO of a large US multinational in Brazil conceded that during the January 1999 devaluation of the Real, most companies, including his, made lots of money on preventive hedges or speculative moves. If in contrast the focus were on real productivity, Brazil could have grown at rates of 6 to 8% a year. As a result, the reform process is integral to lifting Brazil from its abysmal growth rates of 1-2% a year, which just keeps pace with population growth. Further, the reforms could help Brazil double its per-capita GDP like Korea did between 1985 and 1995[1].
Following, we describe what is currently being done and what we believe should be done to position Brazil at the leading edge of the world’s developing economies.
Fiscal reform (Please see Appendix 2 for graphs on fiscal issues)
Fiscal budget equilibrium is key for maintaining the stability achieved in the past years, and the recently passed Fiscal Responsibility Bill reflects major improvements for Brazil. This bill establishes that only a maximum of 60% of state and 50% of the federal budget can be used for payroll. In fact, the law stipulates that the government can fire employees to achieve this number, which is unprecedented in Brazil. Additionally, there are restrictions on debt issuance and financial deficits as well as the onus of criminal responsibility for non-compliance.
In the past, state governments had their own commercial banks, which by issuing debt acted as pseudo central banks expanding the monetary base of the economy. Currently, these banks are being privatized, including Banespa, the state bank of Sao Paulo. All these measures make it very difficult for states to generate deficits, which in the past have created serious problems for the federal government. For example, a default in January 1999, by the rich state of Minas Gerais (led by Itamar Franco, an unscrupulous former president), triggered the devaluation of the Real. With the passing of the Fiscal Responsibility Law, the federal government will be unable to bail out state governments and therefore state debt issuance will be rated by the market independently.
The fact that this law has passed through both chambers, despite opposition from the municipal lobby, was, according to all our interviewees, an indicator of a high degree of political maturity in Brazil and something unthinkable in pre-reform times. Interestingly, support for macroeconomic stability has weighed more heavily than employment stability among the politicians’ constituencies. This process towards more responsible fiscal policies from political actors could, however, step back as some opposition parties now support a large increase in the minimum wage which would indirectly contribute to the government deficit, via their effect on pension payments.
Tax reform
The Brazilian tax system is characterized by a burdensome tax structure. All our interviewees agreed that dealing with an archaic tax system that includes over 50 different taxes was a large obstacle for doing business in Brazil. Further, inconsistent tax enforcement across different economic sectors generates huge distortions in the economy, which in turn hampers productivity growth. Tax evasion by small, informal firms enables them to match the lower cost structure of the larger, more productive firms. This provides the small firms with incentives to stay small and disorganized since growing larger would mean having to pay more taxes. This vicious cycle can only end if taxes are better enforced or when formal firms become so efficient that they can beat the “tax free” prices of the informal sector. In some sectors like construction and food retail, informal firms make up over 65% of the output[2]. This has the effect of making basic needs, like housing and food, more expensive for all Brazilians since smaller firms have a lower productivity.[3]
Another tax-related issue omnipresent in the interviews was the high profile competition between states to attract foreign companies. For a company that has already decided to invest hard assets in Brazil, the fact that regions compete with each other by offering subsidies only ends up creating a net transfer from the states to the company treasury.
Currently, the state and federal tax codes are being analyzed for ways to simplify enforcement and collection and to control the subsidies granted to foreign firms. Some proposals presented to congress include a rationalization of the complex system of indirect taxes and corporate social contributions.
For the reasons mentioned above, we believe tax reform and enforcement is critical for the development of Brazil. Basically, strong directives from the country’s leadership are critical to achieve these goals.
Pension system reform
The importance of this reform derives from the fact that social security deficit is around 3% of GDP, and constitutes a large portion of the government’s total deficit. (Here, it is worth mentioning that current reforms will generate further temporary deficits) Reforms approved in the last two years include a redesign of the pension system, including the setting of a minimum retirement age for public-sector workers and ceilings on benefits for private workers, and changes in methodologies for calculating benefits. Most of our interviewees were not very optimistic about these changes, and felt that in this sensitive area strong opposition from congressmen will delay reforms in the short term. If this is the case, then long term economic stability could prove harder to achieve.
Protection of legal rights; reform of judicial system
This is another critical reform on the government’s agenda. Protection of legal rights is certainly one of the critical determinants of investment, which in turn is key for Brazil’s economic development.
According to our interviewees, when contractual infrastructure is insufficient it is important to do business with people you know. The fact that the Brazilian judicial system has traditionally been very slow introduces many obstacles for economic development. A related problem is that in the past, different Brazilian governments acquired a reputation for disregarding contracts. For example, many economic plans launched in the last two decades to reduce budget deficits and tame inflation were accompanied by measures of freezing deposits from the public in the bank system, which ended up reducing their real value. The lack of initiative to address these problems could prove to be an obstacle for foreign and domestic investment. Currently, there is not an emphasis in solving them. We believe that these issues should be addressed immediately.
Brazil: Politics
The political environment in Brazil is an interesting dichotomy. Though presidential in nature, Brazilian politics exhibits all the possible ills of a multi-party parliamentary democracy. After the end of the military rule in the mid-eighties, Brazil's government believed that encouraging multiple parties would tremendously help in strengthening the fledgling roots of democracy in Brazil. Therefore, a multiparty federal system was instituted, bringing with it the evils of unstable governments, coalition politics and a notoriously slow reform system. A recurring theme during the visit to Brazil was the strong bi-polarization of Brazilian politics. On the one side were the reformists who support economic liberalization, cuts in government spending and privatization. The incumbent President Fernando Henrique Cardoso and his center right government spearheads this group. On the other side are the conservatives, who are publicly opposed to large changes in Brazil's economy and advocate a slower pace of reforms. The most prominent leader in this group is Lula, who himself was a blue-collar worker before entering politics. Although Lula and his party enjoys tremendous support not only among the poor but also among some relatively prosperous Brazilians (as evidenced by a visit to one of Lula's meetings), many Brazilians doubt that Lula could get elected. They additionally believe that even if elected, Lula would find it extremely hard to backtrack from the reforms already taking place in Brazil. Further, the general feeling among the Brazilian business community and population is that a populist President, like Chavez in Venezuela, is an impossibility in Brazil. Therefore, there does not seem to be any major threat to Brazil’s economy due to a potential change in political leadership. Instead, it is the nature of the Brazilian political structure and the inner struggle for power within the ruling coalition that Brazilian business fears could hinder economic growth in Brazil.
Problems and changes necessary
A major problem in Brazilian politics is “horse-trading”, a term used to describe the fact that in the Brazilian parliament over 50% of the legislators have changed their parties more than once. This process tremendously complicates the task of passing crucial bills and retards the effectiveness of the law-making system in Brazil. Interestingly, in Brazil it is not the parties that command loyalty, but rather the home states and the cross-party sectoral lobbies. Most members of congress are not reelected for a second term due to their failure to cater to the needs of regional politics. Thus, the lawmakers primary concern is getting a larger share of the total "Federal Pie" to their home state. The power of regional politics was recently seen when the governor of Minas Gerais, a prosperous state next to Rio de Janeiro, defaulted on its domestic obligations. Thus, the first key reform required in Brazilian politics is to better define the power of regional politics. In this regard various bills have been passed (e.g., Fiscal Responsibility Bill discussed previously) and some are currently pending in the Senate.
The second problem in the Brazilian political system is the disproportionately large weights given to states with small populations[4]. Consequently, in southern states like São Paulo, there is one congressman for approximately 300,000 voters, whereas in Acre there is one for every 40,000 voters. The southern population tends to be generally more "progressive" and reform minded. The northern and northeastern population is more rural and controlled by "pseudo-feudalistic" landlords, who use the political power from the faulty electoral system to bargain favors with the federal government. When this aspect is combined with the disproportional weights given to the economically lesser developed and rural states, a tremendous barrier is created for reforms and reform minded politicians. Sentiments of Brazilian leaders suggest that the education of the Brazilian population is key to alleviating political ills and increasing democratic benefits. In this regard, successive governments have tried to increase the quality and quantity of education in Brazil, and statistics show progress but not enough. Hence, as long as the general population is poorly educated, the tension between the reformists and the conservatives will mar Brazilian politics and could contribute to the cost of doing business in Brazil.
Another issue in Brazilian politics is related to government workers. Many Brazilian states use over 90% of their budget to pay their employees. Guaranteed employment “clauses” have made it impossible for states to fire their workers. Another more subtle reason was discovered during the meetings in Brazil. The government employees act as important vote banks and support pillars for the local politician who often depends on them for his political success. He is therefore unable / unwilling to lay off these employees. This problem is also being aggressively addressed by the passage of the fiscal responsibility bill that gives governors the power to downsize the employment in the public sector.
Additionally, Brazil is probably the only country in the world to combine a proportional representation system with an open list. Thus, voters vote for parties without the candidates being formally announced. This strongly weakens the party system as many candidates within a party stand against each other. In order to correct this and various other flaws in the political system that weaken the party structure, a bill was recently proposed in congress. This bill not only proposed a mixed electoral system, but also had clauses reforming the campaign process including requiring the legislators to vote along with the party whip. Even though this bill did not pass in its entirety, the public in Brazil has become more sensitive to such issues and a precedent has been set for other bills aiming to reform the political system in Brazil.