Brazil: The Challenges Ahead
Whoever wins the Brazilian presidential election on Sunday, October 28, will face tremendous challenges. The economy is in depression, the unemployment rate is in the double digits, and the fiscal situation is bleak. A sharp polarization has characterized the election campaign. The disapproval of each of the two leading candidates is higher than the support they get from the electorate. In the years to come, the political uncertainties and economic doldrums might not go away.
Public corruption scandals have led to political chaos. Former President Luiz Inácio "Lula" da Silva of the socialist Workers' Party is in prison because of corruption. His successor, Dilma Rousseff, continued Lula's populist agenda but was impeached and removed from office.
Michel Temer, who followed her in the presidency, has never gained popular support. He has been unable to consolidate the country’s public finances or revive the economy. A heavy burden will fall on the next president when he takes over the helm on January 1, 2019.
Much Potential, Little Accomplishment
Brazil is the largest country in South America with a size like that of the United States without Alaska. The country has a population of 207 million, and in terms of gross domestic product, its economy ranks number eight. The author Stefan Zweig called Brazil a land of the future, while cynics added that it always will be. Throughout its history, Brazil has experienced a series of spurts of growth, all of which ended in prolonged stagnation. This has also recently happened. After a period of high growth rates and much exuberance in the decade from 2002 to 2012, the economy fell into an ongoing deep recession.
Brazil suffers from many political barriers that stifle its economic progress. The country’s bureaucracy is the main force of obstruction along with its judicial system. Brazil’s political leadership enjoys the dubious privilege that, because of Brazil’s immense natural wealth and its favorable overall geographic conditions, they do not get much punished even when they make severe blunders. Many incompetent and corrupt politicians enjoy frequent reelections.
Brazil’s economic progress suffers from the country’s flirtation with the welfare state that came with the new constitution of 1988 after the country had shed the military dictatorship of 1964 to 1985. Brazil’s democracy has fallen victim to a process of competition in social handouts. The political game requires an endless process of coalition making, with each of the individual political parties expecting a special treatment for their clientele as the price of supporting the government.
Brazil’s integration into the world economy comes through the country’s wealth of natural resources. During commodity booms, Brazil’s currency is overvalued, and when the boom is over, its industry often lies in tatters. As for everything other than natural resources, Brazil’s international competitiveness is weak. Domestic industry speaks loudly in demanding protectionism.
Brazil’s governments follow a tradition of focusing on the short term and neglecting structural reforms. All knowledgeable observers agree about the fundamental challenges. Yet a kind of paralysis keeps the Brazilian government from addressing the fundamental deficiencies of the country in infrastructure, innovation, and education.
Obstacles to Development
There are many problems that inhibit the Brazilian economy from achieving steady economic growth. These problems go beyond short-term macroeconomic management. Brazil is a country notorious for its intricate web of irrational regulations, its complicated tax structure, its overly powerful judicial system, its vast bureaucratic inefficiencies, and corruption at all levels. These are nightmares for those doing business in Brazil. There has been a profound negligence of basic education, and widespread professional incompetence spreads throughout the whole society. The result is a low level of productivity, even by Latin American standards (see figure).
A lack of capital formation results from a low savings rate. Low productivity and innovation characterize Brazilian businesses. Private companies spend little on research and development. There is a huge governmental apparatus in place, which should promote scientific progress but works as a bureaucratic web and hampers more than it promotes innovation. Instead of doing away with these burdens, the Brazilian government prefers monetary stimuli, implements ad hoc interventionist measures, and leads a confusing public discourse about utopian plans and fantastic measures.
The deplorable macroeconomic condition of Brazil — with insufficient savings and a weak industrial base — comes with a rotten political system and Brazil’s heavy bureaucracy. Brazil’s public administration is a gigantic apparatus that holds down the country’s economy with a myriad of useless and senseless regulations and their foolish execution. Brazilian bureaucracy represents a major blockade to economic modernization. Brazil has one large macroeconomic bottleneck — lack of savings — and it has a large structural hole where the country’s energy evaporates in the form of over-regulation of its economy.
The country’s leadership has never abandoned the corporatist development model of the 1930s. The result is that Brazil has a large but inefficient industrial sector ranging from vehicles and small airplanes to agricultural machinery and chemicals. Yet these industries are sleeping giants limited in flexibility and innovation because of a tight web of governmental regulations and direct interventions.
Paths to Prosperity
It is not enough for Brazil to consolidate its macroeconomic policy. To advance its economy, the country needs to take serious steps toward better governance. As of now, however, not only have the governments of the past been doing little to improve governance, but there also has been a lack of understanding about the urgency and importance of fundamental reforms.
With more privatization and deregulation, huge investment opportunities would emerge on the horizon. The development of Brazil's gigantic agricultural potential has only just begun. Beyond that, there is the need for privatization and deregulation in infrastructure. Everything from ports and airports to the road system offers tremendous opportunities. With the help of foreign direct investment, Brazil’s metal-mechanical sector could be brought to a world-class level, as is also the case with the country’s food-processing, pharmaceuticals, and chemicals industries. All it would take for this to happen is to take some courageous steps toward de-bureaucratization; Brazil could emerge as the economic miracle of the 21st century.
State of the Economy
Brazil’s economic freedom score is 51.4 according to the index of the Heritage Foundation. With this score, Brazil ranks as the 153rd freest country in the 2018 index and falls into the category of “mostly unfree.” It ranks 27th among the 32 countries of its region, and its overall score is below the world average (see table).
The judiciary, although independent in a formal sense, is overburdened with lawsuits. Inconsistent and imprecise legislation makes judicial processes uncertain, protracted, and subject to special-interest influences. Corruption has become an integral part of political life. Only with the recent judicial actions and convictions of prominent politicians, the former President Lula da Silva among them, has a signal been sent to elected officials that bribery will no longer be tolerated.
Despite a high tax burden, the fiscal situation of the country has deteriorated. The budget deficit reached over 10 percent in 2015 and stands at 7.8 percent in 2018. From around 50 percent in 2010 and 2013, the ratio of public debt to gross domestic product climbed to 70 percent in 2016 and stands now at 74 percent.
The personal income tax rate is 27.5 percent while the standard corporate rate is 15 percent, but specific transaction taxes lift the effective rate to 34 percent. The overall tax burden equals 32.0 percent of total domestic income. The effective tax burden is much harsher than the numbers suggest because of the complex and contradictory tax code. Many companies use the lack of simplicity to enter legal disputes, which then may last for decades.
While salaries are low by international standards, the economy is burdened with a heavy load of non-salary labor costs, business-unfriendly labor laws, and a judiciary biased against private enterprise and in the hands of the trade unions.
The low labor productivity is only in part the result of the low quality of the labor force. The bureaucracy, the poor infrastructure, rigid labor laws, many non-tariff trade barriers, the complex tax code, and a plethora of diffuse regulatory requirements stifle economic efficiency.
Conclusion
In order to put the Brazilian economy back on track, economic policy must move forward with key reforms. The Brazilian government should recognize that the country must improve its infrastructure and its system of education. It is high time to deregulate the labor market and to cut red tape. The country must end the horrendous privileges and absurd salaries in the public sector and in the judiciary. Brazil must adapt its pension system to the conditions of the future, as Brazil faces an aging population.
To improve its position in the world economy, it is not enough for Brazil to consolidate its macroeconomic policy. Brazil needs to take serious steps toward better governance. The governments of the past have done little to improve the workings of the political system. There has been a lack of understanding about the urgency and the importance of fundamental reforms. Future governments must end this negligence.
The next government has much to accomplish. Yet it is not impossible. Most of the reforms do not require new laws, new institutions, and much higher spending. On the contrary: what must be done is to cut many of the superfluous items of public expenditure, eliminate the many harmful regulations, and scale down the bureaucracy. Improving the infrastructure does not require new massive spending, but a better administration, effective cost control, and ending corruption.
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