November 26, 2014
Brazil in the doldrums
Global difficulties, incompetent policies and misfortunes are the roots of the present gloomy economic situation
RIO DE JANEIRO — Brazil’s real gross domestic product (GDP) in 2013 grew by 2.3 percent, following rates of 2.7 percent and one percent in 2012 and 2011 respectively. Perspectives for 2014 on this front are not optimistic.
Meanwhile, annual inflation has remained stubbornly high, at around six percent, and the balance of payments position has been less than comfortable, with increasing deficits being recorded in its current account (exports of goods and services minus imports).
The silver lining comes in the labour market, where not only practically full employment has been maintained, but the quality of jobs seems to be holding up, with workers shifting from the informal to the formal markets, where they qualify for benefits such as unemployment compensation and pensions.
Only a few years ago, together with its BRICS partners (Russia, India, China and South Africa), the Brazilian economy was hailed as the new frontier of growth in the international arena. Today, gloomy projections are routinely issued by international institutions and domestic expectations seem to remain subdued. What could possibly have happened to change the picture so dramatically in such a short time?
The roots of the present economic situation seem to be a complex combination of international difficulties, not-so-competent policy-making and random misfortunes. In addition, recent political evolution has contributed to complicate matters even more.
Taking each factor at a time, the most visible difference with the performance of the Brazilian economy during current President Dilma Rousseff’s first term of office relates to the international environment. During President Lula da Silva’s second term (2007-2011), the Brazilian economy benefited from tail winds represented mostly by strong Chinese demand for raw materials and agricultural goods, which not only helped the country to maintain a comfortable position in its balance of payments but also pushed its domestic economy strongly upwards.
This era seems to be over, given the publicly expressed concerns of the current Chinese government to cool and reform its own economy. The cooling of exports growth has helped to highlight one “structural” problem of the Brazilian economy, particularly strong after high inflation was defeated in 1994.
Since that time, with short intervals in which the trend was temporarily broken, an overvalued domestic currency has been perhaps the most powerful tool to keep inflation under control. The possibility of importing goods at prices made low by a strong domestic currency not only provided domestic markets with cheap goods but also scared local producers into avoiding raising their prices and losing their markets to imports, a force particularly strong in the manufacturing sector.
This means that since the Real Plan in 1994, Brazil has been captured by a dilemma: inflation can be kept low by overvaluing the domestic currency or manufacturing growth can be sped up by devaluing the currency, but one does not know how to achieve both. As a result, the Brazilian economy has been plagued by periods of intense “deindustrialization” (when the currency is overvalued) or by inflationary pressures (when the currency is devalued).
While the Chinese economy was growing fast enough to carry raw materials exporters like Brazil, overall growth could be kept by substituting growth of exports for growth of manufacturing. But the recent deceleration of Chinese growth has made the dilemma faced by the Brazilian economy explicit.
The strong dependence of the international economy has been a major feature of the last twenty years and the weakening of international trade has made the limitations that define current policy-making more dramatic than ever. Unable to change the terms of the trade-off opposing a higher inflation rate (by allowing steeper currency devaluations) to higher growth rates, particularly of the manufacturing sector (by allowing the real to get stronger), Rousseff’s government has appealed to ad hoc policies that not only have not had the expected effect but, on the contrary, have created new problems.
As an example, unable to implement a coherent exchange rate policy to stimulate domestic manufacture, the government has conceded targeted fiscal relief to selected sectors. This strategy, if one can call it that, is of very limited efficiency. Benefits are temporary, generally given to help sectors to go through difficult periods. They do not signal market priorities, they just help some firms to get by. They cause state revenues to fall but do not stimulate investments or expansion of production. Businessmen learn that it may be more profitable to lobby for favours than to invest and increase productivity. The fall in revenues leads to increased political pressure from believers in “austerity”, often forcing the government to cut other expenditures. Necessary public investment is always the adjustment variable.
The inability to define strategies to insert the Brazilian economy in a world economy going through deep changes has been a permanent feature of post-democratization governments and it may be partly due to the realities created by the way the political system was reconstructed after the military went back to the barracks.
Finally, one has also to acknowledge that bad luck has also had a hand. Bad weather, in the form of a particularly nasty drought, has affected the production of food and the generation of electric power, in a country where hydropower is by far the most important source of electricity. This has not only kept inflation pressures up but has also clouded the future, making firms even warier of investing.
In sum, it is not a comfortable time for the Brazilian economy. That important elections are also coming up in October this year does not help because the political debate tends to polarize, so that nobody expects important decisions to be made this year. This means that things should not improve significantly before 2015 at the earliest.