Economic Development - Why have we been left behind? (with 9 charts)

/ Fundação FHC auditorium

“There is a coincidence between us having been left behind and the redemocratization process. These two facts are linked; they are not random.”

Samuel Pessoa, economist and researcher at the Fundação Getulio Vargas Brazilian Institute of Economics (FGV-IBRE)

“Between 1973 and 1983, the drop in the product/capital ratio occurred in tandem with the import substitution policy. Like the Vargas Llosa character (in ‘Conversation in the Cathedral’), who said ‘Yo haría cualquier cosa por saber en qué momento me jodí’, the time when Brazil lost its way was the Geisel period (1979-83).”

Edmar Bacha, economist and director of the Institute of Studies in Political Economy /Casa das Garças (IEPE-CdG)

The two economists presented different but complementary answers to the question “Why have we been left behind?”, the title of this seminar organized by the Fundação FHC in partnership with Insper. In it they discussed the reasons why Brazil grew on average a little over 2% a year between 1982 and 2017, after having been one of the countries with the highest growth rates throughout the 20th century.

Bacha blamed the exacerbated statism of the Geisel government for rupturing Brazil’s long high-growth cycle. For the ex-president of the BNDES (Brazilian National Development Bank) and the IBGE (Brazilian Institute of Geography and Statistics) and a member of the economic team that formulated and implemented the Real Plan, the data show that the collapse in capital accumulation and the stagnation in productivity began in the second half of the 1970s, in the wake of the penultimate military president’s decision to stake everything on the closed economy model and heavy state intervention.

Whereas for the economist Samuel de Abreu Pessoa – professor in postgraduate level economics at the Fundação Getúlio Vargas in Rio de Janeiro (EPGE/FGV) and head of the Economic Growth Center at the Brazilian Institute of Economics (IBRE/FGV) -- the deceleration in growth is explained by the combination of already existing problems (high inequality, low investment in education, closed economy, etc.) with the difficulty the post-redemocratization political system had in resolving disputes for public funding in a manner compatible with more accelerated economic growth.

“I agree with nearly everything Edmar said”, said Pessoa, “but those distortions from the 1970s could have been eliminated, after all, it has been nearly 40 years. I am more concerned about understanding the social forces that have maintained these distortions and added others, resulting in mediocre growth in recent decades. I think it (the low growth) is more closely associated with the functionalities and dysfunctionalities of our democracy.”

While diverging on the diagnosis of the origin of low growth, the speakers converge in relation to the prescription of the “remedy””: increase productivity in the economy.

More than just a set of measures, Bacha proposed a strategy for tackling the problem.  

“There is no doubt that we have many issues to resolve, but if we tackle them all at the same time, we will not solve any of them”, he stated. “In the style of the economist Albert Hirschman (1915 to 2012), it is fundamental to define the strategy we need to follow and around which the other conditions necessary for growth should be aligned. I am convinced the main driver of growth for Brazil is a pre-announced commercial opening program based on three fundamental pillars to be implemented gradually over the four years (of the future government).”

“In practice the speakers converged. In Brazil we are seeing the beginning of a convergence around a diagnosis of what must be done about certain fundamental questions”, said Fernando Henrique Cardoso at the end of the event.

“Above all, the question is political. Will a leader emerge who is capable of explaining to the population, to the voters, what the benefits (of a policy of opening up the market and increasing economic productivity) will be? Differently from the time when inflation was out of control, I still do not feel that Brazilians are dramatically motivated to support the changes necessary to make the country grow faster. And, if we do not do what needs to be done now, the cost later on will be much higher”, the former president warned.

There follows a more detailed account and seven graphs showing the arguments presented by Samuel Pessoa and Edmar Bacha. The complete presentations made by the speakers are available In the section Conteúdos Relacionados (on the right of this page), as is a video recording of the debate (in Portuguese).

Upon beginning his presentation, Samuel Pessoa showed the table above, which provides information about the country’s average growth between 1982 and 2016, as well as in five specific periods which coincide approximately with the presidential terms of FHC, Lula and Dilma’s: between 1982 and 1993, in FHC’s two terms of office  (1994-2001) and in Lula’s two terms (2002-2010), in the first Dilma government (2011-2014), and from 2014 to 2016 (when the country experienced a recession, during the Dilma and Temer governments).

In the table, he emphasized two pieces of information: not only was economic growth low, 2.4% on average between 1982 and 2016, but also it was mostly due to population growth, in particular the economically active population. Productivity remained virtually stagnant.

The table leads to an inevitable conclusion. Given that the economically active population will not grow in the future as it has over recent decades, because Brazil is aging, growth will have to come from increased productivity.

After this, Pessoa presented the graph above which compares per capita GDP growth in Brazil with diverse other countries since 1985 (above). Brazilian per capita GDP grew below the world average and far below that of the leading Asian countries. Among the Latin American countries, only Chile presented high per capita GDP growth rates during the period in focus.

Pessoa  mentioned 10 factors which directly or indirectly jeopardize productivity and impede the accelerated growth of the Brazilian economy:

1. High and constantly growing public spending;

2. High tax burden;

3. Low aggregate savings;

4. Complex and high-cost labor legislation;

5. Deficient economic regulation, with fragile regulatory agencies;

6. Poor infrastructure;

7. Economy closed to international trade;

8. Expensive, slow and unpredictable judiciary system;

9. Low educational level;

10. Very small, informal and inefficient companies. 

He concentrated on the first factor: the continuous increase in public spending and, to finance it, in the tax load. According to the FGV professor, redemocratization in Brazil generated heavy pressures on the treasury, and the political system was incapable of arbitrating the dispute for public funds. The “easy” solution was to increase the tax load.

For Pessoa, this fiscal trajectory reflects a political reality: “Perhaps to avoid political crises and to preserve our new-born democracy, we began to generate countless mechanisms for redistributing income to the poorer classes, but also to the middle and even the wealthier ones. 

On the one hand, the politicians had to respond to the demands of the poorer citizens, who are the majority of the electorate. On the other, since society is very unequal, not only in terms of income distribution, but also in terms of power, the better organized groups, normally linked with the higher income sectors, maintained their capacity to guarantee fiscal, financial and tax benefits (exemptions and subsidized credit for companies, corporate privileges for certain civil service categories, etc.).

This generated growing fiscal pressure, which pushed the tax load to over 30% of GDP, making Brazil one of the median income countries with the highest tax loads. Notwithstanding this, public debt increased. The increase in public debt, in turn, put pressure on interest rates, making credit more expensive. High interest rates and a heavy tax load put a drag on growth.    

To illustrate the increase in spending on the poorer classes, the speaker presented the chart below, which shows the increase in federal government spending in the social area.

The biggest increase is in the INSS, the Brazilian social security system, and to a large extent reflects the policy of increasing the value the minimum salary during the FHC and Lula governments (70% of benefits are indexed to the minimum salary). On this question, Pessoa underscored: “In each of  FHC’s terms of office, the increase in the minimum salary was 20%, in real terms. In the two Lula governments, 25% and 22%, respectively. Therefore, it is not a trend attributable to one party or another, but rather a consequence of the redemocratization social contract”.

However, Pessoa indicated that not all the increase in social spending benefited the poorer classes. One case, for example, is the increased spending on higher education. In Brazil, per capita spending on higher education students, compared with spending on basic education, is much higher than in other countries, as is shown in the table below.

Where as the distribution of funds by the state to the wealthier segments Pessoa exemplified by presenting the following table, which shows BNDES disbursements (subsidized credit).It should be noted that large companies get more than 60% of the total.

For the FGV professor, the mechanisms of political equilibrium based on the distribution of public funds have been exhausted. It is no longer possible to carry on increasing public spending and the tax load, just as it is no longer possible to continue to expand public debt, which is close to 80% of GDP (it has increased by more than twenty percentage points since 2011). This political balancing mechanism is killing the country’s growth capacity. Without higher growth there is no solution for either the fiscal crisis or the social crisis.

The mechanism described by Pessoa enabled important, but insufficient social advances. On the other hand, it preserved privileges for corporations and sectors with greater political power. Pessoa warned that it is necessary for the country to put its public accounts in order without sacrificing the reduction in poverty and inequality agenda.   

At the end of his talk, he outlined one more optimistic and another more pessimistic scenario for Brazil.

Optimistic scenario:

Even with low growth, the democratic Brazil expanded coverage of social policies aimed at the poorer classes. Moreover, it developed an institutional framework which, in spite of sporadic crises, has been functioning, with free elections, separation of powers and Judicial independence, an active Public Attorney Service and freedom of the press, among other factors, favoring accountability, transparency, alternation in political power and growing social awareness of the problems that need to be tackled. Combating corruption and privileges has advanced and there is greater societal pressure for better use of public resources, greater efficiency in public services. Fiscal responsibility is also more highly valued by society.

The perfect storm which hit the country over the last four years could be considered to be an accident, explained by a rare and unfortunate combination of adversities (see “A malaise política no Brasil: causas reais e imaginárias”, by Marcus André Mello, published in October 2017 by the “Journal of Democracy em Português”).

Once the storm has been overcome, that advances obtained under the auspices of the 1988 Constitution (the strengthening of the Public Attorney service, for example) and the Real Plan (government commitment to low inflation) and the lessons learned from the recent crisis (importance of fiscal balance, predictability of rules in the economic game, general policies that create systemic benefits and not just for chosen sectors, greater integration with the global economy, etc.), all these factors should be strong enough to put the country on the path to higher growth with greater equality.  

Pessimistic scenario:

The recent economic crisis and growing political polarization, the weakening of parties, the strong corporatist reaction of diverse sectors of society in defense of their privileges, the increase in violence, the strengthening of organized crime are processes that have reached the point where they have become irreversible and determine the foreseeable future of the country. We have lost the capacity to reorganize public accounts and ensure an efficient state and to inspire trust in public authorities. The country is headed towards a situation of higher inflation, economic stagnation and growing risk to democracy and the rule of law.  

“Where are we headed? Will we be able to restore public accounts and resume growth, while at the same time maintaining an agenda of reduced inequality, or are we heading towards a complete disorganization (of the state and the economy)? Sincerely, I do not know the answer”, the FGV lecturer concluded.

Open the economy to escape from the ‘middle income trap’

Edmar Bacha showed greater confidence in the country’s future than Pessoa, but even so he painted a picture replete with major challenges. He started by showing the chart above which presents the evolution of Brazilian per capita GDP (in purchasing power parity) compared with the United States, from 1950 to 2014. “In 1950, our per capita GDP was equivalent to one fifth of that of the US. At the peak of the economic miracle (1980), it reached one third and since then, with the exception of the period of the commodity boom (2006 to 2010), it has gone downhill. In 2017, it was only 26%, one quarter of the US per capita GDP. What the hell happened?”, he asked.

Then, the former BNDES president asked permission to conduct an“excessively technocratic analysis” (“it won’t take long and it will be the only one this afternoon”) and presented a complex equation that shows that “the collapse of capital accumulation unfolded in conjunction with the drop in the capital/product ratio and the increase in the relative price of investment, while the savings rate, differently from what people think, did not vary much” (see the Conteúdos Relacionados section, on the right hand side of this page).

As if this was not enough, Bacha added, the cost of money in Brazil has become prohibitive for investment: “In the 2010, the real interest rate was 5.5%, while the average rate for a group of 34 countries was 0.2% (see the table above). In other words, the interest rate was sky high. In March of this year, 2018, the real interest rate is 2.7%, while both Turkey and Mexico have higher rates. This is an extraordinary advance, but the problem is that the bank spread in Brazil is around 20%, while in the rest of the world it is around 5% on average. Brazilian consumers and companies pay extraordinarily high interest”, the economist stated.

High cost of capital, heavy taxation, supply restricted by insufficient investment, markets protected against foreign competition, this set of factors makes Brazil a country with “surreal” prices. To exemplify this Bacha presented the graph above, which shows the difference in price of a Toyota Corolla and 1 minute of prepaid cellular telephone conversation in Brazil and other countries.

How to escape this vicious circle?       

According to Bacha, the 12 countries that were able to overcome the middle income trap after the Second World War, including Singapore, South Korea, Hong Kong, Israel and Taiwan, did it by opening up their economies to international trade. While the average income in Brazil is around US$ 15,000, in these 12 countries it is US$ 43,000 on average. Foreign trade represents 27% of our GDP, in those countries it accounts for 75%.

“Different from these 12 countries that progressed, Brazil is big, unequal and closed. I don’t know if it is possible to solve the problem of being big, unequal is also difficult, but closed, who knows, maybe we can do something”, said Bacha, for whom integration into global trade drives competition, brings in leading edge technology, and ensures scale and specialization in the areas in which the country is more competent.

Lastly, the Casa das Garças (a think tank based in Rio de Janeiro) director argued that the new government (to be elected in October this year) should implement a pre-announced program to open Brazil up over a 4-year period, underpinned by three independent pillars:

1. Reduction of the “Brazil Cost”, focused on tax reform and infrastructure concessions;

2. Reduction in tariffs and other restrictions on imported goods and services;

3. International trade agreements (prioritizing agreements with the EU and Japan, because these are where negotiations are most advanced).

Bacha recognized the importance of maintaining a competitive exchange rate so that the strategy of opening the economy functions. To alleviate pressures that could lead to an appreciation of the exchange rate, he advocated the hypothesis of establishing mechanisms to control inbound capital flows.       

“I really hope that, with the election of someone sensible in October, we can implement  this strategy next year”, Bacha concluded.

Further information:

Brasil, brasileiros: Por que somos assim? - Um diálogo entre Cristovam Buarque e FHC

Reforma Trabalhista: o que muda, o que deve mudar

Brasil: uma agenda de produtividade e de competitividade

Crescimento, Distribuição de renda e Democracia

It is also possible to watch the Web Dialogue Os Dilemas da Renovação da Política, conducted in partnership with the website Quebrando o Tabu and transmitted via Facebook, with Eduardo Jorge, Ilona Szabó de Carvalho and Pablo Ortellado.

Otávio Dias, journalist, is specialized in politics and international affairs. He was the correspondent for the Folha in London, editor of  the estadã website and chief editor of the Huffington Post in Brazil.

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