Charting new directions: - Alfred Herrhausen Gesellschaft

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18Charting new directions: Brazil’s role in a multi-polar worldA key factor for Brazil’s successin the past eight years has been apragmatic and responsible approach tomacroeconomic policyput more pressure on the Brazilian government toincrease the country’s international competitivenessthrough structural programmes or reforms. The listof usual suspects includes tax reform, financialdevelopment and better infrastructure, but it alsoincludes a more active role for the state in planningand coordinating large investment projects as well asstimulating research, development and innovation.Fiscal and macroeconomic challengesThe new Brazilian model combines economic growthwith a reduction in income inequality. The aim for the2011-14 period is to achieve an average annual GDPgrowth rate between five percent and six percent, sothat labour productivity and real wages keep growing,the middle class continues to expand, inflation remainson target and public finances continue to improve.There are two main challenges to this objective.First, to manage the growth of public spending in away that is consistent with fiscal stability and, at thesame time, consolidates the social safety net built inthe recent past and attends to new social demands.Second, to manage the growth of investment andconsumption in a way that sustains growth withoutaccelerating inflation and, at the same time, avoids asubstantial increase in the country’s current accountdeficit.Consider first the fiscal challenge. In general thetax revenues of the Brazilian government have beengrowing slightly faster than GDP in the past yearsbecause of the increase in per capita income andreduction in the share of informal markets in theeconomy. Since there are still unexplored gains tobe made by bringing more people and firms to theformal economy, it is reasonable to expect thatgovernment revenues will increase slightly fasterthan GDP in the next years. 1 In turn, this expectedgrowth in government revenues means that therewill be some space for tax cuts even while increasingsocial spending per capita. Key to this solution is thatthe Brazilian population is expected to grow 0.7%per year during this decade. For instance, if socialspending grows five percent in real terms every yearwhile GDP grows at 5.5%, there will be no additionalpressure on the government’s budget from socialprogrammes, but per capita social spending will stillincrease by 52% in 10 years. The main challengeto public spending is therefore more political thaneconomic: to manage the expansion in socialprogrammes in a way that is consistent with bothfiscal stability and people’s expectations.Moving to the macroeconomic balance, thegovernment simulations indicate an average annualGDP growth of 5.5% would require an increasein Brazil’s investment ratio from 19% in 2010 tosomething between 22% and 23% in 2014 to keepinflation stable. This result would require an averagegrowth rate of 10% in investment, which in turnmeans that consumption would have to grow slowerthan GDP in the near future in order for Brazil to avoidan excessive increase in its current account balance.But is the required growth rate in consumptionsocially acceptable? Again the question here seemsmore political than economic, since even a relativelyslower expansion in consumption would still increasethe per capita consumption substantially in the nextyear.To illustrate the previous point, a simplemacroeconomic exercise shows that Brazil canreach an investment ratio of 22.5% by 2014, with arelatively stable trade balance in goods and services1 The market estimates of the GDP-elasticity of government revenues range from 1.1 to 1.3.Building Brazil’s economic future | Nelson Barbosa
Charting new directions: Brazil’s role in a multi-polar world 19in terms of GDP, provided that the country maintainsan average annual growth rate of 5.5% for GDP, 10%for investment, and 4.5% for consumption. 2 In turn,the relatively slower growth in overall consumptionis consistent with an average expansion of fivepercent in private consumption and three percentin government consumption. 3 Considering theexpected growth in Brazilian population, an averageannual growth rate of five percent in consumptionmeans a cumulated increase of 18% in per capitaconsumption in just four years.Financial developmentIn addition to macroeconomic consistency, theexpansion in Brazil’s investment ratio also dependson financial development. In the past eight yearsmost of the domestic funding in investment hasbeen supplied by the federal government through itsdevelopment bank, the BNDES. Since this source offinance has a high fiscal cost because of Brazil’s highreal interest rate, it is necessary to develop privatesources of finance in domestic currency whilereducing the economy’s interest rate. This challengewould require three parallel actions.First, maintain fiscal and monetary stability, withrealistic inflation targets, to continue to reduceBrazil’s real interest rate. The obvious trade-off hereis that a fast reduction in inflation targets means aslow reduction in real interest rates and vice versa.Second, change financial regulation to adaptthe economy to a low inflation and low interestrate context, in particular by reducing interest-rateindexation in public debt and eliminating institutionalfloors to market interest rates. Here, the main tradeoffis between the long term gains of changing theterm and index structure of public debt and the shortrun cost of doing it.Third, improve financial supervision and regulationto expand long term finance for investment in fixedcapital and housing, while preventing speculativebubbles. The obvious trade-off here is between fastercredit expansion and stronger supervision.Commodities and manufacturing:finding a balanceBrazil has been a strong commodity-exportingeconomy throughout its history. Its abundant naturalresources give it natural advantages in the productionof agricultural and mineral commodities, whereas thenewly discovered oil reserves indicate commodityexports may become even more significant in thenear future. Despite this background in primaryproducts, Brazil has also been able to develop a largeand diversified industrial structure since the mid 20thcentury.The main reasons for this industrial developmentwere a set of nationalistic government policies andprogrammes dating back to the 1950s and, moreimportantly, the size of the Brazilian domesticmarket. In contrast to other commodity exportingeconomies, the size and scale of Brazil’s domesticmarket makes it possible for the country to buildcompetitive advantages through temporaryprograms of industrial or productive development.The key to success in this area is to devise a setof transparent policy instruments that is capable ofstimulating investment, research and development,while avoiding the creation or permanent protectionof inefficient production. In line with Rodrik’s analysisof industrial policy, it is more important to drop thelosers when that condition becomes clear than topick the winners when one does not know who theymight be. 4In the specific case of Brazil the challenge for thecoming years is use the extraordinary “profits” fromcommodity production, especially oil, to financeand stimulate the development and diversificationof the rest of the economy. The activities to be2 The “starting” conditions are an investment-ratio of 19% of GDP and a trade deficit in goods and services of one percent of GDP on 2010.3 To put these numbers in historical perspective, the average growth rate of private and government consumption in 2003-10 was 3.6% and 4.3%,respectively.4 See, Rodrik, D. (2010), “The Return of Industrial Policy”, available at: http://www.project-syndicate.org/commentary/rodrik42/English.Building Brazil’s economic future | Nelson Barbosa
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