South America’s economic star cannot live by commodities aloneby Jim O Neill / April 24, 2012 / Leave a comment
Published in May 2012 issue of Prospect Magazine
Crowding out: government money still discourages Brazil’s private investors
Along with the other “Bric” nations —Russia, India and China—Brazil is showing signs that its post-2008 economic rebound is slowing down. This raises questions about its ability to generate persistently strong growth. Investors should take note. Complete data for 2011 showed that the economy expanded by around 2.7 per cent in real terms, a number considerably weaker than the previous year’s 7.5 per cent and not especially different from the growth rates typically enjoyed by many developed economies, especially before the crisis. This evidence has led observers to wonder whether Brazil has reached the limits of its popular status as a Bric, and that we should no longer assume overarching growth rates. A more sober picture has developed, reflecting Brazil’s vulnerability to the so-called Dutch disease—where nations rich in natural resources suffer a corresponding decline in their manufacturing sector. Certainly, last year’s “disappointment” is partially due to the weakness of manufacturing activity, which appears to be being subdued by the impact of the very strong performance of Brazil’s currency, the real. This development is, at least partially, related to the strength of global commodity prices. In my judgement, Brazil’s short-term dilemmas are compounded by the fact that in the wake of the 2008 crisis, the government chose to boost its own spending. While helping to limit the effects of the consequences of the global crisis, added to the challenges facing the central bank in reaching its mandated inflation target. In this sense, Brazil faced two simultaneous “shocks”: first, the problems arising from increased commodity prices; and second, the clash of higher interest rates with generous government spending. At a time of exceptionally low nominal interest rates throughout the G7 world, high Brazilian interest rates, especially when adjusted for inflation, have stood out as a very compelling attraction to investors around the world. In order to deal with this cyclical and structural challenge, it is important that policymakers think carefully about their spending policy. I believe that the Brazilian government should tighten fiscal policy even further than it has suggested, to allow interest rates to decline. This would lessen the attractions of the real and help to lessen its excessive, damaging strength. It would also ensure that the inflationary consequences of any currency decline would be modest. On top of this, the tightening of government spending would reduce any “crowding out” of the domestic private sector, whereby government money leaves no room for private investment. This would allow the non-commodity industries in particular a chance to develop momentum. Such steps would be especially necessary if commodity prices were to reverse course and decline sharply. While this currently seems unlikely, it would be naïve to assume it won’t occur. Indeed, it may happen sooner rather than later, especially if the Chinese authorities persist with their apparent new-found resolve to slow down their economy deliberately and enter a new phase based on higher quality—as opposed to just a high quantity—of growth. In such a scenario, heavy energy polluting and other industries will be constrained. Brazil’s very diverse commodity richness probably allows it more flexibility in this regard than perhaps some other well-known commodity-producing economies, but there will inevitably be consequences. If China were to face a “hard landing” [see previous article] in which the policymakers found it impossible to stop a major slowing of the economy, then the consequences for all global commodities and commodity-producing countries would be negative. Making Brazil’s growth sustainable must involve reducing its vulnerability to any external shocks that might influence commodity demand and prices. Brazil is endowed with a large and relatively young population, and this generation has had its outlook dramatically changed by the past decade’s low and stable inflation. This is a contrast with the previous 30 years of repeated bouts of hyperinflation that made it impossible for individuals to plan, save or invest. By concentrating on keeping inflation low and stable, in many ways Brazil is emerging as a new nation. The fruits of these developments have not yet manifested themselves, but if they are to be fully exploited, the authorities should allow the private sector more room to develop and in particular to boost both its savings rates and investment capacity. Lower nominal interest rates (and especially lower real interest rates) would be extremely helpful in this regard, and would also probably encourage greater foreign direct investment into the country. Brazil has enjoyed an excellent first decade as a Bric nation, and in many ways it has been the most positive surprise of those countries. Looking back, it has confounded so many of those people who advised me not to think about its chances in such exalted company. As I have demonstrated with my colleagues, by 2050 Brazil has the potential to be an economy with an annual GDP of close to $10 trillion. Although this will not take it to the same levels that are projected for China or India, and of course the United States, it could very easily become the fourth largest economy in the world. In order to achieve this, some decisions in this second decade as a Bric will be crucial. Above all, Brazil must reduce its exposure to changes in commodity prices and patterns of global demand—this volatility is coming. Brazil must prepare, or risk losing out.