Brazil was booming when it won the right to host the Olympics. But as the Games begin it is suffering its worst economic crisis in living memory. What went wrong?by George Magnus / July 14, 2016 / Leave a comment
When President Dilma Rousseff lit the Olympic torch in May at the presidential palace in Brasília, the capital of Brazil, to the cheers of schoolchildren and the sound of Air Force jets flying past, the opening of the Rio Games felt tantalisingly close. Yet less than two weeks later, after a 20-hour debate, the Brazilian Senate voted to bring impeachment proceedings against Rousseff. She was immediately suspended from office for six months. The overwhelming Senate vote (55 votes to 22 in favour of opening proceedings) suggests that when the impeachment vote is finally called, the requisite two-thirds majority will force her permanently from office. Her one-time coalition partner, Michel Temer of the Brazilian Democratic Movement Party, now acting President, will then take office until the next scheduled elections in 2018. It will fall to him to steer the nation through not only a constitutional crisis, but also a grinding economic crisis: Brazil is now going through its deepest recession since records began at the start of the last century.
How did it come to this? Only seven years ago, the Olympic games were awarded to Rio as a sort of exclamation mark on Brazil’s economic success and self-confidence. But now the country’s economy is broken, already 9 per cent smaller than at its peak in early 2014, even though it isn’t at war and there is no financial crisis, run-away inflation or any other large external factor. Brazil went through a 15-year boom driven by high commodity prices and plentiful credit. That boom is now over and deep-seated economic weaknesses have become visible. The amount of money that Brazilians save is 14 per cent of GDP—that’s not enough. The amount they invest is about 17 per cent of GDP—again, that’s not enough. Its emerging market peers such as China and India have savings and investment rates two to three times that size. Although Brazil’s banks are in good shape, the country boasts successful retailing companies and Brazilian aerospace conglomerate Embraer battles for the title of the world’s third largest aircraft manufacturer, much of Brazil’s corporate universe is mired in cumbersome regulatory and tax arrangements. The country suffers from insufficient infrastructure, low integration into the world trading system, shortages of skilled workers and low productivity growth.
It’s often said that, “Brazil is the country of the future and always will be,” a cutting assessment behind which lurks a nasty economic reality. Brazil has become an economic case study for what it means to become stuck in the middle-income trap: that stage in economic development where the increase in income per head stalls. It is sobering to think that Brazil is one of many countries stuck in this trap. For a few years in the 2000s and until 2012, it looked poised to escape. But in reality little progress had been made in altering the country’s economic and political structure. According to a 2013 World Bank report, 101 countries were classed as middle-income in 1960. Of these, only 13 were high-income by 2008, including South Korea, Taiwan, Singapore and Hong Kong, as well as Greece, Ireland, Spain, Portugal and Israel. The intriguing question is why Brazil has been unable to make the same leap to success.
Brazil is no stranger to political and economic volatility. In 1964, a military coup overthrew the Labour Party government of President João Goulart and put the generals in charge for just over 20 years. A federal constitution enshrining democratic rule was adopted in 1988. The transition to democracy, however, was complicated by a flawed democratic model, and by protected vested interests that stifled social and economic progress.
Rousseff’s Partido dos Trabalhadores (PT) or Workers’ Party, which came to power in 2003, tried to cut through this tangled legacy. It developed the Bolsa Família or “family allowance,” which the World Bank has called one of the most successful anti-poverty programmes ever implemented. Under the scheme, poor families were given payments for each child who was fully vaccinated and attending school. The money was predominantly paid to female heads of household, and by 2008 it had started to reduce the poverty and drug-related violence that had become notorious in its favelas or urban slums. Earlier this year, I visited Rocinha, Brazil’s largest favela with a population of around 200,000, which is located on the steep verdant slopes to the south of Rio de Janeiro. Our guide kept us well away from the drug gangs but, even so, there was no hiding the overcrowded living conditions, low-quality housing and mass of exposed telephone and electrical cables. Yet there were also welcoming smiles, normal commercial life, people commuting to jobs in downtown Rio, modern banks without obvious security, new public welfare and leisure facilities—as well as posters pledging support for Rousseff.
Despite the social improvements for which the PT can take credit, it failed in the end to distinguish itself from its rivals as a clean political party—a shortcoming that has cost it dearly. This is not least because of the political system itself. Many countries, including India and Italy, have a proliferation of parties. In Brazil, though, there are 32 registered parties, 28 of which are represented in the legislature. As a result, Brazilian presidents rarely dominate: the PT, for example, has only 11 out of 81 seats in the Senate. Intense competition for votes has led to pork-barrel politics, where governments make generous concessions to legislators’ pet projects in return for their votes. Fragmented politics have left many voters anxious about corruption and poor representation. The biggest ever street protests in Rio and São Paolo took place in June 2013, and they quickly spread to Brasília and other cities. The demonstrations were ostensibly about higher public transport charges, but the two million protestors soon shifted their focus to poor public services, inflation, the exorbitant cost of building Olympic stadiums, political corruption and the remoteness of political parties.
It is understandable that Brazilians feel cut off from their political system. Brazilian corporations have become the dominant source of funding for political parties and election campaigns, while political spending has risen relentlessly. According to a recent report from the Organisation for Economic Co-operation and Development (OECD), corporate donations finance 75 per cent of Brazil’s state and national election campaigns.
In 2015, the Supreme Court banned corporate donations to candidates and political parties. Yet the damage is proving hard to undo. In 2005, the so-called Mensalão (big monthly payment) scandal brought to light the illegal use of campaign finances. President Luiz Inácio Lula da Silva, more commonly known as Lula, survived politically, but some of his colleagues did not.
The current anti-corruption investigation, which has engulfed Rousseff, began in 2013 as a low-level enquiry into money laundering at petrol stations and laundries in the southern state of Parana—hence the name of the police investigation, Lava Jato, or car wash. The inquiry centres on allegations of wrongdoing at Petrobras, the state-owned oil company, and has implicated senior politicians and other public figures. It is the scandal that has fuelled the current crisis, a crisis in which businesses spending and investment have ground to a halt, intensifying the worst economic crisis anyone can recall.
Brazil has run into economic crises many times in the past. During the 1970s, the price of commodities rose and delivered a decade of high growth for the country. Brazil borrowed heavily from overseas in the 1980s to finance industrialisation, and to pay for the oil it needed to propel its expansion. In the early 1990s, persistently high inflation developed into hyperinflation of 2,000-3,000 per cent. In the last 30 years, Brazil has experienced crises brought about by government spending and other factors, which have forced it to seek assistance from the International Monetary Fund (IMF) three times: during the Latin American debt crisis of the 1980s; after the Asian crisis in 1997; and once again in 2002. Some analysts argue that it must do so again now.
Sustained economic growth has been rare, but it did happen in the 2000s, following economic and political reforms introduced by President Fernando Henrique Cardoso between 1995 and 2002. Under Lula, economic growth was about 4 per cent per year, while under Rousseff, whom he picked to succeed him, it remained at roughly 3 per cent annually between 2011-2014. Rousseff won a second term in October 2014, though by that time the corruption investigations were spreading quickly, interfering with political processes and restraining the economy. In a mirror image of the 2000s, the Brazilian economy was being choked by the collapse in commodity prices and the end of the credit boom.
Brazil got a boost from the economic upturn in China, which took off in 2000-01. The surge in China’s investment in heavy industry and property sucked in imports of industrial commodities, such as iron ore, which figure prominently in Brazil’s exports. Brazil’s trade with China grew from $1bn in 2001 to $85bn in 2014, with China supplanting the United States as Brazil’s biggest trade partner. Other important commodity exports include soybeans, of which China has become a net importer, as well as sugar, beef, tobacco and orange juice. As prices soared, the share of commodities in Brazil’s exports increased from less than a third in 2001 to about a half in 2014. By contrast, the share of manufactured goods dropped from 55 to below 40 per cent. The China boom, however, is now over. Because China is building much less its need for commodities has decreased. If Chinese growth were to slide further—which is likely—the knock-on effects for Brazil and other emerging countries would be significant.
In addition to the problem of commodity dependence, Brazil’s economy is not as open as other emerging markets. Openness to trade and integration into the global trading system are key factors in the successful development of manufacturing and high productivity and economic growth. Brazil’s exports of goods and services are only about 11.5 per cent of GDP, which according to the United Nations is about the same as Argentina. By contrast, Mexico and Chile have an export share of about 33 per cent, while China and India have shares of about 23 per cent.
During the last decade, Brazil also developed an addiction to credit, much like western economies during the 2000s, and China more recently. According to Fitch, the credit rating agency, credit held by the private sector rose from an amount equal to 25 per cent of GDP to about 70 per cent in 2015. This level is twice that in Mexico and its effects have been exacerbated by high interest rates that make servicing the debt painful—in July 2015, the Brazilian central bank raised its benchmark Selic rate (short-term interest rate) to 14.25 per cent, where it has remained ever since. The recession is cutting away at profits and wages, making debt even less affordable for companies and individuals. In the household sector, the cost of servicing debt, including mortgages, eats up over a fifth of disposable income.
Brazil’s public sector has also become more indebted. Public debt has risen from 55 per cent of GDP in 2011 to about 70 per cent. The budget deficit, which was kept at roughly 2-3 per cent of GDP until 2013, reached over 10 per cent in 2015. Trimming the deficit in a recession is always politically difficult and economically painful, though Rousseff did lower unemployment insurance and other benefits, and raise some taxes and charges, including on fuel, water and electricity. The new government of acting President Temer faces a big challenge in changing fiscal policy: large areas of expenditure are protected either by the constitution or legislation. The pension system alone accounts for just over 11.5 per cent of GDP, significantly higher than in Japan (10 per cent) or the rapidly-ageing OECD area (8 per cent).
“During the last decade Brazil developed an addiction to credit, not unlike western economies during the 2000s”
Amid all these problems, the success of the Bolsa Família anti-poverty programme stands out. According to the World Bank, it cost about 0.5 per cent of GDP, and has raised infant survival rates, school enrolment, literacy and attendance levels, participation in vaccinations, nutrition standards and consumption. Over the decade to 2011, 40m people were lifted out of poverty, income inequality measures fell sharply, and household income per head of population rose by over a quarter. Several countries, especially in Latin America, have already adopted the Bolsa Família or are experimenting with variants.
Since the financial crisis in 2008, economic recovery in western countries has been weak, and since 2011, emerging markets, which many insisted would help to drive global growth, have lapsed. Among the so-called “Brics” economies—Brazil, Russia, India, China and South Africa—only India is growing at a relatively high, sustainable rate. The reasons for the economic misfortunes of advanced and emerging economies are complex. While some transcend national boundaries, many are not uniform across countries and regions. Brazil’s crisis, though, does suggest a few things the rest of the world should note.
First, an open and diversified trading system, with a focus on manufactured goods, is not only how low-income countries catch up, but how middle-income countries keep going. Geography is important: it helps to be physically close to large markets and supply chains. Brazil does manufacture high-value products but its commodity focus became too big, and its trade intensity is much less than that of China, India, Mexico and even Peru. Nowadays, with world trade stagnant, and most emerging and developing countries experiencing weaker exports, Bangladesh, Cambodia and Vietnam stand out as examples of countries that are bucking the trend. They are developing the low-value manufacturing that’s needed to build the trade surpluses that pay for capital goods imports. Some countries in east Africa, for example, Kenya, Tanzania and Rwanda are also achieving this.
Second, it is very hard for countries to expand at a sustainable rate and generate the productivity that drives rising living standards if savings and investment rates are as low as they are in Brazil. High income nations tend to have lower saving and investment rates, but in emerging countries, high investment rates are essential for economic development and for higher productivity and prosperity. China has taken this to an extreme and over-invested, uncommercially, in real estate and heavy industry, but Brazil is at the other end of the spectrum.
Third, an excessive reliance on commodity exports does not lead to durable economic success. In the last 60 years we have only had two commodity price booms: in the 1970s and in the 2000s. Both were followed by a bust. When that happens, the distortions created by that dependence are laid bare, as we can see in countries across South America, in Africa, and even in low-population, oil-producing countries such as Saudi Arabia.
Fourth, and perhaps most importantly, emerging economies have failed to develop the strong institutions that are key to achieving sustainable productivity growth. Brazil is a case in point, but this applies to China and India, just as it does to Greece, Italy and even the US and UK. If Brazil is to break out of the middle-income trap, it needs those institutions. The quality of nations’ institutions are monitored by bodies including Transparency International’s Corruption Perceptions Index, the World Bank’s Doing Business Index, and the Fraser Institute’s Economic Freedom of the World Index. These rank countries according to the independence of the judiciary, the degree of contract enforcement, the fairness of electoral politics, and labour, business and financial regulation. They also assess education, healthcare and social institutions. In 2015, the World Bank’s Doing Business Index ranked Brazil 116 out of 189 countries, lower than China (90) Saudi Arabia (49) and Russia (51).
The example of Brazil shows that the veneer of economic growth and prosperity can disintegrate easily. In the western world, we found this out with dramatic consequences only a few years ago. Brazil reminds us that the key to sustainable gains in economic and social welfare lies in the endless task of having a worldly, rather than isolationist, view, implementing sensible politics, and in nurturing the civil institutions without which no modern successful country can hope to function. The implication for the rest of the world is that weak or fractious economic conditions are not all about bad luck.