Although the recent degradation of the Brazilian economy was not the product of a single presidential term, it was during the first mandate of president Dilma Rousseff (2011-2014), and under her direct responsibility, together with that of her main economic advisors, that the Brazilian economy underwent a consistent, irrepressible and fatal descent into the abyss of its worst economic recession in 80 years, with a mega destruction of wealth never seen before in the economic history of Brazil. The definitive deformation of the economic situation took a little longer, but the essential and decisive strikes that were at the origin of Brazil’s loss of its investment grade status – announced first by Standard & Poor’s in September 2015, shortly thereafter by Fitch – were mainly inflicted during her first term in office. She deliberately planned and prepared the changes and completed them in less than four years.
The president and her economic team were the authors of a strange animal called the “New Economic Matrix”, conceived with the objective of sustaining an enlarged demand for consumption goods, as part of a promised “vast domestic mass market”. What it provoked, instead, was more inflation, less growth, worrying double deficits, a significant exchange devaluation, a total budget disorganization, together with an entire series of failed sectorial policies and an overall degradation of economic governance. The troublemakers blamed these consequences on an inexistent “international crisis,” but they were entirely made in Brazil.
To understand how this happened, and explain how Brazil underperformed in the context of the world economy, at a time when many emerging economies were growing twice or almost three times as fast as the advanced countries, we have to look at the larger picture, with a certain sense of the historical perspective, taking also into account the regional and international contexts, and the political and social implications of Brazil’s economic policies implemented in recent times. The solution of the current crisis, which is certainly the worst since the early 1990s, and probably since the 1930s, cannot be purely economic. Nor can it wait on the resolution of an alleged international crisis. Fundamental changes in Brazilian governance will be needed.
A brief economic history of a mounting disaster
Brazil has not experienced an equivalent economic disaster since the great crash of 1929 and the following recession of 1931 and 1932. Certainly, Brazil experienced many smaller crises, some provoked by external transactions disequilibrium and a rapid exchange deterioration, others by accelerating inflation and disorganization of the public accounts. Turbulence was recorded during the oil shocks of the seventies, and an humiliating penury of exchange followed the external debt default at the beginning of the eighties, as well as the moratorium unilaterally declared in 1987, creating a prolonged low growth period that was not surmounted before the hard renegotiation of the commercial and official debts during the first three years of the nineties. Successive adoption of six currencies attempted to ameliorate the dramatic acceleration of the inflation, until the Real Plan (1994) came to reintroduce a certain sense of rationality into a system of political and economic governance that had forced Brazil to seek rescue from the IMF three times between 1998 and 2002.
There were middle term adjustments in the Real Plan including first an exchange anchor system and then an inflation targeting system, together with the adoption of a floating exchange regime in1999 and a fiscal responsibility law in 2000 that prepared Brazil for a new phase of productivity gains and a competitive integration into the world economy. Energy shortages in 2001, and the final collapse of the convertibility scheme inaugurated in Argentina ten years earlier brought new turbulence to that picture. This was exacerbated by the presidential campaign of 2002, when the prospects for a victory of the PT’s candidate caused a decline in the exchange rate, and an increase in Brazil risk and in inflation. But after the election, the new socialist leader ignored his party’s rhetoric and preserved the same policies established by the previous economic team. As a result of these sensible policies a virtuous cycle of economic growth and external transactions improvements followed for the next five years starting in 2003.
Those years, which saw a “Chinese bonanza” pushing commodity prices to historical peaks – soybean at 600 dollars a ton, iron ore at almost 200, and many others –, were not exempt from policy retrocessions, such as the renewed growth of the state and the increase in the number of public officials (many, if not all, selected from party apparatchiks), both moves that interrupted a positive process of trimming the excessive state apparatus built up during the military regime. Lula, the effective president during both his and Dilma’s administrations, started a conscious and consistent program of rebuilding state power in Brazil, creating many new public agencies, squeezing the regulatory bodies that were implemented during Cardoso’s times and expanding a comprehensive program of social benefits – Bolsa Familia – that was created out of the many separate sectorial benefits that existed previously. The public legitimation for the later was “social inclusion”, but in fact the intention was to consolidate a vast electoral device in favor of his party. It worked: Lula was reelected once (2006), as the amended Constitution (by Cardoso, 1997) authorizes, and was able to elect (2010) and re-elect (2014) his right-hand assistant, Dilma Rousseff.
Although Lula’s years were characterized by overall positive results after a bad start – which was caused by market fears of an adventurous economic policy, in the hands of a formally socialist party – the fact is that there is a clear break of style and substance in economic policies from his first term in office to his second term. In his second term Dilma Rousseff emerged as the new powerful cabinet head following the demise (already for corruption scandals) of the “great vizier” of the first Lula government (José Dirceu), and acquiring even more power after the demise of the first Finance Minister (Palocci) – who acted totally in line with the previous economic policies –, she inaugurated the practice – supported by Lula – of having the public expenditures growing always ahead of the GDP’s growth rate, and even ahead of the inflation rate and of the tax receipts. Not surprisingly, annual budgets started to be voted and applied with a certain stress in the public accounts, which were conveniently disguised under questionable accounting practices, mixing some flows between the Treasury, the National Bank for Development (BNDES), and state companies and banks (like Petrobras, Banco do Brasil and Caixa Econômica Federal).
It was in the context of such practices that it became possible to give generous benefits to the assisted people of Bolsa Família – who knew “Chinese rates” in their income growth, in fact a mere subsidy for consumption – and rises in the minimum wage above the inflation rate and also incorporating a politically fixed “productivity growth”. Of course, many of those social policies materialized only because the fiscal charge was continuously expanding, from the 34% of the GDP to almost 38% (in fact, just 35.9% in nominal terms, but only due to a methodological correction in the national accounts); the heavier taxes penalized goods and services consumed by the middle classes as well as the productive activities of the business sector. In fact, expanding expenditures benefitted much more a small bunch of crony capitalists – who are the great financiers of PT and its apparatchiks – than the poor people of the Bolsa Família.
Lulanomics worked relatively well during the Chinese bonanza years, up to the American housing and financial crises, when some Keynesian measures were taken to contain the reduced external demand and the changes in the foreign credit supply. Other measures – almost all in the public sector – were introduced, supposedly for a transitional period, but maintained for a longer extension of time than required by the partial recovery of the world economy after 2010. Dilma’s presidency, starting in 2011, represented the exacerbation of the worst kind of policies of the old school of ECLA’s (the Economic Commission for Latin America of the UN) “developmentalism”: sectorial subsidies and tax exemptions, State intervention in the micromanagement of investment policies in the case of SOEs, requirements of local content in contracts for all public companies, a “new automotive investment framework” in a clear disrespect for WTO rules, and many other commercial and trade policies devices, as if Brazil still had an “infant industry” to protect.
Adding to this confused set of improvised measures, there were political fixes and opportunistic manipulations of both interest rates and exchange rates, which resulted in increasing inflation, exaggerated devaluation and declining growth. At a certain moment Brazil had a totally contradictory picture of a declining unemployment rate and an increase in the insurance payments for the unemployed. More disturbing was the perspective of not having the national accounts properly reflecting the erosion of tax receipts, a true result of the fiscal falsification already in the run. When the terms of trade inverted the course, due to the lessening of China’s growth, the castle of cards start to crumble, although it was not immediately visible, precisely because of the hidden indicators in the public accounts. The downturn accelerated during the 2014 presidential campaign, and was finally revealed in the open just after the ballots confirmed Dilma’s victory for a slight margin of votes.
Dilma’s economic unraveling of Brazilian economy, or the Big Destruction
Again: the process of deformation of the Brazilian economy was not only the product of misguided economic policies during Dilma’s years. It is the result of many years of erroneous macroeconomic and sectorial policies during Lula’s presidency, which shaped the two main features of PT’s economic management: commoditization and deindustrialization. The economic consequences of Lula’s government were reflected first of all in the aggrandizement of the state, secondly in the over-stimulus of the demand side of the economy, combined to a total lack of care for its productive, for the infrastructure and against the basic requirements for a productivity growth, which would have required set of reforms – labor, taxation, social security, education, etc. – that were never undertaken by Lula or Dilma.
Commoditization and early deindustrialization are the two sides of the same coin: an over reliance on the high price peaks of exported Brazilian commodities, and a gradual loss of competitiveness of the domestic manufacturing basis. Over valuation of the Real – due to the huge inflow of dollars – and high prices in the domestic supply – taxed for an average rate of 40%, either in goods or in services – turned Brazil into a very expensive country, inducing the middle class to look to external markets to purchase many durable items: Miami became the new big shopping mall for the affluent and even the less fortunate consumers of the middle class. At a certain point in the American crisis, Brazilian buyers were acquiring plenty of Florida low-priced condos, and flooding Miami shopping malls, for as high as 4 or 5 billion dollars a year in their purchases.
The declining contribution of industry to national economic activity accelerated at a troubling pace in the final year of Lula’s presidency and during Dilma Rousseff’s entire first administration. The plunge in the trade surplus was catastrophic in the industrial section of the current transactions, although this situation did not create an immediate current account deficit because the floating exchange regime – albeit manipulated by the Central Bank with an eye in the inflation rate – intervened to rebalance the disequilibrium. But it became clear that the bad results reflected in the main economic indicators were not a mere side effect of an alleged “international crisis”, as proclaimed by the government, but a consequence of the bad policies entirely “made in Brazil”, by the government.
The deindustrialization was not due to Chinese competition – although that was always present even if limited by high tariffs and antidumping measures – but was totally due to over-taxation, overregulation, super-protection and cartelization, as well as the already mentioned state intervention at every level, in all sectors. Excessive expenditures, a chronic deficit in the social security system (especially in the public sector), too low savings and investments rates, a marginal (if not negative) labor productivity growth, and a really poor rate of technology innovation (due to low quality education at every level) complete the bleak picture of the current Brazilian panorama.
The dramatic, negative growth in 2015 (-3,8% of GDP), and the very bad prospects for 2016 and 2017, that is, from recession to depression, clearly point to the longest and the worst crisis in the Brazilian economic history since 1931. Over a five year period, we can estimate a loss, for the GDP, of about -10%, that is, Brazilians are becoming poor, and are due to stay in that condition for a while. Are there any prospects for an inversion of this vicious circle? Perhaps, depending on the posture to be taken by the politicians in the Congress: they have a rent-seeking behavior, but could help to invert Dilma’s Great Destruction if further deteriorations of Brazil’s risk assessments by rating agencies intervenes at any time. That will certainly happen when the domestic debt rise to new highs, that is, more than 70% of the GDP.
Those ratios of public debt do not seem to be very upsetting, taking into account the Maastricht criteria of national debt (60% of the GDP, also considering 170% for Greece and more than 270% for Japan), but the real question is not its absolute value, but its cost. Interest rates in the case of public debt in Brazil can be as high as 14% (half of that in real terms), a significant part of that being of a short term maturity; the already higher expenditure in the public budget is the service of the debt, as high as 7% to 8% of the GDP, which is a truly unsustainable charge. Of course, in the bonus side of the picture, Brazil possesses enormous natural resources, a largely renewable energy matrix (based mainly in water powered electricity), a very competitive agribusiness, no foreign conflicts to be dealt with, an active professional diplomacy and a well prepared state bureaucracy (especially federal prosecutors and investigators, who are dealing with the worst corruption case in the Brazilian history, with the Worker’s Party occupying the center stage of the crime scene, as its apparatchiks ransacked the state oil company, Petrobras, and probably many other state companies as well).
What’s to be done, after the economic and political deluge?
But, the big word, today, in Brazil, is uncertainty: we do not know what will be the value of the Real in dollars, tomorrow, the next week, or the next month; we do not know the depth of the deficits, the ceiling for the reference interest rates (today at more than 14%); how deep will go the unemployment; if the investments will continue to be completely paralyzed; and we do not even know if we’ll have this one or another government in a matter of weeks or months. Uncertainty, and insecurity, those are the words of the moment in Brazil. How can an entrepreneur make plans for a year, two years, or five years ahead? Economists were overtaken by the most pessimistic statistics in 2015. Even experienced political analysts do not try to even guess, or imagine, what the immediate political future could be at the beginning of 2016.
This complex set of problems requires, at the economic level, three sets of measures to be instituted simultaneously: (a) urgent measures that have to be adopted in terms of fiscal adjustment and budget balancing, followed by (b) medium term decisions that have to be taken to promote confidence building adjustments, facilitating the return of investments, and (c) the launching of a long term program of structural reforms in order to create a new institutional framework looking for the recovery of competitiveness of the Brazilian industry, and creating a solid basis for a productivity overhaul of the economy. At the political level it is almost impossible to foresee any stable governance in the months ahead. Reforms are also due at the sphere, but the political system is plagued by a myriad of small and opportunistic parties, and regional differing interests, all of which makes an impossible dream to have a stable governing coalition.
Political and economic crises are sustaining each other, and it is difficult to tell where is the Gordian knot. Who will deliver the decisive coup? No guesses for the moment…
Paulo Roberto de Almeida, Professor of Political Economy at the Master and Doctoral programs in Law of the University Center of Brasília (Uniceub); career diplomat (www.pralmeida.org; http://diplomatizzando.blogspot.com).