Project Syndicate
Now that impeached Brazilian President Dilma Rousseff is out of office, the newly empowered administration of President Michel Temer must clean up the mess she left behind. Can Temer’s government save Brazil’s crumbling economy?
The situation is certainly dire. In fact, Brazil has lately been experiencing the most powerful economic contraction in its recent history. Its per capita GDP will be more than 10% smaller this year than it was in 2013. And unemployment has soared to more than 11%, up four percentage points from January 2015.
Brazil has no easy route to recovery for a simple reason: the current rout derives from the intensification in recent years of long-standing economic vulnerabilities – in particular, fiscal imbalances and anemic productivity growth.
Consider Brazil’s fiscal position, which has deteriorated rapidly since 2011, with a 3.1%-of-GDP primary surplus giving way to a deficit of more than 2.7% of GDP, leading to an overall budget deficit of close to 10% of GDP. In fact, the groundwork for that deterioration was laid a long time ago.
Brazil’s primary government expenditures as a proportion of GDP rose from 22% in 1991 to 36% in 2014. Much of that expenditure can be explained by a commitment to tackle endemic poverty – and effort that includes the world’s largest conditional cash-transfer program – without reducing the privileges enjoyed by Brazil’s wealthiest citizens.
For some time, Brazil’s government was able to fund higher expenditure with tax revenues, which also rose as a result of new levies on consumption and labor-market formalization. And high global commodity prices helped sustain GDP growth of around 4.5% per year from 2003 to 2010, which also bolstered government revenues.
But, of course, the formal labor force cannot expand forever, and commodity prices always fall eventually. Unfortunately, Brazil’s leaders failed to take advantage of the good times to implement counter-cyclical policies and support productivity gains. Indeed, only 10% of Brazil’s GDP growth in 2012-2014 can be attributed to total factor productivity gains, while two-thirds was the result of an increase in higher-skill workers entering the labor force. So when Brazil’s tax-revenue boosters finally collapsed, legally mandated increases in public spending drove Brazil rapidly toward a fiscal cliff.
It is too late now for counter-cyclical policies; there simply isn’t enough fiscal or monetary space. This leave Brazil’s government with only one real option for restoring business confidence and reviving economic growth: tackling Brazil’s structural weaknesses.
The good news is that Temer’s government seems to recognize this imperative. Already, it has presented to Brazil’s Congress a constitutional amendment forbidding for the next 20 years nominal annual increases in public expenditures, including at the subnational level, that exceed the previous year’s inflation rate.
Provided that inflation stabilizes at some lower level, such a cap would cause public expenditure as a share of GDP to decline as soon as the economy began to grow again. If increases in tax revenues accompany GDP growth, fiscal imbalances and the accumulation of public debt would automatically be addressed. At a time when Brazil has little flexibility in its budget, such a rule could turn out to be a fiscal game changer.
Of course, a cap on expenditure growth would not eliminate the need to address existing budget rigidities. Temer’s government has declared its intention to present to Congress a pension reform plan for precisely this reason.
As for productivity, the government is focused on reducing waste in infrastructure construction and operations, which also promises spur private investment in other sectors. The key will be to fine-tune the division of responsibilities between the private and public sectors – including independent regulatory agencies – in the various segments of infrastructure services.
Temer’s government also hopes to tap investment in human capital as a source of productivity growth. As it stands, private companies in Brazil invest less in personnel training than those in other countries with similar per capita incomes, owing largely to disincentives embedded in tax and labor laws – incentives that Temer’s government hopes to change.
To maximize the impact of these efforts, Temer’s government should also focus on reducing waste in the private sector. The more efficient use of human and material resources would make firms more competitive and boost Brazil’s total-factor productivity, especially if Brazil’s human capital were enhanced. Add to that efforts to facilitate foreign trade, and Brazil’s “animal spirits” of entrepreneurship could be unleashed, enabling Brazil to shake off Rousseff’s legacy once and for all.
Otaviano Canuto is Executive Director on the Board of the World Bank for Brazil, Colombia, Dominican Republic, Ecuador, Haiti, Panama, Philippines, Suriname, and Trinidad and Tobago. A former vice president and senior adviser at the World Bank, he previously served as executive director of the IMF, and vice president of the Inter-American Development Bank. Prior to those assignments, he was State Secretary for International Affairs at the Ministry of Finance in Brazil.
First appeared at Project Syndicate