Letter to the Brazilian People 2.0

With Brazil’s economic problems deepening and its prospects looking increasingly gloomy, it is high time for President Dilma Rousseff to draft a new agenda of comprehensive reforms – just as ex-president Lula did when he took office in 2003. If Brazil is to overcome its current problems, change must happen at the economic level as well as the political.

The beginning of a new presidential term is generally a time of great hope. If a president is re-elected – even if only by a thin margin like Brazil’s Dilma Rousseff was in late 2014 – the new term often reinforces the work of the previous one and strengthens directives going forward. If policy adjustments are necessary, the newly bolstered president is likely to gain popular support for them when dealing with Congress and other socioeconomic actors.

But half way into 2015, Brazil’s outlook is gloomy. The economy is in a recession. Dilma Rousseff is at odds with leaders in Congress, and her governing coalition is severely fractured. Her political group – PT, the Workers’ Party – is at the center of the largest corruption scandal in Brazilian history. A sophisticated and complex graft scheme involving state-owned oil giant Petrobras, construction companies, and senior politicians has paralyzed the country. Short- and longer-term uncertainties abound. Brazil is now a country performing below its potential. Why is that happening?

When Luiz Inácio Lula da Silva, Rousseff’s predecessor and founder of PT, campaigned in 2002, he signaled his willingness to stick to the tenets of sound economic governance that were established by Fernando Henrique Cardoso – Brazil’s president from 1995 to 2002, whose ‘Real Plan’ stabilized Brazil’s economy by doing away with the high inflation rates that had lasted decades. Nonetheless, Lula pushed for change on other fronts by writing his ‘Letter to the Brazilian People.’

In that historical document, Lula promised to adhere to fiscal responsibility and inflation targeting. He also vowed to face social inequality head on. Contracts would be honored and the country’s debts paid down. A new industrial policy based on sacrosanct ‘local content’ would arise. Surprisingly, he also promised to push for the reform of Brazil’s outdated labor laws. He pledged to make its tax and social security systems simpler and less burdensome.

Policies implemented over the past 12 years by Lula (whose two presidential terms ran from 2003 to 2010) and by Dilma Rousseff (now in her second term), seemed to work. Brazil benefited significantly from the world commodity boom. A few chosen entrepreneurs delighted at privileged credit lines offered by official banks to foster ‘national champions.’ Foreign direct investment flowed in to set up local production plants and take advantage of an overprotected domestic market. Fiscal incentives to automobile or home appliance manufacturers helped Brazil minimize the effects of the 2008 world crisis. Structural reforms, however, were forgotten along the way.

Brazil’s future is dependent on redefining politics so it can rebuild its political economy. These are the inescapable preconditions that must be met for the country to reignite its growth engine

But the economic model that produced such accomplishments has now been exhausted. Privileging consumption over investment, sectoral over horizontal policies, and the domestic market over global trade has ceased to work wonders. Brazil’s so-called ‘national-developmentalism’ now seems limited in its capacity to lift the country out of the middle income trap. Continued social policies depend on sustained growth over the years. The way out of the current stalemate in Brazil must include the drafting of a new ‘Letter to the Brazilian People.’

Brazil has yet to find its place in the ‘reglobalization’ now in the making – a world shaped by plurilateral trade and investment deals such as the Trans-Pacific and Transatlantic Partnerships, as well as China’s new growth model, which is supposedly less dependent on the import of mineral and agricultural commodities.

Down the Hill

Brazil’s economy is now heading towards a painful 2.5% recession. This comes on top of disappointing numbers throughout Dilma’s term, averaging under 2.0% of yearly growth in 2011-2014. Unemployment is on the rise and inflation is edging dangerously close to 9.5%, and therefore far north of its 4.5% target.

As the effects of monetary tapering in the US settle in, the Brazilian real will continue to depreciate. Interest rates are soaring, and further weaken Rousseff’s claim of being the first president in Brazil’s history (for as long as there have been credible economic statistics) to bring the price of money down to the single digits – as was artificially the case at one point during her first term.

In search of good news, the government hopes to continue pushing its ‘concessions’ programs forward in areas such as energy and highways. After a long process of ideological soul-searching – the ruling Workers’ Party never wanted ‘management concessions’ to be conceptually equated to unholy ‘privatization’ – the president and her closest aides decided concessions were a good way to continue to attract foreign direct investment and to show a ‘market-friendly’ face.

But bureaucracy, micromanagement (like trying to define profit margins in advance of concession auctions), and the prospect of further government meddling diminish the allure of concession opportunities. This set of inefficiencies is well-known to many. The great uncertainty for Brazil in the next couple of years is whether continued under-performance will result in inertia or change.

When millions took to the streets in June 2013 – the largest demonstrations in Brazil’s history – they were protesting more than just fare hikes in public transportation. They were not only denouncing the poor quality of public services offered by a state that collects 36% of national income and, at best, only invests 3% of it. Perhaps unknowingly, they were also crying out against Brazil’s current model of state capitalism and its self-serving appetite.

For some, the way forward should feature more state and less capitalism. This may seem like a viable option, especially if Brazil’s most productive sectors, such as its world-class agribusiness, continue to generate the surplus resources to cover state-led inefficiencies.

For others, it is time to cut loose from the current model and truly reinvent Brazil. Dilma Rousseff struggled to assemble a new economic team after the bitter political strife that led to her re-election, and tensions have built up between continuity and change.

When millions took to the streets in June 2013 – the largest demonstrations in Brazil’s history – they were protesting more than just fare hikes in public transportation. They were not only denouncing the poor quality of public services offered by a state that collects 36% of national income and, at best, only invests 3% of it. Perhaps unknowingly, they were also crying out against Brazil’s current model of state capitalism and its self-serving appetite

The divide between the “more of the same, nothing is wrong” discourse from Rousseff’s campaign and the no-nonsense imperatives of economic reality that compelled her to shift course has become a major source of tension in her own political support base.

Rousseff’s appointees at the Ministry of Finance and Ministry of Planning signaled change. They opted for larger doses of orthodoxy and transparency in macroeconomic management. They are doing their utmost to eliminate all traces of Dilma’s ‘new economic matrix’ and her administration’s creative accounting. These were undesirable features of Dilma’s first term that left an indelible mark on Brazil’s lackluster growth over the past four years.

Far Beyond the Economy

If Brazil is to overcome its current difficulties it will have to change not only its economic policy, but also its political economy. Macroeconomics alone will not shape a brighter future for Brazil. Compare the performance of most Latin American countries with the rise of the southeast Asian nations: the latter have far outperformed the former in delivering a microeconomic environment conducive to business, long-term planning, and competitively interacting with global value chains.

In terms of Brazil’s political economy, the trend for Rousseff’s second term is no doubt inertial. Devoid of any strategic plan to face the rise of a new cycle in globalization, we should expect a continuation of the state capitalism model that has reigned for the past 12 years. If left to their own devices, Rousseff and her party will certainly try to revive Brazil’s domestic, market-led growth by giving isolated fiscal benefits to certain industrial sectors and instigating selective cuts in labor taxes. Official banks and state-controlled companies will continue to be used as instruments for fostering (protectionist) local content, in the hope of generating local jobs and tax revenues – at a very heavy cost to Brazilian consumers and taxpayers.

But in the same way that markets drive Rousseff’s macroeconomic policies away from the experimentalist adventures of the recent past, failure and scandal in Brazil’s current political economy may help bring the country closer to a more market-oriented, pro-business environment.

It is impossible for Rousseff to again focus on cyclical attempts to promote growth through the appetite of Brazil’s domestic market for high levels of consumption. Such tactics do not constitute a driver of sustained development over time – as Rousseff’s first term clearly shows. Likewise, under greater public and media scrutiny and the very real possibility of having the country’s credit rating downgraded, there is no room now for the BNDES, Brazil’s development bank, to continue its creative accounting.

As transparency improves, the BNDES will no longer be able to be seen as a receiver of subsided loans from the national Treasury. Nor is it in a position to resuscitate the privileged financing of ‘national champions’ that consumed more public resources over the years than the Bolsa Família, the poverty alleviation cash transfer program that raises the living standards of millions.

Given its current corruption scandal, Petrobras is now too weak and demoralized to be used as an instrument of industrial policy. With both its resources and its credibility reduced, it will no longer be a major shaper of demand across the oil and gas sector and beyond. It will have less muscle to precipitate positive spillover effects aimed at Brazil’s much-desired reindustrialization.

Less wiggle room for the BNDES’s discretionary credit policies and the travails of Petrobras may be blessings in disguise. They both invite more horizontal policies, better governance and compliance, and more pro-competition attitudes.

It will be hard for Rousseff to restore confidence to 2010 levels, when Brazil’s economy grew by 7.5%, merely by improving macroeconomic policy. For Brazil’s economy to shine again, Rousseff must do more than summon a team of well-versed financial managers. She must emphasize change over continuity in policymaking beyond macroeconomics. Brazil’s economy is one of the least open to trade, and its level of investment as a percentage of output is the lowest among the world’s 10 largest economies. Its savings rate is only about 15% of its GDP.

In a country with great potential as a creative economy, Brazil directs only about 1% of its GDP to research, development, and innovation. Despite its vibrantly entrepreneurial society, Brazil ranks only 120th among 189 nations, according to the World Bank’s Ease of Doing Business report. This calls for measures going far beyond macroeconomic management.

There is no doubt that the second Rousseff administration is being forced to move swiftly back to the so-called ‘tripod’ of inflation targeting, fiscal responsibility, and a freely floating exchange rate. But it must also demonstrate resolute willingness to work on structural reforms, which should be the country’s top priority.

This also affects economic foreign policy. Brazil should engage in the negotiation of dynamic free trade agreements – without the straitjackets imposed by Mercosur – with the US, the European Union, and the Pacific Alliance countries of Mexico, Colombia, Peru, and Chile. And this is all complementary to the essential role Brazil plays in fostering its relations with BRICS countries and working towards the institution-building process of new global governance tools such as the New Development Bank and other BRICS-related initiatives.

For the last 12 years the Workers’ Party has been in power, there were many junctures in which the alignment of different political forces, strong public support, and a favorable global scenario came together and provided the right atmosphere for Brazil to promote structural reforms. But Brazil did not take advantage of these times and enact good policies.

Right now, the adoption of sound macroeconomics, a more interdependent approach to foreign policy, and at least the promise of reform must be pursued within the framework of a rearrangement of global economic forces that do not look so favorable to Brazil.

Further complicating matters are the prospects for structural change, which are challenged by a political state of affairs marked by ongoing investigations into corruption and the inability of Rousseff’s administration to devise a constructive agenda with Congress.

Brazil’s future is therefore dependent on redefining politics so it can rebuild its political economy. These are the inescapable preconditions that must be met for the country to reignite its growth engine.

Official partners

Logo nkibrics en Logo dm arct Logo fond gh Logo palata Logo palatarb Logo rc Logo mkr Logo mp Logo rdb