Is the Brazilian economy living up to its potential?

In Brazil, it is known as the Maracanazo. The country’s national football team, playing the final group match of the World Cup on home soil against little Uruguay, needed only to avoid defeat to prevent their opponents from taking home the trophy. No one doubted that Brazil would become champions of the world, so when they contrived to lose in front of 200,000 shocked fans, there was a debilitating effect on the nation’s confidence and belief that it was a superpower of the future. Recent poor growth performance would suggest that expectations in another Brazilian miracle, this time of the economic variety, might go similarly unfulfilled.It is odd that Brazil is lumped together with China as one of the BRICS, as in many ways they are polar opposites. Brazil relies too heavily on consumer spending and needs investment in infrastructure, whereas China must boost its domestic demand. Brazil’s currency, the real is overvalued while China’s is cheap. Both face the ’trilemma’ in different ways; in Brazil inflation kicks in at a very low rate of growth, leaving the Central Bank to raise interest rates very quickly during an expansion resulting in a currency appreciation. On the other hand, in China the authorities require a cheap currency to keep productive capacity high, making it hard to raise rates when inflationary pressure takes hold.
The main problems with the Brazilian economy are mainly to do with competitiveness, especially when framed within the performance of exports. On the face of it, the outlook seems strong; Brazilian exports of goods and services grew by 262% between 2000 and 2010, twice the rate of the world average. Yet compared to the emerging countries that Brazil is grouped with, this was fairly poor; exports grew by 439% in the other BRICS countries.

There is a concern that Brazil does not export the right kind of products. The percentage of high-end technology products as part of overall exports has fallen, while the opposite has been true of commodities. This is problematic as the growth in commodity exports has not been based upon productivity gains or increased investment, suggesting that Brazil will not cope particularly well when global prices are not so favourable.
The country suffers from the low integration of trade. While in some ways this is to be expected in an economy of Brazil’s size, it does mean that it loses out on the benefits that increased trade can bring. The closed nature of Brazil’s exporters is also problematic. From 2003-09 the survival rate of exporters was extremely high. This would suggest that there are high barriers to entry for new firms, and a lack of new exporting firms is normally associated with low productivity and high exporting costs. Brazil suffers from a fundamental lack of competitiveness.

What is noticeable about Brazil is how expensive everything is relative to the country’s stature. The currency, the real, has been overvalued but there are more significant problems with the supply side that contribute to the lack of dynamism in the economy. The lack of investment is a key factor. It is currently at around 20% as a share of the economy, and investment devoted towards new infrastructure is around a tenth of that. It had been hoped that the two major sporting events that Brazil is due to host- the World Cup in 2014 and the Olympics in 2016, would bring about increased spending in these areas. Although preparations for Rio are proceeding well, this is not the case for the World Cup.

The planning for the return of football’s premier competition has been a classic example of Brazil’s problems. It had essentially emerged as the only credible candidate to host in 2004, and was officially selected in 2007, yet planning was delayed and chaotic and it appears as if some of the infrastructure may not be ready in time. The decision to use more stadia than is necessary has left some cities likely to be lumbered with white elephants, further reducing the return on the overall $15bn investment.

The low investment reduces the country’s productive capacity. If Brazil’s supply chain is built upon creaking factories and ageing transport links, then supply cannot keep up with demand, leading to rising prices. Higher prices also stem from problems with the labour market as education also suffers from poor financial support. Schools are underfunded, and the average Brazilian student stays in school for only seven years, less than in any other middle income country. There are some successes in this sector – the University of São Paulo is in the top 200 and Brazil has unveiled a huge foreign scholarship programme, but the shortage of skilled workers means that firms struggle to hire qualified applicants, resulting in higher training expenses and lower productivity, while wages for the small pool of skilled labour are bid up, contributing to ever rising costs.

Overall this lack of investment means that the Brazilian economy runs at a high capacity (around 85%, 5% higher than the average of other emerging markets), with the consequence that inflationary pressure builds very easily. The government, lead by president Dilma Rousseff, seem to acknowledge the need for supply side reform, as last year they eliminated payroll taxes for dozens of industries, overhauled the electricity sector to cut rates by as much as 28 percent and unveiled plans to auction control of ports, roads and airports.

Yet the political elite does not have much room for manoeuvre. The government oversees a very generous benefit system, pensions being the biggest culprit. Fabio Giambiagi, economist at the National Development bank suggests: ’[the pension system] is absolutely the most generous in the world. The economy of Brazil is very different from Greece’s. But in terms of retirement rules, we are worse.’ Brazil has 10 over-65’s for every hundred 15-to 64-year-olds, the least of the G7. Yet it still spends the second highest amount on pensions, only slightly less than Italy where the share of old people is three times higher. This reduces the potential for spending elsewhere, not only on improving the ease of doing business (Brazil came 130th in a 2012 survey) but combating problems such as child poverty.

However, there is potential for future growth built on deep sea oil found off Brazil’s coast. It was estimated in 2011 that Brazil’s oil-and-gas supply chain’s share of the economy could jump from 10% to 25% by 2020. In Petrobras, Brazil has a fairly well run partially state-owned company ready made to realise the gains these fields could bring. However, the positives of hitting oil will only be achieved if Brazil can sort out its supply-side problems and avoid risking the ’Dutch disease’ that can come with such finds.

After curing its historic inflation problem, Brazil’s vast resources in a time of favourable commodity prices and emerging market growth (especially Latin America) has meant that the country has enjoyed a strong economic rise. Now that the problems left unattended during that rise are coming home to roost, it will be interesting to see how Brazil moves forward in dealing with them and manages in trying to live up to its potential. ’Ufanismo’ is a Brazilian phrase that defines a form of excessive pride and expectation in a country and one might suggest that the country’s public, pundits and some politicians alike have been a little guilty in indulging in it during Brazil’s ascent. Hopefully this feeling will not be damaged by problems more significant than the chance of historic rivals Argentina lifting the World Cup in the Maracanã next year.

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