Five Steps to Kickstart Brazil

On October 26, 2014, 108 million Brazilians voted in the second and final round of the country’s presidential election. Incumbent Dilma Rousseff defeated challenger Aécio Neves by a slim but definitive margin (52 percent to 48 percent), earning her a second term in office through 2018. The results suggest that the election was not about change but rather about continuation — the continuation of helping Brazil’s new middle class pursue upward mobility.

Over the last 20 years, Brazil has taken crucial strides towards achieving its weighty, if elusive, economic potential. Finance Minister (later President) Fernando Henrique Cardoso’s Real Plan established a stable macroeconomic foundation in the 1990s, which allowed his successor, President Luiz Inácio Lula da Silva, to implement social programs that helped lift upwards of 40 million people out of poverty in the 2000s.

Strong growth gave Brasília fiscal leeway during the global financial crisis; an aggressive stimulus package in 2009 led to claims that Brazil was the last country in and first country out of the Great Recession. Investment poured in, and many wondered if a new day had finally dawned for the perennial “country of the future”.

Since 2011, however, Brazil’s burgeoning middle class has faced growing pains. For tens of millions of nouveau stable, simply participating in the country’s economy is no longer enough. They seek continued access to opportunity, and they fear a return to poverty.

A stagnating economy spurs disquiet. Growth, which averaged 4.5 percent annually from 2004 through 2010, has averaged just 1.6 percent since. When hundreds of thousands took to the streets to protest in 2013, and when 108 million people voted in October 2014, they demanded improved efficiency, transparency and, above all, a return to growth.

What happened to Brazil’s momentum?

Prior to offering any prescription, we must consider the underlying cause of low growth.

International observers often attribute the Brazilian slowdown (current and expected), to a shifting external environment as commodity prices and international financial conditions become less favorable. Much has been made of the risk of an economic “hard landing” in China and its potentially devastating consequences for the Latin American BRIC.

But this view has one major fallacy: External demand constitutes only a fraction of the Brazilian economy. Brazilian exports account for just 12 percent of GDP; in Mexico, by contrast, this figure eclipses 30 percent. Exports to China make up about a fifth of total Brazilian exports, accounting for less than three percent of GDP. A downward trend in commodity prices hurts, to be sure, but alone it cannot explain Brazil’s sluggish performance.1

Analysts also cite the absence of structural reforms, along the lines of what Mexican President Enrique Peña Nieto has pursued during his sexenio. Such reforms would address taxes, infrastructure, labor regulation and the overall business environment. Brazil would certainly benefit from such reforms, but somehow the country managed explosive growth from 2004 to 2010 without much progress on this front.

So why is the economy grinding to a halt now?

Imagine an economy as a shellfish, where the supply or production capacity is the shell and demand is the body filling the shell. The body can grow unimpeded as long as there is space left in the shell (economists call this space “slack” or “output gap”). At the same time, the productive capacity (the “shell”) can also grow by adding workers, by adding capital or by using the two more efficiently (total factor productivity).

In Brazil, the boom years started with plenty of wiggle room in this metaphorical shell. Lulaera momentum can partially be attributed to a series of one-off events: the rapid rise of China, the commodity super-cycle, and the lifting of millions out of poverty and into formal employment.

These trends allowed Brazil to rapidly fill the output gap. At the same time, however, a growing labor force increased the size of the shell itself, and for several years the country was able to accommodate expanding demand. High growth observed in the 2000s was thus a transitional phenomenon that was bound to end in the absence of productivity enhancing reforms regardless of the external environment.

This insight guides our prescription for a return to growth. Brazil’s malaise is nothing new, and it is not the outside world’s fault. Rather, it stems from a persistent need for improved efficiency and productivity. In her second administration, President Rousseff has an opportunity to pursue such ends.

Here are five ways to accomplish that:

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