Brazil's take-off won't happen without real reforms
Last week Brazil overtook the UK to become the World’s 6th biggest economy. The news was played down by the country’s leaders, keen to avoid hubris in the middle of the euro crisis. But there's no secret they're aiming even higher: ‘We can overtake the large economies in the coming years’, said Guido Mantega, finance minister.
Brazil probably can. But it probably won’t. The reason? Its economic performance, economists say, will continue to resemble the halting flight of a chicken - looking like it is about to take off one minute and heading earthwards the next.
The metaphor certainly applies to Brazil’s recent performance. Boosted by government stimulus in the aftermath of the financial crisis, its economy managed to pull off modest growth in 2009, when the rest of the World was mired in recession. More fiscal largesse in 2010, a presidential election year, then buoyed GDP growth to 7.5% by the end December – almost as fast as China.
But probably too fast. Inflation figures soon matched growth on the upside, reaching 6.5% by the middle of the year. And so the Central Bank was forced to crank up interest rates – at the exact moment when governmental hand-outs ended, the Eurozone crisis started, and the exchange rate, on the up relative to the dollar, started to hammer local industries. Bottom line: Brazil’s economy contracted in the third quarter of 2011, and previsions for 2012 were drastically revised.
Is that a big deal though? Aware of the slowdown, Brazil has shown that it’s not willing to play, well, chicken. Its Central Bank took the rather bold step of cutting interests by 0.75 basis points last Wednesday, anticipating a domestic slow-down. And with interest rates still at 9.75%, there’s still plenty of margin for further easing. So Brazil should be able to reach 3-4% next year without too much trouble.
But if the country is to earn its high-flyer loyalty card, much more is needed. For Brazil’s problem is not that it is growing below potential – it is that its growth potential, which most reckon is around 4%, is too low. Unless it addresses the structural flows of its economy – an unwieldy tax system, insufficient spending in education, R&D, and infrastructure, and a bloated public sector – Brazil’s dream to reach the top league will remain just that.
And so far it looks like it will. For an illustration of how the government continues to get the wrong end of the stick, look at the current trade spat between Brazil and Mexico. In 2002 both nations agreed to a bilateral pact that allows free trade in cars between them back. Since then Mexico has opened its market by lowering tariffs, adopting friendly laws and joining regional agreements, and become a base from which carmakers from can export everywhere. Applied across the board, this attitude has allowed overall manufacturing to retain a steady share of GDP, at 17-18%.
By contrast Brazil has spent most of its energy coercing carmakers into building factories within its borders, so as to reduce the country’s dependence on exports. It has also demanded that goods entering the country have a minimum local content (i.e. 40 % of a car’s parts being made in Brazil) and wants to limit tariff-free imports with Mexico – the reasons why the row between both nations broke out. Despite the protection it promises to local producers, the policy has failed to deliver: car imports have grown by 30% since 2010.
Such a protectionist stance, which economists label ‘import substitution industrialization’, may well be working elsewhere. Brazil has seen momentous inflows of FDI over the past couple of years in the energy and agriculture sectors, speeding up their development and boosting exports. But other industries have largely suffered. Higher costs for importing materials and parts, added to the usual domestic burdens, have rendered most Brazilian products uncompetitive.
Dilma Rousseff, Brazil president, could still get things right. She’s got good cards in hands: she’s popular, pragmatic, and is praised for her serious, no-nonsense approach. But now she needs to prove she can be a reformer, too. Without prospects of a proper take-off, foreign investors may soon decide it’s not worth being in for the long haul.