How Brazil’s economy can bounce back

Brazil has lost its swagger. Growth estimates for this year put Latin America’s largest economy above only Venezuela and El Salvador in the region, and the outlook for next year is not much better. Brazil’s currency, the real, has fallen to its lowest level against the US dollar in more than four years, compelling the government to pump billions of dollars into the foreign-exchange futures market and raise interest rates to deter capital outflows – just a few years after imposing a new tax to deter inflows. So what is really happening in Brazil, and what can be done to secure a prosperous future?

To be sure, Brazil has done remarkably well on some measures of economic performance over the past decade. For example, its extensive social programs, combined with past GDP growth, have improved the country’s income distribution markedly.

But, over the same period, annual GDP growth has averaged a modest 3.5%, and productivity growth has slipped into negative territory. Brazil’s labor productivity is one-fifth that of the United States and lower than that of Mexico and Chile. As a result, Brazil may not be as well positioned to take advantage of its demographic dividend (when a rising share of working-age people creates new opportunities for economic growth) as its leaders believe.

One factor limiting Brazil’s prospects is its low productivity, which can be explained partly by an anemic investment rate of 18% of GDP – low for Latin America and paltry compared to East Asia. Insufficient investment has meant inadequate infrastructure. Thus, despite massive spending on stadiums for next year’s World Cup, logistics costs remain high, sapping Brazil’s competitiveness and limiting its growth prospects. Meanwhile, corruption scandals and widespread frustration with the low quality of public services are fueling social discontent and reducing investor confidence.

Brazil’s economic boom was largely a product of skyrocketing commodity prices. Despite a push by Brazil’s development bank, BNDES, to shore up competitiveness and promote the formation of larger, multinational industrial firms, Brazil’s manufacturing position has continued to decline. While the agricultural sector has shown some productivity gains since 2000, high logistics costs have constrained its impact. Brazil is still searching for new drivers of growth.

President Dilma Rousseff’s administration, like that of her predecessor, Luiz Inácio Lula da Silva, clearly has not absorbed the primary lesson of East Asia’s economic rise: while industrial policy can augment economic development, it is no substitute for investment in infrastructure, human capital, and export-oriented industries.

Although Brazil boasts effective tax collection and its central bank has a reputation for prudent monetary policy, fiscal resources are squandered on social programs and on constitutionally mandated expenditures that produce low returns, owing to poor public-sector implementation. Meanwhile, high domestic borrowing costs are undermining private investment. According to the World Bank, Brazil ranks 130th out of 185 countries in terms of the ease of doing business.

Against this background, Rousseff’s government was perhaps rash to decry the inflow of “unwanted capital” in recent years and to erect import barriers aimed at protecting domestic industry by hampering market competition. A wiser strategy would have been to boost investment by using financial intermediation to allocate these funds to firms that are being crowded out of domestic capital markets by excessively high borrowing costs.

In fact, the government’s approach served only to exacerbate Brazil’s problems of low capital investment, weak competition, and relatively little innovation – problems that have prevented the country from achieving any gains in total factor productivity in the last two decades. Most local forecasters now put Brazil’s growth rates well below potential output. If they are right, it will be difficult to maintain the hard-won economic and social gains of the last decade.

To avoid such an outcome, Brazil’s leaders must increase the efficiency of government spending and use the freed-up resources to clear infrastructure bottlenecks. Success should be measured according to impact on, say, the quality of education and skills acquisition, rather than according to the mandated level of public spending.

Furthermore, policymakers should pursue comprehensive reform aimed at eliminating domestic firms’ privileges and boosting competition, including with foreign firms. In order to enhance Brazilian industry’s export competitiveness, industrial policy must support a transition to high-value products and services. To this end, BNDES loans should be reallocated from incumbents to innovative firms.

Success in all of these areas depends on effective implementation, monitoring, and cooperation between government and business. In the next 10-15 years, Brazil will have a tremendous opportunity to capitalize on its demographic dividend. Unless it has achieved high enough levels of productivity and growth, it will miss its chance.

Manufacturing, which fell from 30% of GDP in 1980 to 15% in 2010, must become an engine of innovation and GDP growth. At the same time, the rapidly growing services sector – which accounts for 90% of Brazil’s newly created jobs – must be made more productive, which requires a stronger emphasis on services linked to manufacturing and exports.

After a decade of reforms and retrenchment under President Fernando Henrique Cardoso in the 1990’s, and a decade of policies favoring social inclusion under Lula, Brazil needs a decade of economic growth. Its government has no time to waste.

The opinions expressed here are those of the author, not necessarily those of the World Economic Forum. Published in collaboration with Project Syndicate.

Author: Danny Leipziger, Professor of International Business at George Washington University and Managing Director of the Growth Dialogue, was a vice president of the World Bank and served as Vice Chair of the Spence Commission on Growth and Development.

Image: Traders work the floor at the stock exchange market in Sao Paulo REUTERS/Paulo Whitaker.