In Nouriel Roubini’s July 14 post, he issues a further warning about the slow and halting pace of recovery in the United States. How alarming is this scenario of slow global recovery for Latin America? Is commodity-driven and capital-dependent Latin America inevitably being channeled into another “lost” half-decade because of the weak U.S. and external environment?
The answer to this last question is: not necessarily. The extent of vulnerability depends on a number of factors, including how well each of the Latin economies has weathered the financial storm so far and the extent to which each economy can rely for stimulus upon local demand. In a larger sense, the post-2010 recovery in Latin America will depend upon the lessons learned from the decline and fall of “market fundamentalism”, in particular whether Latin American policy can get the balance right between open markets and a strong state. Not every economy is going to get it right, but some will.
Brazil is the most interesting case in point right now and something of a bellwether for the rest of Latin America.
In a recent article in O Estado de Sao Paulo, notedeconomist Ilan Goldfajn suggests that Brazil could still do relatively well in the post-2010 context of a global economy marked by below-trend growth in the United States. The reasoning behind this is worth considering. Two facts stand out.
First, the world economy is in need of more “consumers of last resort” for it is the disappearance of the U.S. consumer that is behind the deep GDP recession and the huge increase in U.S. deficit spending, as Martin Wolf reminds us in this week’s FT. In a “massive shift to prudence”, the private sector in the United States in the last two years has effected a 10.3% of GDP shift in the balance between its income and spending. Furthermore, the de-leveraging process of the U.S. consumer has really just begun as measured in terms of gross household debt to GDP which has fallen by only two percentage points in two years. The huge impulse to global demand provided by the U.S. consumer is a thing of the past.
Second, global growth post-2010 is going to have to depend more on demand growth in the emerging economies, especially the surplus economies. Of course, here we have the China story where industrial production is already starting to approach pre-crisis levels thanks to an accelerated process of saving and investment. In turn, Chinese and broader Asian growth already is benefiting countries such as Brazil already by building in a demand for its commodities. More importantly, consumption is growing in Brazil again in response to this and other factors, including a government fiscal stimulus on the order of 3% of GDP. Brazil does have a global role to play to compensate for the decline in the U.S. consumer. It is one of those larger surplus economies that can and should increase domestic absorption (consumption and investment) and should contemplate switching to a deficit on current account after years of external debt-induced preoccupation with surpluses and reserve accumulation.
It may sound like tempting fate for a country such as Brazil with too little savings and a history of external debt problems to consume and borrow more from abroad, but it makes sense for Brazil and for the global economy.
Why? Brazil has an enormous capacity to grow as measured by a large domestic market with per capita consumption something like one-fourth of U.S. levels. While it always struggles to accumulate savings, Brazil has the potential to sustainably private and public investment by 5-10 percentage points of GDP on a permanent basis. Moreover, it has taken steps in the last fifteen years to lower the risk of investment which is apparent in the still robust flows of foreign direct investment it is receiving even in this crisis climate. (Consensus estimates for 2009 foreign direct investment inflows to Brazil are on the order of $25 billion.)
Other factors as well make Brazil a natural candidate to attract a larger share of global capital flows in the future.
Brazil has emerged from the global debacle in relatively good shape. Consensus growth estimates for 2010 have risen to about 3.5%. (See chart.) The financial sector in Brazil has withstood the global shock. International reserves remain at levels in excess of $200 billion. Counter-cyclical policy has been effective in delivering stimulus. An active debate in Brazil is occurring the multiple dangers of increasing permanent fiscal expenditures, but, from afar, it is hard to criticize Brazil’s economic management. Fiscal policy has delivered an important stimulus of about 3% of GDP. Yes, the overall ratio of public sector debt to GDP has risen slightly more than 40%, and may rise some more, but the key component of net external debt in percent of GDP is a negative 10%.
So to come back to the main argument, Brazil can and should play a role in rebalancing world growth as one of a larger number of emerging market “consumers of last resort”.
The interesting question is whether or not Brazil is ready to do so in terms of economic structure and, more broadly, in terms of the prevailing mindset among elite groups. On both fronts, changes in longstanding policies and ways of thinking are needed.
First, for Brazil to become a major recipient of global capital flows inevitably implies a long-term trend for the exchange rate to appreciate; in fact, this process is probably already underway. While currency appreciation is healthy in many respects, including by helping hold down inflation, it could be seen as a big threat to Brazil’s global manufacturing position. In a sense, absent sea changes in the Brazilian business environment, sustained currency appreciation might require that Brazil become less, rather than more, dependent on agriculture and commodity exports, a development bound to meet substantial political resistance from powerful lobbies and constant pressures for government intervention, including capital controls.
Second, Brazil will need to re-examine the relationship with China and other emerging centers of economic power and global finance. China is going to be a huge source of infrastructure finance in the future; already the largest banks in the world are Chinese, and Chinese currency reserves are staggering. China needs to diversify its international assets, diversify trade, and secure access to commodities; Brazil needs a reliable source of long-term finance to offset the diminished flows from a weakened Wall Street. The logic of much closer economic and financial relations, much beyond what we have seen so far, between Brazil, China, and emerging Asia seems compelling.
Third, more importantly, for Brazil to become a major destination for global savings in the future will require learning the right lessons from the global crisis. As Joseph Stiglitz reminds us in the July issue of Vanity Fair, Brazil is one of those emerging markets where a conviction exists that the global economy has not treated it fairly, even though it has done relatively well. For many in Brazil, and throughout Latin America, Wall Street’s cherished ideals of “free and unfettered markets” are something to run from, not embrace. Stiglitz is right in arguing that the proper lesson from the current crisis is that what is required for long-term economic success is a regime in which the roles of market and government are in balance, not one in which excessive market intervention by the state undermines markets and destroys incentives. Brazil in many areas needs to improve the functioning of markets, promote competition, curb the powers of banks and other special interests, regulate intelligently, and reduce the amazing number of obstacles to doing business in the country.
It is in this realm of ideas that the most interesting debates in Brazil are taking place. I would be confident that Brazil will preserve the foundations of a market economy even while strengthening many forms of government intervention, including government financing of private companies, heretofore scorned in the United States. But confidence is not complacency. A more affluent Brazil will need to get the balance between market and state right. Failure to do so would be a huge lost opportunity for Brazil and a blow to hopes for more balanced growth in global demand in the future.