On Sunday, October 31, Brazilians will choose the next president up until 2014. Despite the poor quality of the debate during the election campaign, the quote from Churchill that “democracy is the worst form of government except for all those others that have been tried,” remains valid.
The main economic issues were not adequately discussed during the presidential election run-off campaign. Moreover, the candidates frequently changed their positions on issues at the whims of marketers and their unfathomable intentions. The following is a list of some of the key issues for which it will be fundamental for the future president to act.
I begin with long-term themes, which are the most important, despite always being relegated to second place. It is commonly and correctly asserted that the rate of investment to GDP, especially investment in infrastructure, will have to increase significantly in order to achieve sustainable growth.
Besides physical capital, it will be necessary to increase investments in human capital, thus improving the educational level of our workforce. A great deal of progress has already been made. Nowadays, nearly all children go to school and the average number of years of schooling has been gradually increasing. Unfortunately, our schools teach very little. International standardized tests show that our students obtain very low scores compared to students from other countries, several of which are poorer than Brazil. It is common to attribute the inefficiency of our educational system to a lack of funds, as if the mere allotment of a certain percentage of the budget to education would be able to resolve all problems.
Notwithstanding the importance of accumulating more physical and human capital, it is just as, if not more important, to raise total factor productivity (TFP). TFP is a measure of the economy’s overall efficiency, including technology and the allocation of factors of production. Research in the field of economic development has underpinned the formation of policies designed to increase TFP. Various studies show that Latin America’s low levels of TFP, even after the implementation of important economic reforms, is related to inefficiencies in factor of production allocation. Informality plays an important role in reducing TFP, because informal firms tend to be inefficient due to their inability to grow. Other factors that are detrimental to TFP’s growth in Brazil are: barriers to the entry and exit of firms from Brazilian markets; labor legislation that hinders efficient worker reallocation; a very complex tax system with excessively high taxes; an economy that is still closed to international trade; the high cost of credit and firms with a low innovation capacity that hardly invest in research and development. The removal of some of these obstacles to growth requires wide-ranging reforms, but others could be removed by smaller, more focused measures. Bringing back some of the past’s good practices, such as independent regulatory agencies staffed by competent professionals, would also improve TFP.
The main long-term risk facing the Brazilian economy is a fiscal one involving public and private pensions. Brazil’s demographic prospects provide an excellent opportunity to resolve this problem in a gradual fashion over the next 20 years when there will be many people working in relation to the number of older people and children. But it is difficult to carry out the reforms that are essential to the country in the long term, given the significant short-term political costs, as shown by the recent French example.
Among the medium-term challenges, one should highlight the issue of financing higher rates of investment. In order to achieve sustainable growth rates of around 5% a year, it will be necessary to substantially increase investment levels. Given our economy’s low internal savings capacity, especially in the public sector, we will have to tap external savings. That is, in order to achieve sustainable growth, we will have to face a long period of high balance of payments current account deficits. This is not necessarily a problem, as the investments undertaken, for example in the pre-salt oil fields, will generate funds in the future. Nevertheless, having to absorb a high volume of foreign funds during a considerable period of time will require the economic authorities, particularly the Central Bank, to remain vigilant to prevent the development of speculative bubbles that would abort growth when they burst.
In spite of the countless advances recorded in the development of a sound institutional framework, highlighting especially the Fiscal Responsibility Law (2000), the main medium-term risk is also fiscal. The resumption of economic growth, together with an increase in the formalization of firms and workers, has led to successive increases in tax revenues. Unfortunately, the government has spent these additional funds on current expenditures instead of making necessary investments and increasing public savings. But this is not all. Recently, the government has learned a new trick: how to create fiscal revenues or loans to official financial institutions without increasing its net debt. If these reprehensible practices, which are demoralizing our fiscal statistics, are maintained in 2011, the fiscal risk will increase substantially. It is crucial to restore the lost credibility of our fiscal statistics.
Even in the short term, the impacts of this enormous recent fiscal expansion are extremely negative. Fiscal expansion based on current spending increases aggregate demand and inflation, forcing the CB to maintain high interest rates. Additional spending arising from fiscal expansion hampers investment, and also increases consumption spending, especially on non-tradable goods. That is, it contributes directly to the real exchange rate appreciation. As the Central Bank has to react to an increase in inflation with higher interest rates, the latter attract more foreign capital, which appreciates the nominal exchange rate.
In sum, the combination of an expansionist fiscal policy with a restrictive monetary policy which has been practiced in Brazil for many years, but which has gone into overdrive in recent times, is exactly the opposite of what should be done. This enormous expansion in current public spending must be curbed in order to reduce interest rates and thus help depreciate the real exchange rate. The effectiveness of capital controls, like those that have been created recently is relatively limited and short-lived. It would be highly desirable that the next president, right at the beginning of his or her mandate, make changes in fiscal policy aimed at reducing the growth of current fiscal spending. If this is not done, we run the risk of still hearing the well-worn joke that Brazil is the country of the future and always will be, when the next presidential election comes round.
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