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Brazil sean-1

  1. 1. WHY IS BRAZIL AN EMERGING MARKET ECONOMY? BY SEAN WILLIAMS APRIL 2011 In 2001, Jim O’Neill, the head of global economic research at Goldman Sachs, coined theacronym “BRICs” to refer to Brazil, Russia, India, and China, the emerging market economies(EMEs) he thought would lead world economic growth for the next 50 years. Since that timemany academics, economist, and journalists have written about the idea of the BRICs, and theacronym has become common. This FAQ seeks to explain briefly why Brazil is an emerging market economy (EME)and warrants being the first letter in BRIC. The FAQ will begin by highlighting and explainingsome of the factors that make an economy an “emerging economy” as opposed to a developing,developed, or advanced economy. As EMEs are somewhere between developing and advancedeconomies, the FAQ will then explain why Brazil is not already an advanced economy beforegoing on to explain what Brazil has done to emerge from the status of a “developing economy.”The FAQ will conclude with a section explaining some remaining issues that Brazil must addressto reach the goal of becoming an advanced economy. WHAT DOES “EMERGING MARKET ECONOMY” MEAN? There is no fast and simple definition of an emerging market economy, but when readingabout EMEs some common themes emerge. EMEs are characterized by fast economic growth,increased foreign investment, and increased international political clout. Fast growth isevidenced by strong economic data, as in rising gross domestic product (GDP), GDP per capita,trade volumes, and foreign reserves. Faster growth generally means higher profits for foreign 1
  2. 2. investors, which encourages more foreign investment in a country, which, in turn, promoteseconomic growth. Countries can attract foreign investors by pursuing sound macroeconomic policies andbeing open to international trade. EMEs are generally more open to international trade thanother economies, including advanced economies. This openness is spurred initially by export-ledgrowth models, but it functions to diversify the goods countries export. Some experts argue thatdiversification and general integration into the international economy help reduce the effects ofsudden changes in global prices or other internal or external economic shocks, making thecountry more stable for investors. Macroeconomic policies are policies that affect broad parts of the economy. Soundmacroeconomic policies help stabilize financial inflows and make foreign investors lessconcerned about the safety of their investments. Economists that focus on developing andemerging economies typically define sound macroeconomic policies to include privatization ofstate-owned businesses, liberalization (i.e., opening) of domestic banking systems and stockmarkets for easier access by foreigners, sound fiscal and monetary policies, and a reduction inexternal debt. This list is by no means exhaustive. Fast growth and high rates of investment often lead to increased influence on a regionaland international scale. The level of international political clout varies from country to country,but EMEs generally are gaining power and influence internationally, especially compared toother developing countries. They are leaders in their respective regions, and are oftentimesresponsible for representing the interests of that entire region in global economic affairs. The term “emerging” suggests that EMEs have not achieved a level of development onpar with advanced economies such as Germany or the United States. One could point to many 2
  3. 3. factors that contribute to the status of an EME, but some of the most important are policyfailures, weak institutional structures, and inequality. Policy failures could come in manyforms—two common examples are uncontrolled spending and protectionist trade regimes. Apolicy is considered a failure if it prevents the economy from performing at its highest possibleefficiency. Bad policy and weak institutional structures (e.g., regulatory and judicial) raisetransaction costs for foreign and domestic investors, which makes doing business in that countrymore difficult and therefore less inviting to potential investors. Inequality among a country’s population hinders overall economic potential. Thoughinequality has many negative side effects that can affect an economy (e.g., more crime), theinefficiency it causes in investment by denying parts of the population the funds needed to startpotentially lucrative businesses or otherwise invest in their communities is among the mostimportant. This happens because lending institutions view the very poor as high credit risks, andtherefore are not willing to lend to them unless they (financial institutions) are able to chargehigh interest rates or obtain adequate collateral as security for loans. These requirementsprevent the nation’s poor from gaining access to credit or force them to use that credit morerestrictively to ensure their ability to repay, both of which prevent the credit from being used asproductively as possible. If a whole segment of the population is not fully participating in theeconomy, the economy does not function at maximum capacity or efficiency. Some economists argue that the negative effects of inequality are compounded incountries where the people with the money are also the people with the political power. Theargument assumes that wealthy politicians are more likely to underfund basic public services(education, housing, public transportation, etc.) that they themselves do not use or need, to lowertheir own tax burden. These economists suggest that if instead they provided those basic public 3
  4. 4. services, more citizens would be able to participate effectively in the national economy, whichwould increase growth and widen the tax base, opening the possibility of lowering the tax burdenon the wealthy. In other words, all sectors of society would share the benefit of equal economicparticipation. With these factors in mind, one can effectively answer the question “why is Brazil anemerging market economy?” Putting aside the problematic aspects of the terms “emerging,”“developed,” or “advanced,” to determine why Brazil is an EME, one must first determine why itis not already a developed or advanced economy. WHAT WENT WRONG IN BRAZIL AND WHY DID IT NEED TO CHANGE? Brazil’s economic story is long and complex. For our purposes, only the basics arenecessary to understand why it is not yet a developed country. When Brazil achieved itsindependence from Portugal in 1822 it had the lowest GDP per capita of any New World colony.It wasn’t until the early twentieth century that the Brazilian economy began to show signs of life.From 1913 to 1980, Brazil grew faster than any other country in the Western Hemisphere thanksto high commodity prices and industrial production spurred by government spending programs.The growth stopped in 1983 when Brazil defaulted on its foreign debt. This historic low-pointis a good place to begin a more in-depth analysis of Brazil’s economic history. From 1965 to 1985 a military junta ruled Brazil. The regime followed import-substitution policies designed to foster industrialization by protecting Brazilian industries fromforeign competition. This required the country to borrow vast amounts of money to build theinfrastructure (roads, ports, factories, etc.) necessary to support industrial production. When theOrganization of Petroleum Exporting Countries (OPEC) raised oil prices in 1979, Brazil had todouble the amount it spent on imported oil—money it borrowed from foreign banks flush with 4
  5. 5. petrodollar deposits from OPEC countries. In 1981, the United States compounded Brazil’sbudget issues by raising interest rates, which increased Brazil’s debt service payments, alongwith those of several other Latin American countries. In 1982, Mexico defaulted on its foreigndebt, instantly drying up foreign sources of capital for many Latin American countries, includingBrazil. With no access to foreign capital, Brazil was unable to pay its debts and continuedspending on its industrialization program. Having defaulted on its foreign debt, it had no otherchoice but to turn to the International Monetary Fund (IMF)—a lender it had long avoidedbecause of the strict conditions put on loans—for the financing it needed. The IMF, as Brazil’s lender-of-last-resort, held significant power over Brazil’s economicpolicies. The Fund required Brazil to devalue its currency, cut public spending, freeze all wages,reduce the level of subsidized credit available, and cut the amount of foreign borrowing by state-owned enterprises as conditions for IMF loans. In 1983, Brazil’s GDP fell 4%, employment fell12%, and inflation was at 211%. For the next 25 years the country’s economy barely grew at all. HOW DID BRAZIL EMERGE? In 1985, the military regime handed power to a civilian government led by José Sarney,but he too was unable to control inflation and ultimately defaulted on the country’s foreign debtagain, leading to deep distrust of the government. In 1989, Fernando Collor de Mello becamethe first democratically-elected president in nearly thirty years. He quickly adopted a liberalinternational trade regime (i.e., lower barriers to imports) and privatized many state-ownedbusinesses—the first in a decade of reform that set the stage for Brazil’s current growth.Inflation continued to be a problem until 1994, when Collor’s successor, Itamar Franco,announced the “Real Plan,” written by future President Fernando Henrique Cardoso. 5
  6. 6. Before the Real Plan, the Brazilian government had tried various policies to stophyperinflation (in 1990 it reached nearly 7,000%) including wage freezes, price freezes, and afixed exchange rate. The Real Plan was a much more comprehensive plan. The Plan introduceda new currency (the real), de-indexed the economy (prices were no longer pegged to the rate ofinflation), tightened monetary policy, introduced a managed floating exchange rate regime, andincreased taxes. There were also provisions to lower tariff barriers for foreign importers whosecompetition, in theory, would prevent Brazilian monopolies and oligopolies from raising pricesunilaterally. Tariffs ultimately fell from an average of 51% in 1988 to 14% in 1994. The launch of the Real Plan was the first time Brazil showed the economic disciplinenecessary to attract the foreign capital and investment that has propelled Brazil’s growth. It wasalso successful in raising the standard of living throughout the country by lowering inflationfrom 45% in 1994 to less than 1% in two years. Lower inflation has the practical effect ofraising real wages by reducing prices, and therefore increases the buying power of wage earners.The success of the Plan is what propelled then Minister of Finance Fernando Henrique Cardosoto victory in the 1994 presidential election. In his first term in office, Cardoso continued the privatization process started by PresidentCollor, stabilized a weak banking sector, and started a conditional income transfer program (theBolsa Família program) to help the poor. He won reelection in 1998, but in his second termBrazil faced yet another crisis—the 1999 “Real Crisis.” Though the 1994 Real Plan is widely considered a success, it failed to properly addressthe country’s growing fiscal deficit. Unfortunately for Brazil, concerns over the sustainability ofits debt began to arise right as the developing world experienced a series of financial crises.Brazil was not immune from the “contagion” of the 1997-98 Asian Financial Crisis (discussed in 6
  7. 7. the E-Book), where currency speculators bet against the currencies of several countries,successfully forcing down the values of those currencies. Speculators then focused on Brazil.To stave them off and prevent capital outflows, Brazil raised interest rates, which makescurrency speculation less profitable. As a side effect of raising interest rates, industrial production fell as domesticconsumption faltered due to higher borrowing costs. Lower industrial production meant Brazil’sexports decreased, and therefore its ability to pay for imports without borrowing declined aswell. To pay for necessary imports, Brazil had to borrow and increase its debt even further.Because Brazil had defaulted on its debt twice in the last twenty years, as its debt level increasedinvestors began to fear another default and began withdrawing capital from the country.Speculators also bet against the currency—betting that its value would decrease. PresidentCardoso’s inability to pass fiscal restraint legislation through Congress further raised investors’concerns about a possible default. To alleviate fears of default and defend against currencyspeculators, Brazil sought and received a $41.5 billion loan from the IMF. The fatal blow camefrom within Brazil when the state governor of Minas Gerais announced that the state would nolonger pay its debts to the federal government. After this announcement, capital outflowsskyrocketed from already high levels, forcing Brazil to devalue its currency by 9% andeventually allow the real to float freely in international markets. Then came the great surprise. The crisis did not cause a long-lasting disruption of the flow of foreign capital into Brazil.Cardoso’s macroeconomic policies had proven successful—public sector revenues were rising,which gave Brazil more money to pay its debts, privatization reduced the losses borne by thestate, and increased agricultural production helped keep food prices stable—all of which helpedblunt the effect of the crisis. Banking reforms had forced banks to keep more cash on hand by 7
  8. 8. lowering acceptable leverage rates, ensuring that banks had sufficient capital to pay fleeinginvestors without causing banks to fail or creating a risk to the entire banking system. The crisis quickly subsided and the real stabilized. Cardoso was able to finish his secondterm by capping discretionary spending and raising tax revenues—both of which helped addressthe long-standing issue of ever-rising debt, but failed to bring the dramatic change necessary toput Brazil’s debt problems in the past. Cardoso was constitutionally barred from running for athird term, and was replaced in 2002 by Luiz Inácio “Lula” da Silva. It was under Lula that Brazil truly began to emerge economically. Though his politicswere generally very liberal, he sought to appease foreign investors while on the campaign trail bypromising to honor contracts, protect private property, assert fiscal discipline, and pay off debts.Once in office, he eliminated nearly all concerns by following the “orthodox” economic path ofhis predecessor. He also gave the Brazilian Central Bank greater operational autonomy, ensuringthat it would make policy choices based on what is in the best interest of the economy withoutpolitical influence. Interest rates fell to 6% (Cardoso had lowered them from 20% to 10% inspite of having to raise them during the Real Crisis), which made it cheaper for Brazilians toborrow money to expand businesses inside and outside Brazil. None of this prevented Lula from pursuing a social development agenda. He lifted tensof millions of people out of poverty by increasing social expenditures, but he paid for thisspending by increasing tax collection, not by borrowing. He also fostered greater ties with otherEMEs and developing countries to help lessen dependence on the developed world as a source ofconsumers of Brazilian products. Lula had his turn at facing a financial crisis when the 2008 U.S. financial crisis spreadglobally. A common feature of the EMEs is that they generally handled the 2008-2009 financial 8
  9. 9. crisis better than developed economies. This had not been the case in past crises. For EMEs, aglobal recession generally meant higher unemployment and a larger contraction of industrialproduction than in the developed world. Brazil’s GDP shrank slightly in 2009 before returningto booming growth in 2010, while the U.S. economy is still barely growing in 2011. WHY DID BRAZIL HANDLE THE GLOBAL FINANCIAL CRISIS SO WELL? Brazil’s strong performance through the global financial crisis is partially attributable tothe fact that its banks were and still are less exposed to the U.S. mortgage-backed securitiesmarket where the crisis started. Thanks to President Cardoso’s reforms, Brazil’s banks wereunable to expose themselves to as much risk as other banks around the globe. Brazil’s bankingsector also benefits from having one central regulator—the Central Bank. Some observers arguethat having one regulator supervise every aspect of banking activities is more efficient andeffective than the systems with multiple regulators responsible for supervising different aspectsof the banking sector, as in the United States. Taken in combination, these policies ensured thatBrazil’s banks would not need large bailouts to stay afloat, unlike their U.S. counterparts. Brazil also benefited from a low unemployment rate and less dependence on trade withthe developed world. Having a low unemployment rate meant that Brazil had a large number ofwage earners to keep demand for Brazilian manufactured products high. Increased trade tieswith other developing and emerging economies also helped keep demand for Brazilian goodsstable. Those increased ties were a focal point of Lula’s foreign policy. Having a diversifiedprofile of customers made Brazil less dependent on demand from the developed world, meaningthe demand for Brazilian goods stayed high even as developed world demand droppedprecipitously. 9
  10. 10. This is not to say that Brazil went through the crisis completely unscathed. Thegovernment did have to provide a stimulus package amounting to 1.5% of its GDP to spur theeconomy, but that paled in comparison to the stimulus packages in Japan (15% of GDP) and theU.S. (7% of GDP). Brazil’s unemployment rate also rose slightly during the crisis, but has sincehit record lows while the developed world continues to struggle with high unemployment. President Lula da Silva’s greatest success may have been his ability to increase Brazil’sinfluence internationally. He led calls for greater voice for the developing members of the IMFand for a shift from the G-7 to the G-20 (which includes more developing countries, includingBrazil) as the main forum for addressing global economic issues. Both of these calls wereultimately successful. The IMF recently agreed to shift more voting power to EMEs (includingBrazil), and in 2009 the G-20 became the major forum for international economic cooperation.However, Brazil has not been successful in its demand for a permanent seat on the UN SecurityCouncil, though the U.K. recently endorsed its campaign. This failure is due, in part, to Brazil’sopposition to sanctions against Iran for continuing to pursue a nuclear program. When Lula handed power over to his successor, Dilma Rousseff (the first femalepresident of Brazil), his approval rating was over 80% and the economy had just grown by 7.5%in 2010. He had increased spending near the end of his term, which heightened fears of inflation,but President Rousseff promised fiscal restraint during her term, while continuing Lula’s policyof allowing the Central Bank to operate autonomously to control inflation. The promise to cutspending, along with a promise to cut the nation’s high interest rates, is exactly what investorsthink is necessary to ensure that inflation does not derail Brazil’s current growth. PresidentRousseff’s first major political win—getting the Congress to agree to a lower-than-desired raise 10
  11. 11. to the minimum wage—surely appeased investors by showing a commitment to both reducingspending (public pensions are indexed to the minimum wage) and controlling inflation. WHAT IS BRAZIL DOING TO BE SO DYNAMIC? Four policies have played, and continue to play, an important role in pushing Brazilforward: 1) its emphasis on building the infrastructure necessary to support a diverse and fullydeveloped economy, 2) a commitment to reducing poverty and inequality to ensure themaximum number of citizens can contribute to economic growth, 3) an increasing openness tothe world, and 4) its movement to reform domestic institutions to foster efficiency.1. INFRASTRUCTURE No economy will function at its highest capacity if poor infrastructure—bad roads,insufficient sea ports, lack of technology—creates inefficiencies at the various stages ofproduction. Brazil has spent much of its new wealth improving infrastructure hoping that it willfacilitate further economic growth. The most important of such projects is the “GrowthAcceleration Plan” (known by its Portuguese acronym PAC), authored by current PresidentRousseff while she was a member of Lula’s cabinet. The “Growth Acceleration Plan” is an umbrella term for thousands of infrastructureprojects across the country. The program started in 2007 with an initial $4.2 billion investment.The main goal is to improve the poor infrastructure that has created a pattern of social exclusion,and thereby expand economic potential in traditionally neglected areas. The poor are more likelyto live in areas with bad roads, poor public transportation, few available jobs, limited or noaccess to credit, and no mail or commercial delivery services. These and other issues prevent thepoor from fully participating in Brazil’s economy. PAC seeks to remedy this problem bybuilding or rebuilding homes and roads, and improving sanitation, sewage, water, and electrical 11
  12. 12. services in the poorest areas of Brazil’s cities. To maximize the program’s impact, thegovernment hires the people that live in those neighborhoods to perform the work. Thissimultaneously creates employment in the short term in areas where unemployment isdisproportionately high, while making changes that should help spur long-term economicgrowth. Regrettably, there are conflicting reports as to whether the projects are actually beingcompleted. President Lula da Silva denied the negative reports, but admitted that progress hadbeen slower than he hoped, blaming bureaucracy for the delays. This admittedly slow progressdid not prevent him from announcing an $880 billion extension of the program in March 2010(PAC II), when PAC I was only 50% completed. PAC II includes more business-focusedinvestments while continuing the poverty-reduction investment projects of PAC I. The maingoals of PAC II are to increase the country’s energy production capacity, build two million newhomes (to cut the estimated housing deficit to three million homes), and make infrastructureimprovements for the 2014 World Cup and 2016 Olympics to be held in Brazil, includingbuilding a high-speed rail to connect Rio de Janeiro and São Paulo—Brazil’s two largest cities.Once completed, these projects will greatly expand Brazil’s economic potential for years tocome.2. REDUCING POVERTY AND INEQUALITY One of Brazil’s most important policy goals has been to reduce poverty to increaseparticipation in economic activities. It has done so through its well known “Bolsa Família”(“Family Scholarship”) program. President Cardoso designed the program (with technical andfinancial support from the World Bank) as a way to reduce poverty and break the cycle ofpoverty. Through the program, poor families receive money each month (about $35) on the 12
  13. 13. condition that they keep their children in school and take them for regular health checkups, withthe hope being that those children will grow up to be healthy, educated workers capable ofindependently supporting themselves and their families. Eleven million families (approximately46 million people) benefit from the program. The program has raised income at the grass roots level, with 94% of the funds going tothe poorest 40% of Brazilian society—most of whom had never benefited from social programsbefore. It allows recipient families to consume more (studies show that most of the money isspent on food, school supplies, and clothes for children), which has created a “trickle up” effect,where Brazilians sellers benefit from having more customers, and producers benefit from sellinglarger quantities of their products. It has given a large boost to rural economies and hasincreased the federal and state tax bases. From 2001 to 2008, the inequality gap shrank by 6%—the largest improvement in Latin America—and millions of people have been lifted out ofpoverty, proving that the program is working.3. INCREASED OPENNESS TO THE WORLD Brazil has further facilitated its economic ascension by opening itself to the worldthrough new international trade and foreign investment policies. Since the mid-1990s, Brazil haslowered its import tariffs while modernizing its overall import system (customs inspections,payments, etc.), making it cheaper and easier for foreign countries and companies to sell theirproducts in Brazil. Due to these changes, Brazil’s imports have steadily increased, helping tobalance its current account surplus. The amount of foreign direct investment flowing into Brazil has steadily increased sincePresident Cardoso introduced the Real Plan in 1994, thanks in part to the high investment returnsassociated with fast growth and high interest rates. Some of Brazil’s other policies have played a 13
  14. 14. role as well. To begin, there is no legislative difference between treatment of foreign anddomestic investors—in other words, Brazil adheres to the national treatment standard. Unlikemany countries, Brazil sets no maximum or minimum level for foreign investments and allowsforeign companies to fully remit profits abroad. For better or for worse, to draw foreigninvestment, Brazil does not evaluate the potential effects of investments on the national economyor ensure that the country will somehow benefit before approving investments. Foreign investment is further facilitated by improvements in Brazil’s capital markets. In2008, the São Paulo Stock Exchange merged with the mercantile and futures exchange to formthe largest exchange in Latin America, and the fourth largest exchange in the world with marketcapital of $1.167 trillion. Disclosure requirements for listing on this exchange are on par withmarkets around the world, giving investors confidence that they have all the relevant informationavailable to them to make a prudent investment. All of these efforts have made it easier, safer,and more profitable for foreigners to invest in Brazil.4. INSTITUTIONAL REFORM As Brazil has grown, it has made a concerted effort to improve government institutions tomake them more efficient for both Brazilians and foreign investors. Most important among thesereforms, at least as far as encouraging investment is concerned, has been reforming the judicialsystem. A 2006 constitutional amendment mandated judicial reform and made judicialexpeditiousness a constitutional guarantee—an important step for Brazil’s traditionally slowlegal system. In 2007, the country passed a new law that allows some decisions of the FederalSupreme Court (the highest constitutional court in Brazil) to have precedential value, meaningcertain decisions will bind lower courts on the particular issue of a case whenever it arises in thefuture. Though this is standard procedure in the “common law” countries like the U.S. and U.K., 14
  15. 15. it is an uncommon practice in so-called “civil law” countries like Brazil. It will prevent thecourts from having to decide the same issue over and over again, making the entire system faster.A fast, efficient judiciary is cheaper and more reliable for enforcing property and contractrights—two things with which foreign investors are deeply concerned. Thanks in large part to these reforms Brazil is currently experiencing possibly its greatesteconomic growth in history—averaging GDP growth of 4.5% per year since 2002. Thecountry’s GDP expanded by an estimated 7.5% in 2010, which brought total GDP to almost $2.2trillion—the highest in Latin America, and GDP per capita to over $11,000 (sixth-highest inLatin America). Furthermore, joblessness is at an all-time low, foreign exchange reserves havesoared (sixth-highest in the world), and the country’s sovereign debt received an all-importantinvestment-grade rating in 2008. By any measure Brazil is in good economic shape. But bydefinition, emerging market economies are not yet fully developed or advanced economies. Sowhat exactly is still holding Brazil back? WHAT IS HOLDING BRAZIL BACK? As is the case with explaining growth, there is no one thing that explains why Brazil isnot “there” yet. The most commonly mentioned problems Brazil faces are 1) policy failures thatinhibit economic activity, 2) a cumbersome regulatory and legal framework that limitsefficiency, 3) excessive inequality that prevents full and equal economic participation for allBrazilians, and 4) external factors that inhibit Brazilian economic interests.1. POLICY FAILURES Brazil’s biggest policy failure is that its government still spends too much money.Among other things, high spending contributes to high interest rates that make borrowing moreexpensive, and currency appreciation that hurts exporters by raising the cost of goods produced 15
  16. 16. domestically. President Lula da Silva was fairly prudent in not spending too much for most ofhis term, but he spent more at the end of his term as he bowed to populist pressures during theelection cycle. President Rousseff promised to cut spending during her campaign, and so far hasshown a commitment to doing so, but it is too early to know if she will ultimately be successful. A second major policy failure is Brazil’s continued dependence on commodity exports(mainly food and oil) to drive growth, which creates inflationary pressure and currencyappreciation. The appreciated currency negatively affects other sectors of the economy—inBrazil’s case, the manufacturing sector whose products are now more expensive and thereforeless competitive globally—making the country even more dependent on commodities over time.Excessive dependence on exports may also increase a country’s exposure to external marketshocks. Unfortunately, Brazil appears poised to expand its dependency on commodity exports asit recently discovered huge oil reserves and has made large investments in its ethanol andagricultural sectors. These commodities are currently as profitable as they have ever been forBrazil, but that may have more to do with a global food shortage and over-speculation in the oilmarkets driving prices up than with any economic wisdom of the Brazilian government. Thegovernment plans to put new oil profits in a sovereign wealth fund to prevent increased spendingfrom further pushing up the value of the real, but whether it will adhere to that policy in the longterm is yet to be determined. Corruption is another major policy failure. Transparency International, an NGO thatmeasures corruption throughout the world, ranks Brazil as the 69th least corrupt country out of178 total. The roots of corruption are far too complex to deal with fully here, but it is importantto note how Brazil’s political structure fosters corruption. Brazil’s political system allows more 16
  17. 17. than twenty political parties to participate in elections. These parties are in a constant scramblefor government money in the form of welfare benefits, government jobs, payrolls, and contractsthat would help influence voters. This system inhibits efficiency and productivity byencouraging corruption, as it is often the easiest alternative to securing funds for constituentswhen politicians lack voting power, as is often the case in a system with twenty political parties.The government must find a way to stop this corruption and prevent public officials fromsiphoning funds away from needy individuals and economically beneficial projects, a task thatmay be more difficult now with enormous potential oil profits looming on the horizon.2. FAILURES IN THE REGULATORY AND LEGAL SYSTEMS With the exception of corruption, the policy failures discussed above have little directeffect on foreign investors. The continuing issues with Brazil’s regulatory and legal framework,however, do affect foreign investors by making it riskier and more expensive to do business inBrazil. The National Federation of Industries termed these extra costs of doing business inBrazil the “Custo Brasil” (“Brazil Cost”). Principal among these costs is the high tax burdenmentioned above. Taxes represent 36% of Brazil’s GDP compared to only 8% in China,meaning that Brazil relies on and collects huge tax revenues to help fund government projects.But besides the high amount of taxes, Brazil’s tax code is extremely complex, makingcompliance a lengthy and expensive process. Brazil ranked 152nd in the World Bank’s “DoingBusiness” ranking in terms of ease of paying taxes. It took the World Bank’s hypotheticalcompany 2,600 hours to fully comply with the tax laws, which makes it a costly endeavor. Thetax system desperately needs to be simplified. Cumbersome regulations also make starting a business an expensive ordeal. Brazil wasranked 128th in the world in terms of ease of starting a new business according to the same 17
  18. 18. World Bank study. It takes an average of 152 days to register a business in Brazil, compared tothe world average of 48 days. Brazil’s labor laws further complicate the system by making itnearly impossible to fire workers due to strict requirements for showing cause (employeelaziness and employer bankruptcy are not just causes for firing workers) and the costly finesimposed for violations. Though Brazilians take pride in finding ways around these regulatorycosts (they have even given the ability to skillfully avoid regulations a name—jeitinho), theysurely make investors think twice before starting a business in Brazil, and must be addressed ifthe economy is to attract foreign companies to Brazil. A slow and inefficient judiciary adds to the “Custo Brasil.” Brazil’s courts simply havetoo large a case load to function quickly or efficiently. Though the courts have never beenknown as exemplars of efficiency, case loads have skyrocketed since the country passed a newconstitution in 1988 that granted extensive personal rights that Brazilians have often sought toenforce through the court system. The increase in cases can also be attributable to the highestcourt’s overly broad original mandatory jurisdiction (meaning the cases it must hear before anyother court instead of waiting for a case to come to it on appeal). Though Brazil has made steps towards strengthening the concept of controlling precedentin its courts, it does not yet apply to all decisions. It is estimated that 90% of the highest court’scaseload still consists of questions that it has already decided, sometimes thousands of times.This not only consumes time and money, but also risks inconsistent application of the law. Oneformer President of the Supreme Tribunal said that judicial caseloads are so high in part becauseof the government’s bad faith refusals to pay judgments, choosing instead to appeal casesindefinitely to delay payment, knowing that it has no chance of winning the cases. The onlyreason this is even possible is that the Brazilian system allows for an inordinate number of 18
  19. 19. appeals of all sorts. Appeals can greatly extend court proceedings and therefore court costs aswell. If these issues have not already scared foreign investors away, there are still moreconcerns. Property rights are poorly defined and not well enforced, there is no pre-trial factualdiscovery process (making it difficult for parties to gather all the relevant facts for trial), andclass actions are becoming more and more common as Brazil leads a movement throughout LatinAmerica to grant shareholders greater rights against the companies in which they invest. Noneof these issues alone is fatal to Brazil, but combined they make the prospect of investing inBrazil potentially both riskier and more costly.3. INEQUALITY Inequality is possibly the most commonly known threat to Brazil’s progress. In spite ofBrazil’s phenomenal growth, inequality still holds it back—it is estimated that for every 10%increase in poverty there is a corresponding 1% reduction in economic growth. For Brazil thismeans that economic growth could increase by two or three percentage points each year byeliminating poverty. Currently, the top 10% of the population accounts for 43% of totalconsumption, while the bottom 10% makes up only 1.1%. While CEOs in São Paulo make moremoney than CEOs in New York City, over 10 million Brazilians live on less than $1.25 per day.The end result is that Brazil is still the eighth-most unequal country in the world and third-mostin Latin America. Brazil’s inequality is not a new phenomenon. It is generally blamed on unequaleducational attainment and unequal land distribution, both of which have their roots in thecolonial era. During the colonial era, the government saw little need for education in areas thatwere heavily populated with slaves and lightly populated by Europeans, and therefore there was 19
  20. 20. no educational infrastructure in those areas when slavery finally ended in 1889. Unfortunately,the educational attainment gap has done nothing but grow since that time. Wealthier, whiterBrazilians have continuously dominated politics and have chosen to invest Brazil’s money in thewhiter southern part of the country, while generally ignoring the black and indigenouspopulations of the north. This is a common practice in cities throughout the country as well. Brazil is not likely to correct this problem in the near future. The education system isinadequate throughout the country. President Cardoso entered the country into the Program forInternational Student Assessment run by the Organization for Economic Cooperation andDevelopment (OECD, an international organization comprised almost exclusively of developedcountries) to compare Brazilian student achievement to student achievement in the developedworld. Brazil now ranks 53 out of 65 (initially it came in last place when fewer countriesparticipated), which is mediocre even by Latin America’s low standards. Any marginalimprovements that have been made are attributed to President Cardoso’s “Bolsa Família”program and his decision to mandate minimum per-pupil spending and teacher salaries. Brazilcould increase spending for education even further if it diverted spending away from generouspensions teachers receive after only 25 years of work for women or 30 years for men, but someobservers doubt that throwing more money at the problem is the best solution. Besides funding, poor quality teachers are an issue in Brazil as well. To become ateacher in Brazil, a university student is not required to take courses on teaching skills or thesubject matter he or she is going to teach, but rather he or she will study the philosophy ofeducation. Few people consider this the best way to train effective teachers. Nearly half of allteachers in São Paulo fail to meet the minimum standards required to receive a permanentcontract. Until Brazil solves these myriad problems with its educational system, there is likely to 20
  21. 21. be little upward mobility for the poor, and the country as a whole will suffer as it will continue todepend on either imported labor or foreign educational systems to provide it with the skilledlabor it needs to continue its economic growth. A poor education system is also related to Brazil’s land distribution problem. The issueis most evident in Brazil’s largest cities where squatters have taken up residence illegally on anyopen space they can find. These illegal settlements have grown into entire neighborhoods called“favelas” where hundreds of thousands of people live with almost no government services,including schools. The residents of these neighborhoods (usually minorities) lack title to theirland, and therefore lack what for many people is their most valuable asset. The residents alsoface gross discrimination from employers, banks, and oftentimes the police just based on theiraddress. The favelas are usually overrun by drug gangs and usually lack basic services likerunning water and electricity. Though the government has made progress in recent years againstthe gangs, the problems facing the favelas will not be solved any time soon, which will continueto effectively exclude many favela residents from participating equally in the education systemand formal economy.4. EXTERNAL FACTORS Brazil’s economic progress is also inhibited by external factors it cannot directly control.Chief among these are U.S. and Chinese trade policies, both of which negatively affect thecompetitiveness of Brazilian goods globally. Brazil has long criticized the United Statesgovernment for subsidizing the production of agricultural goods like cotton, sugar, and corn.These subsidies allow U.S. farmers to compete with more efficient and lower-cost Brazilianproducers by lowering production costs in the U.S., which reduces the demand for Braziliangoods by increasing the supply of the same goods at similar prices. 21
  22. 22. In 2005, the World Trade Organization (WTO) ruled in Brazil’s favor in a case againstthe U.S. regarding a U.S. subsidy for cotton farmers. By 2010, the U.S. had still not compliedwith the ruling, so the WTO granted Brazil permission to place retaliatory tariffs on U.S. goods.The U.S. and Brazil were able to negotiate a temporary resolution that required the U.S. tocompensate Brazil for losses that result from the cotton subsidy, but did not require the U.S. tocut or end the subsidy. Some observers doubt this agreement will serve as a viable long-termsolution to the dispute. Brazil would also like the U.S. to remove tariffs it places on Brazilian sugar-basedethanol to protect its own corn-based ethanol industry. Brazil has spent years developing thetechnology to produce the cheap alternative fuel, only to have the world’s largest oil consumerplace heavy tariffs and effectively deny Brazil’s access to its market. Unless the United Statesremoves these trade barriers, Brazilian producers will continue to lose potential profits to lessefficient producers in the U.S. China also poses a threat to Brazilian economic growth. China, with its enormousappetite for raw materials, is now Brazil’s largest trading partner with huge purchases ofBrazilian goods, especially iron-ore and soy beans. This high demand has increased commodityprices worldwide and produced large profits for Brazil. Should China’s demand ever fall,commodity prices would likely drop and Brazil may be left trying to sell its goods at prices thatare no longer profitable. Though China is Brazil’s largest trading partner, it is also its largest competitor. China’spolicy of preventing its currency from appreciating has left its value artificially low, whichnegatively affects Brazil by making Chinese manufactured goods cheaper than they otherwisewould be compared to Brazilian manufactured goods. This causes Brazilian producers to lose 22
  23. 23. consumers both internationally and domestically to cheaper Chinese producers. Brazil hasplaced tariffs on many goods of Chinese origin to ease the problem, but this only addresses theproblem of Chinese competition in the domestic market, and has no effect on competition ininternational markets. If China does not allow the market to determine the value of its currency,Brazil will continue to lose potential profits. Unfortunately, Brazil cannot force China or theU.S. to change their ways and must continue to suffer the consequences. CONCLUSION Brazil has come a long way since its days as home to the Western Hemisphere’s lowestGDP per capita. The prudent leadership of Presidents Fernando Henrique Cardoso and LuizInácio Lula da Silva has resulted in quick growth, declining poverty, and an increased say ininternational affairs. The country can only hope that current President Rousseff will be assuccessful as her two predecessors. In spite of its recent success, Brazil’s goal of becoming an advanced economy has not yetbeen met. It must continue to diversify its economy, reduce regulatory and legal inhibitors toefficiency, and fight poverty through social spending and education. President Rousseff mustalso find a way to balance the country’s budget without slowing growth. In spite of all theseissues, Brazil is still capable of becoming an advanced economy, and certainly deserves itsposition among the BRIC countries.Sources:Albert Fishlow, Brazil: What’s Next?, Americas Society (2011), available at Ragir, Obama Gets Warm Brazil Embrace From Lula Successor Rousseff,BLOOMBERG, Mar. 19, 2011. 23
  24. 24. Alexei Barrionuevo and Ginger Thomas, Brazil’s Iran Diplomacy Worries U.S. Officials, N.Y.TIMES, May 14, 2010.Alexei Barrionuevo, Strong Economy Propels Brazil to World Stage, N.Y. TIMES, July 31, 2008.Amanda Ruggeri, A Look at the World’s Largest Stimulus Packages Outside the United States,U.S. NEWS & WORLD REP., Jan. 5, 2009.ÁNGEL R. OQUENDO, LATIN AMERICAN LAW 711-12 (2006).Anthony Galano III, International Monetary Fund Response to the Brazilian Debt Crisis:Whether the Effects of Conditionality Have Undermined Brazils National Sovereignty, 6 PACEINT’L L. REV. 323 (1994).Andre Soliani and Diana Kinch, Brazil’s Unemployment Rate Rises to a 10-Month High,BLOOMBERG, Mar. 26, 2009, available at Castelar Pinheiro et al., Brazilian Economic Growth, 1900–2000: Lessons and PolicyImplications, GLOBAL DEVELOPMENT NETWORK CONFERENCE (2001), available at Note: Brazil, U.S. OFFICE OF WESTERN HEMISPHERE AFFAIRS, Mar. 8, 2011,available at Clements, The Real Plan, Poverty, and Income Distribution in Brazil, 1997 FIN. &DEV. 44.Bolsa Família: Changing the Lives of Millions in Brazil, WORLD BANK, available at. (last visited Apr. 8, 2011).Brazil’s Offshore Oil: In Deep Waters, ECONOMIST, Feb. 3, 2011.Carlos Pereira, Obama’s Visit to Latin America: Redefining U.S.-Brazil Relations, BROOKINGSINSTITUTE, Mar. 15, 2011, available at M. Reinhart and Miguel A. Savastano, The Realities of Modern Hyperinflation, 40 FIN.AND DEV. 20 (2003).Central Intelligence Agency World Factbook, (last visited Apr. 8, 2011).DEMAREST E ALMEIDA, BUSINESS LAWS OF BRAZIL 2009-2010 EDITION 112 (2009). 24
  25. 25. Don Sull, Brazil: Why it was the Country of the Future that Always Would Be, FIN. TIMES, July27, 2010, available at Pay in Brazil: Top Whack, THE ECONOMIST, Jan. 27, 2011.Fabiola Moura, Brazil’s Lula Says World Bank, IMF Both Need Reforms, BLOOMBERG,September 23, 2009, available at H. FERREIRA ET AL., INEQUALITY AND ECONOMIC DEVELOPMENT IN BRAZIL (2004).Gary Duffy, Brazil Pushes for Bigger G20 Role, BBC NEWS, Mar. 26, 2009, available at to be New Global Economy Coordinator, REUTERS, Sept. 25, 2009, available at Faleiros, Brazilian President’s Promises Crumble under Weight of Belo Monte Dam,GUARDIAN, February 1, 2011, available at S. SCOTT, INTERNATIONAL FINANCE: TRANSACTIONS, POLICY, AND REGULATION (16TH ED.2009).Human Development Index: Brazil, (lastvisited Apr. 8, 2011).Ignore Brazils Election, Here Are The Real Problems Facing The Country, BUS. INSIDER, Oct.5, 2010, available at Board of Governors Approves Major Quota and Governance Reform, IMF PRESS RELEASENO. 10/477, Dec. 16, 2010, available at O’Neil, Building Better Global Economic BRICs, GOLDMAN SACHS GLOBAL ECONOMICPAPER NO: 66 (2001).Jim O’Neill et al., How Solid are the BRICs?, GOLDMAN SACHS GLOBAL ECONOMIC PAPER NO:134 (2005).Joe Leahy and Samantha Pearson. Brazil Bares Budget Crisis to Damp Inflation, FIN. TIMES,Feb. 9, 2011. 25
  26. 26. John H. Coatsworth, Why is Brazil “Underdeveloped” and What Can Be Done About It?, 6HARV. REV. OF LATIN AM. 7 (2007).John Paul Rathbone, UK Backs Brazil Bid for UN Security Council Seat, FIN. TIMES, November9, 2010.Jonathan Wheatly, Brazilian Growth: 7.5 = 4.5, FIN. TIMES, Mar. 3, 2011, available at de Onis, Brazil’s New Capitalism, 79 FOREIGN AFF. 107 (2000).Juan de Onis, Brazil’s Big Moment, 87 FOREIGN AFF. 110 (2008).Keith S. Rosenn, Judicial Review in Brazil: Developments under the 1988 Constitution, in LATINAMERICAN LAW 144 (2006).Knowledge@Wharton, Lessons from Brazil: Why Is It Bouncing Back While Other MarketsStumble?, 17 LATIN AM. L. & BUS. REP. 10 (2009).Krishna G. Palepu and Tarun Khanna, Institutional Voids and Policy Challenges in EmergingMarkets, 5 BROWN J. WORLD AFF. 71 (1998).M. Ayhan Kose & Eswar S. Prasad, EMERGING MARKETS: RESILIENCE AND GROWTH AMIDGLOBAL TURMOIL (2010).Mira Olson, Brazil Announces PAC 2, RIO TIMES, Apr. 6, 2010.Myrna Domit and Alexei Barrionuevo, Brazilian Forces Claim Victory in Gang Haven,N.Y.TIMES, Nov. 28, 2010.No Longer Bottom of the Class, THE ECONOMIST, Dec. 9, 2010.Quentin Peel, Risks Rise in Shift to a Multipolar World, FIN. TIMES, Jan. 27, 2009.Record Low Unemployment Rate in Brazil for 2010, MERCOPRESS, Jan. 27, 2011, available at E. Messick, Judicial Reform and Economic Development, 14 WORLD BANK RES.OBSERVER 117 (1999).Robert Ellison & Claudio Oksenberg, The São Paulo Exchange – Towards A Regional Hub?, 17LATIN AM. L. & BUS. REP. 8 (2009).Sarah Miller Llana, Farming Superpower Brazil Spreads its Know-How, CHRISTIAN SCI.MONITOR, Nov. 12, 2008, available at 26
  27. 27. Sergio Sardenberg & Francisco A. Fabiano Mendes, Investing in Brazil – Latin America’sPowerhouse, 17 LATIN AM. L. & BUS. REP. 13 (2009).Sílvio Guedes Crespo. Imprensa internacional destaca 1ª vitória chave de Dilma, O ESTADO DESÃO PAULO, February 17, 2011 available at South American Countries with the Worst Income Distribution Inequality, MERCOPRESS,Nov. 1, 2010, available at Earthquake in Brazil’s Planalto, FIN. TIMES, Feb. 3, 2011 available at Schaller, Lula’s Growth Acceleration Program: The Best that Brazilian Funding CanBuy?, COUNCIL ON HEMISPHERIC AFFAIRS, available at C Gruben & John H. Welch, Banking and Currency Crisis Recovery: Brazil’sTurnaround of 1999, Fourth Quarter 2001 ECON. AND FIN. REV. 12 (2001).World Development Indicators, WORLD BANK, available at 27