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Fiscally Sound Social Inclusion:
What, if any, may EMU learn from the Brazilian experience of fiscal and
political Central...
Fiscal Rules at Glance (IMF)
Out of 207 countries, only 14 (6%) adopted Real Expenditure Rules: Australia,
Belgium, Croati...
Real Expenditure Rules
• Brazil is about to adopt a very tough real expenditure rule.
– Constitution amendment (biding)
– ...
Why adopting such a tough
expenditure constrain?
• Severe diseases require bitter remedies!
• Serious lack of credibility
...
How can a country (or a region that decides to work
together) reaches an inter-temporal equilibrium?
Governability
Decisiv...
Old Republic (1889-1930)
Federal
Government
Governors
and regional
parties
• Strengthening of Federalism
• Domination and
...
Era Vargas: centralization
(1930-1937 and 1937-1946)
National
Executive
End of
Federalism
• End of oligarchy federalism by...
Decentralized Democracy: (1946-1964)
Weakened
Executive
Fragmentation
of Congress
• Constitutionally weak president
• No D...
Military Regime (1964-1985)
Strong
National
Executive
Weak
Congress
and
Governors
• Re-centralization of the decision-
mak...
New Constitution in 1988:
New Equilibrium!
Strong Executive
(No Gridlock)
Strong
Checks &
Balance
• Maintenance of strong ...
Brazil in Transition:
Beliefs, Leadership and Institutional Change, 1964-2014
19 6 0 19 6 4 19 74 19 8 5 19 9 4 2 0 0 3
An...
Fiscal Responsibility Law – FRL
• In the year of 2000, Brazil implemented a hard-budget constraint
legislation – the FRL.
...
Brazilian States’ Fiscal Accounts (1993-2010)
-12.00
-10.00
-8.00
-6.00
-4.00
-2.00
0.00
2.00
4.00
6.00
8.00
10.00
1993 19...
Fiscal Responsibility Law (2000)
F
• President
• Mandatory Top-down (the federal government has the exclusive
prerogative ...
Renegotiation of States’ Debts and
Privatization of State Banks
• The view that governors in Brazil wield vast powers is
i...
Tax Revenue %GDP
0
100,000
200,000
300,000
400,000
500,000
600,000
700,000
800,000
2000 2001 2002 2003 2004 2005 2006 2007...
Tax Burden in Latin America
0
5
10
15
20
25
30
35
40
1990
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Argentina...
Net Debt %GDP
-10.0
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Net...
Primary Surplus, % of GDP
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 ...
Why has this equilibrium been out of track?
1. The discovery of pre-salt oil reserves in 2006
2. The boom for Brazilian co...
Dilma Rousseff’s Administration
• New economic matrix
• Creative accounting
• The FRL prohibits the union to finance state...
New Economic Matrix
(Primary Government Expenditure, GDP)
4.9 5.3 5.4 5.5 5.7 5.9
6.2 6.4 6.7 6.9 6.8 6.4 6.7 6.6 6.4 6.6 ...
New Economic Matrix
(Income Transfers, % of GDP)
5.4
5.8 5.8 5.9
6.2
6.4
7.0
7.3
7.7
8.0 8.0
7.6
8.1
7.9
7.8
8.0
8.2
8.6
8...
Very high primary deficit in four consecutive years
(Primary New of the consolidated public sector)
-0.9
0.0
2.9
3.2 3.2 3...
Even with the real expenditure rule, the
primary net would be positive in 2020 only
15.0
16.0
17.0
18.0
19.0
20.0
21.0
EVO...
Expectation post-impeachment
(Consumers and Business Confidence)
60
70
80
90
100
110
120
Sep-05
Jan-06
May-06
Sep-06
Jan-0...
Expectation post-impeachment
(GDP)
-5.4%
-3.6%
-2.9%
-2.2%
-1.2%
0.0%
0.9%
1.4%
2016.I 2016.II 2016.III 2016.IV 2017.I 201...
Expectation post-impeachment
(Inflation)
10.7%
6.6%
5.1%
4.7%
10.7%
6.6%
5.5%
5.1%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
20...
Expectation post-impeachment
(Interest Rate)
14.2% 13.8%
11.0%
10.5%
14.20%
13.8%
11.3% 11.3%
0.0%
2.0%
4.0%
6.0%
8.0%
10....
Conclusion
• Conditions for fiscal reforms to succeed in the
Brazilian federalism
1. Centralization of the political game
...
Fiscally sound social inclusion: what, if any, lesson may EMU learn from the Brazilian experience of fiscal and political ...
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Fiscally sound social inclusion: what, if any, lesson may EMU learn from the Brazilian experience of fiscal and political centralization? (by Carlos Pereira)

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ADEMU mini-conference: Fiscal Federalism within the EMU

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Fiscally sound social inclusion: what, if any, lesson may EMU learn from the Brazilian experience of fiscal and political centralization? (by Carlos Pereira)

  1. 1. Fiscally Sound Social Inclusion: What, if any, may EMU learn from the Brazilian experience of fiscal and political Centralization? Carlos Pereira Visiting Scholar, Hertie School of Governance Professor, Getulio Vargas Foundation – FGV Mini-Conference and Lecture on “Fiscal Federalism within the EMU” European University Institute, San Domenico di Fiesoli, Florence December 12, 2016
  2. 2. Fiscal Rules at Glance (IMF) Out of 207 countries, only 14 (6%) adopted Real Expenditure Rules: Australia, Belgium, Croatia, Denmark, Finland, France, Netherland, Hungry, Island, Israel, Kosovo, Mexico, Peru, and Poland 79 67 40 14 7 0 10 20 30 40 50 60 70 80 90 Balanced budget Debt limits Other expenditure rules Real expenditure rules Revenue rules
  3. 3. Real Expenditure Rules • Brazil is about to adopt a very tough real expenditure rule. – Constitution amendment (biding) – 20 years debt ceiling based on the inflation of the previous year • The 14 countries that have also adopted real expenditure rules applied different methodologies and control mechanisms: – Take into account economic cycles – It is combined with other rules such as debt rules – The nature of expenditure (current expenses versus investment) varies – Adapting exit valves – Smaller periods than 20 years – Not in the Constitution, which makes it more susceptible for adjustments and adaptations
  4. 4. Why adopting such a tough expenditure constrain? • Severe diseases require bitter remedies! • Serious lack of credibility – Executive derives utility from fiscal stability and inflation control because of credibility gains in international markets. • History books – Do the right thing while you are unpopular (about 8%) – Short time-horizon (No-reelection incentives) • Impeachment of the president for fiscal crimes – It provided incentives for the new political elite to overshooting fiscal reforms to justify their actions
  5. 5. How can a country (or a region that decides to work together) reaches an inter-temporal equilibrium? Governability Decisiveness Representation Accountability Equilibrium is the ability political and economic players achieve cooperation inter-temporally. In the case of Brazil, it took more than one hundred years…
  6. 6. Old Republic (1889-1930) Federal Government Governors and regional parties • Strengthening of Federalism • Domination and opportunistic behavior of elites and regional oligarchies • Política dos Governadores • Fragmentation via state political parties • Problems of governability and lack of inclusion of elites not contemplated
  7. 7. Era Vargas: centralization (1930-1937 and 1937-1946) National Executive End of Federalism • End of oligarchy federalism by Vargas • The autonomy of the states was weakened and the end of the monopoly of the state parties • Electoral Justice in 1932 and Proportional Representation in 1935 • Estado Novo: more centralization • State flags were burned • Congress lost powers and prerogatives
  8. 8. Decentralized Democracy: (1946-1964) Weakened Executive Fragmentation of Congress • Constitutionally weak president • No Decree Power • No Urgency Power • No Budgetary Powers • Proportional Representation: Multiparty and fragmentation • Reestablishment of federalism • Minority Governments • Many governability problems
  9. 9. Military Regime (1964-1985) Strong National Executive Weak Congress and Governors • Re-centralization of the decision- making process – Decree Power – Urgency – Budget power and discretion • Marginal role of parties and Congress • Two-party system • Governors regain some powers at the end of military regime with elections
  10. 10. New Constitution in 1988: New Equilibrium! Strong Executive (No Gridlock) Strong Checks & Balance • Maintenance of strong executive • Maintenance of Proportional Representation: Multiparty and Fragmentation • Political Re-centralization and weakening of governors • Coalition governments and and institutionalization of gains-from-trade mechanisms – Cabinet, public jobs – Budget • Institutionalization of a web of accountability • Independent Judiciary • Independent Public Prosecutors • Independent Federal Police • Independent Audit Institutions: TCU/CGU • Independent Regulatory Agencies • Investigatory and Independent Media
  11. 11. Brazil in Transition: Beliefs, Leadership and Institutional Change, 1964-2014 19 6 0 19 6 4 19 74 19 8 5 19 9 4 2 0 0 3 An t i-Aut ho r it ar ian ism Aver sio n t o In f l at io n Mil it ar y Co up St ar t O pen in g Redemo - c r at i- zat io n Real Pl an FHC Lul aTan c r ed o / Sar n ey Co l l o r It amar GeiselCast el o Br an c o Co st a E Sil va Med ic i Fig uei- r ed o Jan g o 6 0 .7 % 2 4 .6 % 9 8 .3 % 1 0 5 0 .6 % 1 0 .1 % Po pul ism Aut ho r it ar ian Rul e Demo c r ac y Wit ho ut Chec ks & Bal an c es Rul e-o f -Law New Co n st i- t ut io n 5 .7 2 % 8 .8 9 % 4 .0 3 % 2 .8 1 % 3 .1 2 % 4 .8 1 % Fisc al r espo n - abil it y Bel ief s Inf l at io n  GD P Po l it ic al O ut c o me - - - + + - - - - - - + + + + Appr oval Event s Timel ine Pr esident Fr an - c hise Devel o pmen t ism
  12. 12. Fiscal Responsibility Law – FRL • In the year of 2000, Brazil implemented a hard-budget constraint legislation – the FRL. • Along with its companion law, the Fiscal Crimes Law, the FRL is the culmination of a relatively successful set of measures to constrain fiscal behavior and control the state governments indebtedness. • The FRL also bars the federal government from financing sub- national governments. This is meant to eliminate the possibility of bailouts as well as any changes in the financial clauses of the existing debt-restructuring agreement. • The FRL illustrates the kinds of policy outcomes that reflect the national executive’s ability to implement its policy preferences in the political game. • There is no question about the positive effect of the FRL with regard to the states’ fiscal situation, which improved considerably since the enactment of the FRL in 2000.
  13. 13. Brazilian States’ Fiscal Accounts (1993-2010) -12.00 -10.00 -8.00 -6.00 -4.00 -2.00 0.00 2.00 4.00 6.00 8.00 10.00 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
  14. 14. Fiscal Responsibility Law (2000) F • President • Mandatory Top-down (the federal government has the exclusive prerogative of setting debt parameters and expenditures ceilings) R • Governors • Control the state governments’ indebtedness (Audit Courts) L • Mayors • Sets parameters for all levels of government (Audit Courts) • provides ex ante and ex post controls on both borrowers and lenders
  15. 15. Renegotiation of States’ Debts and Privatization of State Banks • The view that governors in Brazil wield vast powers is inaccurate • The President was able to impose his fiscal preferences – The President enjoys agenda powers and other legislative prerogatives to implement its agenda. – He controlled resources – such as loans from federal banks and treasury’s advances - that were used in exchange for fiscal reforms, including privatization of state banks and utilities. – He was also helped by the reelection, which strengthened not only the President vis-à-vis governors but also helped extend the time horizons of governors; (19 governors ran for reelection), thus introducing some element of self-enforcement in the fiscal game. – Financial vulnerability state governors faced – High electoral competition
  16. 16. Tax Revenue %GDP 0 100,000 200,000 300,000 400,000 500,000 600,000 700,000 800,000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Consolidated Public Sector Central Government States Municipalities
  17. 17. Tax Burden in Latin America 0 5 10 15 20 25 30 35 40 1990 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Argentina Bolivia Brazil Chile Colombia Costa Rica Ecuador El Salvador Guatemala Honduras Mexico Nicaragua Panama Paraguay Peru D. Republican Uruguay Venezuela Average Source: CEPAL
  18. 18. Net Debt %GDP -10.0 0.0 10.0 20.0 30.0 40.0 50.0 60.0 70.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Net Debt of Public Sector Federal Government Central Bank States Municipalities States Companies
  19. 19. Primary Surplus, % of GDP 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Consolidated Public Sector Federal Government + Centra Bankl Regional Governments States Municiplities
  20. 20. Why has this equilibrium been out of track? 1. The discovery of pre-salt oil reserves in 2006 2. The boom for Brazilian commodities 3. The global financial crisis of 2008 Those shocks, which were unexpected exogenous events with high consequences, have momentarily relaxed the constraints imposed by the fiscal imperative.
  21. 21. Dilma Rousseff’s Administration • New economic matrix • Creative accounting • The FRL prohibits the union to finance states and municipalities. – However, it does not veto the authorization for states and municipalities do contract new debts up to 60% of their revenue, which has allowed new indebtedness. – From 2013 to 2014, the National Treasure has endorsed about R$ 50 billion of new debts at the state level.
  22. 22. New Economic Matrix (Primary Government Expenditure, GDP) 4.9 5.3 5.4 5.5 5.7 5.9 6.2 6.4 6.7 6.9 6.8 6.4 6.7 6.6 6.4 6.6 6.7 6.9 7.4 8.3 4.5 4.7 4.5 4.6 4.9 4.9 4.6 4.5 4.3 4.4 4.3 4.2 4.6 4.3 4.1 3.9 3.9 3.9 4.0 4.2 0.9 0.8 1.1 0.9 0.9 0.9 1.3 1.4 1.8 1.9 2.1 1.8 2.0 2.1 2.1 2.1 2.4 2.7 3.9 3.3 3.6 4.0 3.6 3.7 4.1 4.1 3.0 3.3 3.5 3.6 3.7 3.7 4.0 5.2 4.1 4.3 4.3 4.7 4.3 4.1 14.0 14.8 14.6 14.8 15.6 15.9 15.1 15.6 16.4 16.8 16.9 16.2 17.3 18.1 16.7 16.9 17.3 18.3 19.6 20.1 13.0 14.0 15.0 16.0 17.0 18.0 19.0 20.0 21.0 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Social Security Benefits Personel Others Discretionary spenditure Spenditure Source: IBRE/FGV
  23. 23. New Economic Matrix (Income Transfers, % of GDP) 5.4 5.8 5.8 5.9 6.2 6.4 7.0 7.3 7.7 8.0 8.0 7.6 8.1 7.9 7.8 8.0 8.2 8.6 8.9 10.1 4.0 5.0 6.0 7.0 8.0 9.0 10.0 11.0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Social Security Benefits Pension and Unemplyment insurance BPC Income Transfers Source: IBRE/FGV
  24. 24. Very high primary deficit in four consecutive years (Primary New of the consolidated public sector) -0.9 0.0 2.9 3.2 3.2 3.2 3.2 3.7 3.8 3.2 3.2 3.3 1.9 2.5 2.9 2.1 1.4 -0.8 -1.1 -2.4 -2.5 -5.0 -4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0 5.0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Central Government (Recurrent) Not Recurrent Regional Governments State Companies Cnsolidated Public Sector Source: IBRE/FGV
  25. 25. Even with the real expenditure rule, the primary net would be positive in 2020 only 15.0 16.0 17.0 18.0 19.0 20.0 21.0 EVOLUTION OF REVENUES AMD PRIMARY SPENDITURE OF THE CENTRAL GOVE RNMENT, % OF GDP Net Revenue Spenditure (PEC 241/2016) Source: IBRE/FGV
  26. 26. Expectation post-impeachment (Consumers and Business Confidence) 60 70 80 90 100 110 120 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Consumers Confidence versus Business Confidence CCI BCI Source: IBRE/FGV
  27. 27. Expectation post-impeachment (GDP) -5.4% -3.6% -2.9% -2.2% -1.2% 0.0% 0.9% 1.4% 2016.I 2016.II 2016.III 2016.IV 2017.I 2017.II 2017.III 2017.IV Source: IBRE/FGV
  28. 28. Expectation post-impeachment (Inflation) 10.7% 6.6% 5.1% 4.7% 10.7% 6.6% 5.5% 5.1% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 2015 2016 2017 2018 Actual Inflation (IPCA) Pessimistic Inflation (IPCA) Scenario Exchange rate 2017 Actual R$ 3,25 / US$ Optimist R$ 2,85 / US$ Source: IBRE/FGV
  29. 29. Expectation post-impeachment (Interest Rate) 14.2% 13.8% 11.0% 10.5% 14.20% 13.8% 11.3% 11.3% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 2015 2016 2017 2018 Interest Rate (Selic) Interest Rate (Actual) Pessimistic Interest Rate Source: IBRE/FGV
  30. 30. Conclusion • Conditions for fiscal reforms to succeed in the Brazilian federalism 1. Centralization of the political game • The Union has to have the agenda setting-power • Control of discretionary gains-from-trade mechanisms 2. Reform initiatives have to to be self-enforcing • Politicians in the different levels of the government have to identify

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