OECD-ECLAC Regional Consultation on Inclusive Growth in Latin America and the Caribbean

1. OECD/ECLAC
REGIONAL
CONSULTATION
Inclusive Growth in Latin America and the Caribbean
Inclusive growth in Brazil? Where?
Marcos Mendes
Economic Advisor in the Brazilian Senate

2. 2
Since democratization in 1985, long
term growth in Brazil has been meager
GDP per capita: average annual growth rate for selected countries (1985-
2010) (Source: Penn World Table 7.1)
0,3
0,7 0,9 1,0 1,0 1,1 1,2 1,3 1,3 1,6 1,8 1,9 1,9 2,1 2,2 2,3 2,4
2,9
3,4 3,4 3,5 3,6
4,2 4,4
5,0 5,0
5,4
8,5
9,0
8,0
7,0
6,0
5,0
4,0
3,0
2,0
1,0
0,0
VENEZUELA
PARAGUAY
MEXICO
RUSSIA*
SOUTH AFRICA
ECUADOR
BOLIVIA
BRAZIL
PHILIPPINES
COLOMBIA
PERU
ARGENTINA
COSTA RICA
SPAIN
AUSTRALIA
TURKEY
PORTUGAL
POLAND
BOTSWANA
IRELAND
MALASYA
EGYPT
CHILE
INDIA
TAIWAN
VIETNAM
SOUTH KOREA
CHINA

3. Even if we consider only the best sub-period of the Brazilian
economy (2004-2010), and exclude China and India from the
comparison group, the country does not appear in a prominent
position
GDP per capita: average annual growth rate for selected countries
(2004-2010)
12,0
10,0
8,0
6,0
4,0
2,0
0,0
-2,0
IRELAND
SPAIN
PORTUGAL
BOTSWANA
MEXICO
AUSTRALIA
BOLIVIA
SOUTH AFRICA
PARAGUAY
BRAZIL
PHILIPPINES
COSTA RICA
MALASYA
ECUADOR
COLOMBIA
CHILE
TURKEY
VENEZUELA
SOUTH KOREA
EGYPT
TAIWAN
POLAND
RUSSIA
ARGENTINA
PERU
VIETNAM
INDIA
CHINA
Per Capita GDP annual growth rate Mean Mean excluding China and India

4. Gini Index for Household Income (source: IPEA)
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4
But inequality is falling
60,1
59,5
59,5
58,9
58,1
59,4
59,6
58,8
59,9
58,7
63,4
61,5
61,2
60,2
58,0
60,0 60,0
59,9
59,8
59,3
59,2
59,4
58,7
58,1
56,9
56,6
56,0
55,2
54,3
53,9
53,3
52,7
52,6
64,0
62,0
60,0
58,0
56,0
54,0
52,0
1977
1978
1979
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1992
1993
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Gini Média

5. 0,70
0,60
0,50
0,40
0,30
0,20
0,10
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Despite the fall in inequality, Gini Index
is still very high (source: OECD)
0,00
Iceland
Slovenia
Norway
Denmark
Czech Republic
Belgium
Finland
Slovak Republic
Austria
Sweden
Luxembourg
Switzerland
Germany
Netherlands
Poland
New Zealand
France
Italy
Canada
Estonia
Ireland
Australia
India
United Kingdom
Spain
Japan
Greece
Israel
United States
Russian Federation
Portugal
Indonesia
China
Argentina
Mexico
Uruguay
Peru
Chile
Costa Rica
BRAZIL
Colombia
South Africa
Paraguay
0,7
0,6
0,5
0,4
0,3
0,2
0,1
0

6. Low growth with dissipative
redistribution*
* Alston et al (2012) proposes the definition of
“dissipative inclusion”
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The Brazilian economic model after
democratization (1985) is not of inclusive
growth but one of:

7. Democracy = government susceptible to political
pressure
Inequality = heterogeneous groups, with different
endowments of human and physical capital,
demand different public policies
In order to avoid political crises and reinforce
democracy, numerous redistributive policies are
put in place in favor of:
a) the rich
b) the poor
c) some middle income groups
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High inequality + Democracy =
Low growth with dissipative redistribution

8. The rich always had privileged access to
governmental decisions and could create
exclusionary policies that reinforced inequality.
After democratization, they were able to
preserve many privileges, due to high economic
power and political connections.
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Throughout history, inequality shaped
Brazilian institutions in favor of the rich.

9. • protection of local producers from external
competition (import substitution);
• subsidized public credit to large firms;
• restricted access to an expensive and sluggish
judicial system;
• regulatory agencies captured by regulated
firms
• preferential access of well connected groups
to the capital of public pension funds
• numerous public bailouts to big farmers
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As a consequence, Brazilian society, before and after
democratization, is characterized by features such
as:

10. The Brazilian economy remains poorly
regulated and with low participation in
external trade.
Privileges to well connected firms and
groups abound.
Most of them increase public expenditure
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Consequences...

11. • 8th most closed economy to international
trade among 191 nations (Source: Penn
World Table 7.1)
• 116th among 185 countries in a rank of
“contract enforcement”, (Source: Doing
Business 2013)
• 143rd among 185 countries in a rank of
“resolving insolvency” (Source: Doing
Business 2013)
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Some empirical evidence

12. • Inequality produces political, judicial and
regulatory institutions biased to the rich (Glaeser
et al – 2003; Engerman and Sokoloff – 2002)
• Property rights are ill regulated in unequal
countries, which creates opportunity for the rich to
expropriate others (Gradstein – 2007, Sonin -
2003)
• “Extractive institutions” (Acemoglu e Robinson –
2011)
• Feedback between extractive institutions and
inequality (Chong e Gradstein – 2007)
• The Brazilian case: Zanella et al (2003), Naritomi
et al (2012)
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Literature on the Redistribution to the
Rich

13. • Before democratization pro-poor policies were almost
inexistent: in the 1980’s some social indicators, such
as literacy and life expectancy were similar to those
observed in Sub-Saharan Africa.
• In a democracy, politicians need votes, and the poor
have lots of them (Alesina and Rodrik - 1994; Person
and Tabellini – 1994).
• After democratization, poverty reduction policies
boomed, playing an important role in reducing
inequality and poverty: conditional cash transfers
(Bolsa Família), pensions to rural workers, minimum-wage
real value, which almost tripled in 20 years;
benefits to the disabled and elderly among the poor;
real budget increases for public education and health.
• Important source of poverty and inequality reduction.
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Redistribution to the poor

14. The poor are not the only group of voters that acquired voice
after the transition to democracy. Some middle income
groups are well positioned to influence policies in their
favor. According to Robinson (2008) some groups offer a
good benefit-cost relation for politicians in search for votes.
They mix features of the rich (access to political decision-making)
and of the poor (some large groups with lots of
votes)
• The elderly, religious and ethnic groups (large number)
• Unionized middle income workers (collective action)
• Civil servants (access to decision making + collective action)
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Redistribution to some middle income
groups

15. • Regressive, expensive and unsustainable public
social security system
• High wages for civil servants
• Tuition-free public universities for high and
middle income students
• The Elderly Statute
• Cumbersome labor legislation in favor of middle
income workers
• Some cash transfers that are expensive and not
targeted to the poorest
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Some examples

16. • Redistribution to the rich and to middle
income groups partially undoes inequality
reduction promoted by policies targeting
the poor
• Inequality could be reduced faster with a
lower cost if part of the benefits
distributed by the government had not
leaked to high and middle income
households.
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Dissipative redistribution

17. • Polarization of interests caused by income and
wealth inequality.
• Social groups are unable to agree on any
consensual agenda.
• Political instability is avoided by means of
distributing benefits to almost everybody
• Public expenditure skyrockets
• Excessive regulation to protect rents
• Everybody has incentive to rent seeking
behaviour
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The inverse of a “middle class
consensus”

18. 1. Increasing public current expenditure implies higher
tax burden: reduction of net profits, high compliance
costs, use of distortionary taxes that reduce
productivity.
2. Negative public savings: restriction to investment;
3. Public investment in infrastructure plummeted;
4. Judicial and regulatory uncertainty: discouragement
to investment;
5. Closed economy: no creative destruction or
technological update;
6. Burdensome labor law + high tax burden = firms
remain small (and unproductive) to hide from
authorities;
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Low growth

19. • Despite dissipation, the net result has been a
reduction in inequality.
• The country may be going in the direction of a
“middle class consensus” (Banerjee and Duflo –
2003; Easterly – 2001)
• Part of the redistribution to the poor comes in the
form of more public education, which increases
human capital (Saint Paul and Verdier – 1993)
• Poverty reduction eases credit restriction to the poor
(Banerjee and Newman - 1993, Galor and Zeira -
1993, Ghatak and Jiang -2002)
• In the future there may be less demand for social
policies and more demand for good public services
and a leveled playing field for businesses.
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A virtuous cycle?

20. • Inequality may stop falling and stall at a high
level, perpetuating the present situation of
heterogeneous and unequal groups fighting
for rents provided by the government;
• There are signals that the present trend of
inequality reduction will decelerate (Souza e
Medeiros, 2013);
• Large part of households that escaped from
poverty are still vulnerable to poverty in case
of an economic downturn (Ferreira et al,
2013);
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A vicious cycle?

21. • Emphasize policies and reforms that, at the same
time, reduce inequality and remove barriers to
growth: social security, education, sewage
infrastructure.
• Make governmental budget constraint harder to
limit fiscal space for rent seekers
• However, inequality itself blocks such reforms,
due to entrenched interests. Only political
leaders/coalitions with a long term view can
break the present inefficient equilibrium.
• Otherwise, an economic crisis will be necessary
to foster reforms.
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What to do to increase the odds of a
virtuous cycle?

22. Acemoglu, Daron, Robinson, James A. (2011) Why Nations Fail: The Origins of Power, Prosperity and Poverty. Princeton University Press.
Alesina, Alberto, Rodrik, Dani (1994) Distributive Politics and Economic Growth. The Quarterly Journal of Economics, V. 109, Nº 2, 465-490
Alston, Lee J., Melo, Marcus, Muller, Bernardo, Pereira, Carlos (2012) Changing Social Contracts: Beliefs and Dissipative Inclusion in Brazil.
NBER – Working Paper 18588.
Banerjee, Abhijit, Duflo, Esther (2003) Inequality and Growth: What Can the Data Say? Journal of Economic Growth, 8, 267-299.
Banerjee, Abhijit, Newman, Andrew (1993) Occupational Choice and the Process of Development. Journal of Political Economy, vol. 101, nº 2,
April, p. 274-298.
Chong, Alberto, Gradstein, Mark (2007) Inequality and Institutions. The Review of Economics and Statistics, 89(3), Aug., 454-465.
Easterly, William (2001) The Middle Class Consensus and Economic Development. Journal of Economic Growth, (6), 4, Dec., 317-335.
Engerman, Stanley, Sokoloff, Kenneth (2002) Factor Endowments, Inequality, and Paths of Development Among New World Economies,
NBER Working Paper 9259.
Fernandez, Raquel, Rodrik, Dani (1991) Resistance to Reform: Status Quo Bias in the Presence of Individual-Specific Uncertainty. The
American Economic Review, v. 81, n. 5, p. 1146-1155.
Ferreira, Francisco H.G. et al (2013) Economic Mobility and the Rise of the Latin American Middle Class. World Bank.
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Ghatak, Maitreesh, Jiang, Neville (2002) A Simple Model of Inequality, Occupational Choice, and Development. Journal of Development
Economics, 69, p. 205-226.
Glaeser, Edward, Scheinkman, J., Shleifer, Andrei (2003) The Injustice of Inequality. Jounal of Monetary Economics, 50, 199-222.
Gradstein, Mark (2007) Inequality, Democracy and the Protection of Property Rights. The Economic Journal, 117, Jan., 252-269.
Lisboa, Marcos de B., Latif, Zeina (2013) Democracy and Growth in Brazil. Mimeo. Insper-SP.
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Economic History, v. 72, n. 2, p. 393-422.
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Robinson, James A. (2008) The Political Economy of Redistributive Policies. Background Paper for the UNDP project on “Markets, the State,
and the Dynamics of Inequality: how to advance inclusive growth”. Mimeo.
Saint-Paul, Gilles, Verdier, Thierry (1993) Education, Democracy and Growth. Journal of Development Economics. 42, p. 399-407.
Sonin, Konstantin (2003) Why the Rich may Favor Poor Protection of Property Rights. Journal of Comparative Economics, 31, 715-731.
Souza, Pedro H.G.F, Medeiros, Marcelo (2013) The Decline of Inequality in Brazil, 2003-2009: The Role of the State. Universidade de Brasília,
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References

23. Marcos Mendes, Economic Advisor in the Brazilian
Senate, mendes@senado.gov.br