Now that impeached Brazilian President Dilma Rousseff is out of office, it is up to the newly empowered administration of President Michel Temer to clean up Brazil’s macroeconomic mess. Can Temer’s government save Brazil’s crumbling economy?
The situation is certainly dire. In fact, Brazil has lately been experiencing the most powerful economic contraction in its recent history. Brazil has no easy route to recovery for a simple reason: The current rout derives from the intensification in recent years of long-standing economic vulnerabilities — in particular, fiscal profligacy and anemic productivity growth.
Brazil’s primary government expenditures as a proportion of GDP rose from 22 percent in 1991 to 36 percent in 2014. Much of that spending can be explained by a commitment to tackling endemic poverty without reducing the privileges enjoyed by Brazil’s better-off citizens. For some time, Brazil’s government was able to fund higher expenditure with tax revenues, which also rose as a result of levies on rising consumption and labor-market formalization. And high global commodity prices helped sustain GDP growth of around 4.5 percent per year from 2003 to 2010, which also bolstered government revenues.
But, of course, the formal labor force cannot expand forever, and commodity prices always fall eventually. Unfortunately, Brazil failed to take advantage of the good times to reap productivity growth. Indeed, only 10 percent of Brazil’s GDP growth in 2002-2014 can be attributed to total factor productivity gains, while two-thirds was the result of an increase in slightly better-educated workers entering the labor force. So when Brazil’s tax-revenue boosters finally collapsed, legally mandated increases in public spending drove Brazil rapidly toward a fiscal cliff. The good news is that Temer’s government seems to recognize this imperative. Already, it has proposed to Brazil’s Congress a constitutional amendment forbidding for the next 20 years nominal annual increases in public expenditures, including at the subnational level, that exceed the previous year’s inflation rate.
Provided that inflation stabilizes at some lower level, such a cap would cause public expenditure as a share of GDP to decline as soon as the economy began to grow again. If increases in tax revenues accompany GDP growth, fiscal imbalances and the accumulation of public debt would automatically be addressed. At a time when Brazil has little flexibility in its budget, such a rule could turn out to be a fiscal game changer.
As for productivity, the government is focused on reducing waste caused by insufficient infrastructure construction in recent decades. Scaling up infrastructure investment also promises to spur private investment in other sectors. Temer’s government also hopes to tap investment in human capital as a source of productivity growth. As it stands, private companies in Brazil invest less in personnel training than those in other countries with similar per capita incomes, owing largely to disincentives embedded in tax and labor laws — incentives that Temer’s government has proposed to change.
To maximize the impact of these efforts, Temer’s government should also focus on reducing waste in the private sector caused by other problems with the business environment. The more efficient use of human and material resources would make firms more competitive and boost Brazil’s total-factor productivity, especially if Brazil’s human capital were enhanced. Add to that efforts to facilitate foreign trade, and Brazil’s “animal spirits” of entrepreneurship could be unleashed, enabling Brazil to escape the current crisis and move toward a more prosperous future.
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©Project Syndicate
The situation is certainly dire. In fact, Brazil has lately been experiencing the most powerful economic contraction in its recent history. Brazil has no easy route to recovery for a simple reason: The current rout derives from the intensification in recent years of long-standing economic vulnerabilities — in particular, fiscal profligacy and anemic productivity growth.
Brazil’s primary government expenditures as a proportion of GDP rose from 22 percent in 1991 to 36 percent in 2014. Much of that spending can be explained by a commitment to tackling endemic poverty without reducing the privileges enjoyed by Brazil’s better-off citizens. For some time, Brazil’s government was able to fund higher expenditure with tax revenues, which also rose as a result of levies on rising consumption and labor-market formalization. And high global commodity prices helped sustain GDP growth of around 4.5 percent per year from 2003 to 2010, which also bolstered government revenues.
But, of course, the formal labor force cannot expand forever, and commodity prices always fall eventually. Unfortunately, Brazil failed to take advantage of the good times to reap productivity growth. Indeed, only 10 percent of Brazil’s GDP growth in 2002-2014 can be attributed to total factor productivity gains, while two-thirds was the result of an increase in slightly better-educated workers entering the labor force. So when Brazil’s tax-revenue boosters finally collapsed, legally mandated increases in public spending drove Brazil rapidly toward a fiscal cliff. The good news is that Temer’s government seems to recognize this imperative. Already, it has proposed to Brazil’s Congress a constitutional amendment forbidding for the next 20 years nominal annual increases in public expenditures, including at the subnational level, that exceed the previous year’s inflation rate.
Provided that inflation stabilizes at some lower level, such a cap would cause public expenditure as a share of GDP to decline as soon as the economy began to grow again. If increases in tax revenues accompany GDP growth, fiscal imbalances and the accumulation of public debt would automatically be addressed. At a time when Brazil has little flexibility in its budget, such a rule could turn out to be a fiscal game changer.
As for productivity, the government is focused on reducing waste caused by insufficient infrastructure construction in recent decades. Scaling up infrastructure investment also promises to spur private investment in other sectors. Temer’s government also hopes to tap investment in human capital as a source of productivity growth. As it stands, private companies in Brazil invest less in personnel training than those in other countries with similar per capita incomes, owing largely to disincentives embedded in tax and labor laws — incentives that Temer’s government has proposed to change.
To maximize the impact of these efforts, Temer’s government should also focus on reducing waste in the private sector caused by other problems with the business environment. The more efficient use of human and material resources would make firms more competitive and boost Brazil’s total-factor productivity, especially if Brazil’s human capital were enhanced. Add to that efforts to facilitate foreign trade, and Brazil’s “animal spirits” of entrepreneurship could be unleashed, enabling Brazil to escape the current crisis and move toward a more prosperous future.
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©Project Syndicate
