Saturday, July 6, 2013

Exhausted Brazil

by Luiz Felipe Lampreia

RIO DE JANIERO – The demonstrations that are shaking Brazil’s normally laid-back society are channeling a widespread sentiment: enough is enough! But, with the exception of professional agitators, there is no hatred in the street protests. Instead, there is a kind of impatient fatigue.

This illustration is by Paul Lachine and comes from <a href=""></a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.

Illustration by Paul Lachine

Brazilians are tired of being brutalized by public transport in the country’s metropolitan areas; tired of ghastly hospitals; tired of corruption scandals; and tired, especially, of inflation, which has returned like a dreaded disease, once again eroding people’s purchasing power and threatening to return millions to the poverty from which they only recently escaped.

It is difficult to disagree with the protesters. Nevertheless, there are many economic reasons to worry about the effect of the demonstrations.

Since the Plano Real was put in place in 1994, which brought inflation down to manageable levels, Brazil has achieved remarkable economic and social progress. Presidents Fernando Henrique Cardoso and Luiz Inácio Lula da Silva, both serving eight years in office, managed to ensure rapid economic growth while maintaining price stability and a sound fiscal position. Their success lifted a significant share of poor Brazilians into the middle class and made Brazil an attractive destination for foreign investors.

Yet the current situation is shifting expectations into reverse. To dampen the protests, President Dilma Rousseff’s government has launched various ruses – subsidizing fuel prices and reducing taxes on electric power, automobiles, and household appliances – and has attempted to conceal them in ways that allow the authorities to claim that inflation remains under control. Yet all of Brazil is feeling the impact on prices. If the official inflation target loses credibility, price growth will accelerate further.

The underlying problem is that Brazil’s growth model, which allowed 35 million people to enter the middle class in the last decade, is itself at the brink of exhaustion. The maximum benefit from reducing unemployment, increasing the real minimum wage, and expanding credit – creating a strong rise in consumption, owing to rapid gains in real (inflation-adjusted) income for much of the population – has already been reaped.

Indeed, consumption is now decreasing, with a recent poll by the Brazilian Confederation of Trade and Business Associations indicating a 6.2% annual decline this year. In March, household-debt levels reached a record high of 44% of income. Slower growth and more modest real wage increases are likely, which will reverse households’ optimistic expectations.

Meanwhile, for Brazil’s new middle class, higher incomes have meant higher tax payments – and thus a growing sense of entitlement to improvements in living standards. Many are especially resolved to fight for more and better public goods in view of the government’s misplaced spending priorities, which include soccer stadiums and other pharaonic construction projects.

In fact, Brazilians’ purchasing power could shrink further, owing to the depreciation of the real against the dollar. If Brazil’s government does not tighten fiscal policy, the exchange rate will generate more inflationary pressure from the rise in prices of imported goods. The alternative – an increase in interest rates – would undermine both consumption and productive investment.

What went wrong? Until recently, Brazilians enjoyed rapid GDP growth, full employment, rising incomes, a range of social-welfare benefits, and international praise. The government swore that the global crisis would not reach the country. Now GDP growth is slowing, investment is falling, the budget deficit is widening, and the external accounts are weakening.

One problem is that the inadequacy of Brazil’s infrastructure, which largely reflects poor official decision-making in the last ten years, directly impedes further growth in production and trade. For example, the authorities placed a high priority on a high-speed rail project that has already surpassed several cost estimates and has not yet left the planning stage. Meanwhile, the existing rail system is so precarious that it is impossible to travel by train from Rio de Janeiro to São Paulo or Belo Horizonte or Brasília. The public health-care system is a horror show. With rare exceptions, primary and secondary schools leave students badly prepared for university.

Rousseff’s administration faces a dismal outlook. Slow growth has been accompanied by a loss of competitiveness, leading to massive imports of Chinese goods, for example – and to a self-defeating protectionist reaction. Ambitious public-investment projects are advancing slowly, if at all – or are the wrong projects. And now Brazilians are in the streets demanding change.

As the economist and former president of the Brazilian Central Bank Afonso Celso Pastore put it, “Rousseff and her ministers simply do not believe in orthodox prescriptions.” The trouble is that they do not seem to have a viable alternative.

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