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While Luiz Inácio “Lula” da Silva exceeded expectations within the private sector, his successor Dilma Rousseff has doubled down on a statist approach. (Photo: PT)
Wednesday, September 10, 2014
Perspectives

Brazil: Closer to Free Market?


As the Brazilian economy slips into recession, voters may opt for free-market solutions.

BY ROGER F NORIEGA

Signs of economic stagnation and simmering popular dissatisfaction in Brazil could not have come at a worse time for President Dilma Rousseff, who is seeking reelection in October. According to midsummer polls, voters’ skepticism about her track record and statist platform appeared to open the door to a challenge from probusiness candidate Aécio Neves

Political maverick Marina Silva, who took up the Socialist Party (PSB) banner in August upon the tragic death of her running mate, Eduardo Campos, shook up the race by attracting support from previously undecided and disinterested voters. As a result, Rousseff is even less likely to win a majority of the vote on October 5, and Neves and Silva are battling for second place and the right to face the president in an October 26 runoff. 

The outcome of the election in South America’s most populous country and largest economy will hinge on whether Rousseff is able to convince anxious Brazilians that more of the same is less risky than the alternatives offered by candidates on her political left and right. Given the economic doldrums facing Brazil, voters will probably base their decision on who is most likely to jumpstart economic growth and unlock their country’s productivity and wealth. The stability and prosperity of a natural US partner and potential global player are at stake. 

LULA: A TOUGH ACT TO FOLLOW

Rousseff inherited power from popular president Luiz Inácio “Lula” da Silva, who was president from 2003 to 2011 and balanced orthodox economic policies with robust social spending to produce impressive economic growth and a burgeoning middle class. The same popularity that made it possible for him to designate Rousseff his successor also made him a tough act to follow. Even worse for Rousseff, however, Lula failed to spend political capital to tackle a series of reforms that could have sustained economic growth and created opportunity for Brazilians hoping to improve their quality of life. 

Lula was a machinist with a modest education, and he impressed observers when he declared upon taking office that his certificate of election was the first “diploma” he had ever received. A committed democrat who respected the country’s institutions, Lula stood in stark contrast to a crop of authoritarian caudillos who governed concurrently in Venezuela, Bolivia, Ecuador, and Argentina. While those leaders excoriated neoliberalism and championed “socialism of the 21st century,” Lula hewed to the orthodox macroeconomic and monetary policies of his predecessors that had tamed inflation, spurred growth, and modernized the economy. 

The standard-bearer of the leftist Workers’ Party, Lula exceeded expectations within the private sector at home and abroad, meaning international capital markets were generous with their investment and accolades. Unlike Venezuelan leader Hugo Chávez and a cadre of like-minded acolytes in Latin America, Lula established rapport with world leaders across the political spectrum, including conservative US President George W. Bush.

At home, Lula dramatically expanded government programs aimed at eliminating hunger, alleviating poverty, and encouraging social mobility through education. These social-welfare programs—such as the Bolsa Família cash transfers—have helped 50 million Brazilians out of poverty. In a nation with one of the highest levels of income equality in the world, these programs enjoyed widespread support and earned international acclaim.

In 2005, Brazil earned a seat at the then–G8 (Group of Eight) dialogue and was hailed as an example for the developing world. Indeed, Brazil’s relative stability in the wake of the global financial crisis of 2007–08 appeared to validate the most optimistic forecasts for the country’s economic future. 

The windfall from a commodity boom fueled by Chinese consumption and the discovery of vast deep-water oil deposits in 2007 buoyed the Brazilian economy, lowered unemployment, and filled the government’s coffers. The downside to the country’s apparently boundless prospects was that Lula was under no pressure to invest his considerable political capital in a reform agenda that most experts say was needed to make Brazil more competitive and unlock its full potential. 

FROM SURGE TO STAGNATION

Nearly seven years ago, writing in Brazil’s largest newspaper, Folha de São Paulo, I observed:

Lula can make Brazil’s economy unshakeable by liberalizing the labor market, reforming the antiquated tax system, offering incentives to high-technology industry, and providing protection for intellectual property worthy of a first-world economy. By doing these things, Lula can ensure that Brazil can compete effectively for global capital to sustain high-growth rates, generate millions of jobs that are the permanent cure for poverty, and push Brazil’s economy into a higher orbit. This will make Brazil an industrial giant in its own right, not merely a warehouse for raw materials for China.

Alas, neither Lula nor his successor Rousseff adopted this course. Many economists have identified specific unfinished business in Brazil’s reform agenda, including improving government efficiency and accountability, taming costly public pensions, simplifying the labyrinthine federal and state tax systems, liberalizing the labor code, removing arbitrary obstacles to doing business, and attracting foreign capital and technology into the promising energy sector. 

The Economic Survey of Brazil 2013, published by the Organisation for Economic Co-operation and Development, echoed the need to cut public expenditures and debt, reform the tax and labor codes, and continue to manage inflation. It also recommended education reform that focuses on improving student performance and skills, entrepreneurship, and vocational worker training. 

Moreover, analysts have warned for years that Brazil was too dependent on the Chinese commodity boom. By 2012, Brazil’s commodity exports accounted for 14 percent of gross domestic product (GDP), compared to 6 percent in the 1990s. Then, the tide began to turn. Weakening Chinese demand for agriculture goods and other raw materials hit the Brazilian economy hard, with growth sliding from 7.5 percent in 2010 to 2.3 percent in 2013, and less than 1 percent is projected this year.  Few were surprised when Brazil’s finance ministry announced in late August that the country had entered a recession.

Another example of the dire need for reform is the current management of state-owned oil company Petrobras. Even with the prospects for vast new oil deposits, Brazil’s petroleum sector has failed to reach its potential and is under unrelenting pressure from politicians to generate the revenue needed to fund the state’s social-welfare programs. 

In recent years, Brazil has failed to attract the capital and technologies needed to exploit its resources because of the nationalist ground rules the government has imposed on investors. Domestic-content rules and onerous requirements to enter into partnerships with Petrobras have discouraged many international oil companies from entering the Brazilian market.

Even as Petrobras’s profitability and stock prices have declined, the revenues needed to fund exploration and operations to ensure its long-term success are siphoned off to finance election-year social spending. Early this year, the Brazilian Congress earmarked 75 percent of oil royalties for education and 25 percent for health care. In addition, in a vain attempt to keep gasoline prices low, Petrobras has been required to divert revenue to import foreign oil so as to satisfy domestic consumption.

Recent reports about falling production, exchange-rate losses, and excessive government intervention have triggered a lack of confidence from investors who once believed that Petrobras had the potential to become one of the most profitable oil companies in the world. According to Adriano Pires, a renowned Brazilian energy consultant, “Petrobras is now a tool for short-term economic policy, used to protect domestic industry from competition, and to fight inflation. This disastrous process will intensify if it is not reversed.”

Petrobras had hoped to reverse a recent trend of falling annual production—specifically, a 2 percent dip in 2012 and a 3.11 percent decrease in 2013—by aiming for a 7.5 percent increase in output in 2014. In August, government sources revealed that Petrobras would not meet that ambitious objective because of delays in bringing new platforms into production. Although the company has invested between $22 billion and $47 billion a year since 2008 and made large new discoveries, according to a Reuters report, production is only 5.5 percent greater than it was in 2008.

Inadequate infrastructure is another obstacle to Brazil’s growth. Much attention has been paid to Brazil’s costly renovation and construction of venues and other facilities to host both the 2014 Fédération Internationale de Football Association World Cup and 2016 Summer Olympics in Rio de Janeiro. 

These expenditures stand in stark contrast to the significant countrywide infrastructure deficit that inhibits key sectors of the economy. In contrast to the global average of 3.8 percent, Brazil spends only 1.5 percent of GDP on infrastructure. This underinvestment has resulted in inadequate transportation networks and inefficient ports, which have hampered commerce, raised shipping costs, and undermined the profitability of agriculture, mining, and other industries that depend on the export market.

Overcoming these obstacles is essential for Brazil to sustain healthy growth rates and realize its aspiration of becoming a global economic power. An emerging-markets research analyst at Bulltick Capital Markets warned last year, “Interventionist and erratic policymaking, capital controls, fears of China’s deceleration, and declining commodity prices have affected the Brazilian economy.”

According to a Bloomberg report from early August, “Analysts surveyed by the Central Bank expect the slowdown to continue. . . . They [the analysts] have cut their 2014 growth estimate for 10 straight weeks, to 0.86 percent, which would mark the slowest expansion since the recession of 2009.” The analysts furthermore noted, “Even as economic activity remains uneven, consumer prices may continue to surge above the 6.5 percent upper limit of the Central Bank’s target range.”

AN ANXIOUS ELECTORATE

Slow growth and latent signs of inflation appear to be stoking the anxiety of Brazilian voters. Widespread, spontaneous urban demonstrations in June 2013—sparked by public-transportation rate hikes, spiraling costs of hosting both the World Cup and Summer Olympics, and the government’s perceived ineffectiveness—surprised many observers who considered Brazil a success story. 

The acclaimed social programs that were initiated 20 years ago are credited with expanding the middle class. However, these citizens are now realizing that the government that helped them ascend to the middle class has been much less successful in encouraging the creation of private-sector jobs needed to sustain their quality of life. 

Indeed, government inefficiency and corruption, bureaucratic obstacles to enterprise and innovation, a byzantine tax system, and generous public-sector pensions, for example, have painted the state as part of the problem. In reaction to slowing growth and popular discontent, Rousseff has pledged massive new government-spending programs while eschewing the difficult structural reforms needed to retool the economy to make it more competitive, attractive to investment, and productive. 

Polls of the Brazilian electorate since those well-publicized 2013 demonstrations reflect a dip in public approval of Rousseff’s government—from 65 percent in March 2013 to 38 percent in August 2014, according to the public opinion firm Datafolha. Worse yet for the president, dozens of periodic polls by IBOPE (Brazilian Institute of Public Opinion and Statistics) record a catastrophic slide in public support for specific policies on key issues confronting the country.

For example, IBOPE polls found that Brazilians disapproved of the government’s counterinflation measures by a margin of 71 to 21 percent in June, a negative swing of 55 points since September 2012—when respondents approved of these policies by a narrow 50 to 45 percent margin. Even in the area of fighting hunger and poverty, Rousseff’s policies were rejected by a 53 to 41 percent margin, a negative swing of 31 points in that same period. The government’s health care policies were rejected by a 78 to 19 percent margin; similarly, tax policies were disapproved by a 77 to 15 percent margin and security policies were disapproved by a 75 to 21 percent margin. Although Rousseff is campaigning on a promise to increase government education spending to a staggering 10 percent of GDP, Brazilians polled in June disapproved of her education platform by a 67 to 30 percent margin.

In spite of these disastrous numbers, key polls found Rousseff beating Neves, although the race appeared to be tightening even before the emergence of new Socialist nominee Marina Silva. In light of these overwhelmingly negative impressions of how Rousseff is handling each of the country’s major challenges, it would appear that the incumbent’s best chance at reelection is defining her opponents as radically incompatible with the country’s values or as grossly incapable of managing the nation’s affairs. 

Whether the Brazilian people are prepared to hear arguments from Rousseff—let alone tolerate a negative campaign—remains to be seen. Television and radio campaign advertisements commenced only on August 19.

THE CAMPAIGN

The first-round balloting will be held on October 5. A runoff is required if no candidate obtains more than 50 percent of the vote, and the two top finishers advance to the runoff, which is scheduled for October 26. 

Of Brazil’s nearly 200 million people, about 143 million who are age 16 or older are eligible to vote in the upcoming presidential elections. Voting is obligatory for most persons; voting if voluntary for persons who are ages 16 to 17, older than 70, or illiterate. Forty percent of voters live in urban centers, and the rest in the country’s interior. All votes are cast on touchpad devices. 

Eleven candidates are seeking the presidency in Brazil, although Rousseff, Silva, and Neves are the three frontrunners heading into the October balloting.30 The campaign is dominated by television and radio advertising spots, which are limited to state-purchased blocks of time between August 19 and October 3 that are strictly apportioned among the various alliances. 

The August 13 plane crash that took the life of PSB candidate Campos has changed the race dramatically. A Datafolha poll taken in mid-July found Campos with 10 percent of the vote, Neves with 20 percent, and Rousseff with 36 percent. 

Since Silva was designated as Campos’s successor, a new Datafolha poll gives her 21 percent of the vote, compared to 20 percent for Neves and 36 percent for Rousseff. In a runoff, the poll predicts that Silva would beat Rousseff 47 to 43 percent. That same poll found that Rousseff would beat Neves 47 to 39 percent in a prospective runoff.

That poll also found that Rousseff had the highest “rejection rate,” with 34 percent of those polled saying that they would not vote for her under any circumstances. Silva had the lowest rejection rate, at 11 percent, compared to Neves, whose rate was 18 percent. Oddly enough, that poll also recorded a significant increase in Rousseff’s approval rating, which rose to 38 percent.

Since their television and radio advertising began in mid-August, each candidate will have had six weeks to make his or her case before the first round of voting. The public’s anxiety over the future and its solid rejection of Rousseff’s handling of every key issue may lead voters to take heed of the alternatives being offered by Silva and Neves. However, those challengers are far from “closing the deal” with voters. 

Silva is an experienced candidate, but it remains to be seen if she can deploy a competent message and campaign team in the coming weeks. Her prospects have been buoyed by the rush of media attention, but she can expect much more critical scrutiny as election day approaches. 

Although her appeal for a “new politics” is refreshing, voters will consider whether she has the temperament and talent required to manage Brazil’s fractious political model. These skills will be sorely tested if she moves into the second round and has to wheel and deal to broaden her coalition.

Neves has been betting that Brazilians are open to a fresh approach to retooling the nation’s economy to achieve sustainable growth. Unfortunately for him, Silva’s surge has appeared to eclipse Neves’s message.

Rousseff’s team cannot be sanguine about the tightening race. However, she has the advantages of a rock-solid base of around 40 percent, the powers of incumbency, and her party’s superior political organization. Her best strategy may be to run a sober campaign emphasizing experience and empathy, hoping that Silva stumbles as media scrutiny and the PT criticism intensify. Of course, Rousseff’s campaign will be able to deploy Lula’s legacy to remind the working class and new middle class of his protégé’s role in transforming Brazil.

CONCLUSION

Given the trajectory of Brazil’s economy and the manifestations of public anxiety in recent years, it was entirely predictable that the 2014 presidential race would tighten as the election approached. However, Rousseff intended to play it safe, doubling down on social spending despite palpable popular doubts that these policies could turn the country around. 

The unexpected change in the field of candidates has scrambled the first-round contest and, it appears, will force Rousseff into a runoff. This new scenario means that Brazilians will be paying attention to two outspoken critics of the status quo, giving them more time to envision a new president and a new path for their country.

Roger F. Noriega (rnoriega@aei.org), a former US ambassador to the Organization of American States and assistant secretary of state for Western Hemisphere affairs (2001–05), is a visiting fellow at the American Enterprise Institute and managing director of Vision Americas LLC, a Washington, DC–based firm with US and foreign clients. He is a member of the board of directors of Brazil Minerals, which operates in Brazil. This column is based on an excerpt from a recent AEI Latin America Outlook report.


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