Brazil needs to change the growth model with renewed focus on supply: education, private investment, infrastructure and increasing competitiveness.

BY LATIN AMERICA ADVISOR
Inter-American Dialogue

Brazil's government said July 22 that it will cut its expenditures by 10 billion reais ($4.5 billion) and at the same time lowered its forecast for economic growth this year by a half percentage point to 3 percent. Stagflation has become a looming fear in Latin America's largest economy as inflation hovers around the 6.5 percent upper limit of the central bank's target. At the same time, the government has recently been coping with protesters' demands for lower taxes and better public services. Where is Brazil's economy headed? Is the government taking the right actions to boost the economy, and which sectors stand to gain or lose the most as a result? How closely related are social protests with the public's economic concerns? 

Drausio Giacomelli, head of emerging market strategy at Deutsche Bank: Brazil is at a crossroads. It has made some progress in transferring income to lower classes since the late 1990s, but mostly on the back of lower inflation, plentiful credit and wage policies instead of structural improvements in social security, health and education policies. The new middle class that these policies created has enjoyed higher consumption and naturally favored the incumbent governments in recent elections. However, these demand-boosting policies have reached clear capacity constraints as supply has come well short of the country's growing needs for infrastructure, a more educated labor force and overall productive investment. Brazil's growing pains have more recently been manifested in generalized street protests against corruption and poor services. The new middle class has created additional demands that Brazil's governments have failed to meet. Brazil needs to change its model, which so far has been based on boosting consumption. Loose credit (mainly driven by public banks), inflated minimum wages, broad-based state interventionism, lax policies, limited supply of skilled labor and dwindling confidence have all contributed to inflating labor costs, poor productivity growth, widening current accounts and inflation. With elections ahead and the need to tighten policies amid increasing disarray in its coalition base, the government seems cornered. It is time to change the growth model with renewed focus on supply (education, private investment, infrastructure and increasing competitiveness), but that requires leadership and courage. Meanwhile, we should continue to see the currency, inflation and growth bear the brunt of the adjustment imposed by tightening global liquidity.

Thomas Rideg, managing director of Global Intelligence Alliance: Brazil's economic advance in the last two decades would have been more impressive if it were not bottlenecked by the famous 'Brazil cost.' This cost--mostly related to corruption, bureaucracy and a lack of investments in infrastructure--has always been a known fact for investors, but it has only recently become a phenomenon to the average citizen. Corruption is today blatantly transparent in several areas, and impunity has become appalling to citizens. Also, the emerging C class is now aware of how much tax is paid on top of products and services, and of the inadequacy of basic public services and infrastructure. On top of paying taxes comparable to European standards, Brazilians are also required to pay for things including private education, health and transportation. Further, commercial establishments have recently begun to issue receipts breaking down the 'tax percentage' within the total fees, and the high taxes are visibly apparent to everyone. High taxes are the absolute opposite of economies of scale, and it is scale that drives an economy, not heavy taxes. Despite all of this, Brazil was the last in and first out of the 2008-2009 financial crisis because of its strong internal market, which makes the country less dependent on external factors than any other market in the region. The factors behind the protests (corruption and high taxes) have been part of Brazil for decades, but the actual protests are a result of the internal evidence of this corruption and awareness of high taxes in comparison to other countries. I see cuts in expenditures as a positive response to these protests because it has a large focus on discretionary government expenses. The list of other necessary government responses is extensive, but this is a positive start. There is no doubt that the much-needed tax reform in Brazil will improve the economic outlook. Though seen as a bit alarming in the short term, this is a much needed and long-due move for 'order and progress.' 

Albert Fishlow, professor emeritus at the School of International and Public Affairs at Columbia University: The Ministry of Finance demonstrates a long lag in its regular revisions of growth rate predictions and policy changes. For some time, estimated growth for 2013 has been lowered to between 2.0 and 2.5 percent, with only a modest advance for 2014. Much of the recent concern has been on higher inflation -- both by international banks and Brazilian citizens -- spilling over to demands for greater social expenditure during the protest marches. Trying to satisfy both simultaneously is hardly easy. The underlying problems are Brazil's low rate of investment -- less even than its neighbors, not to mention China and India -- and the inefficiency of its already large social outlays. They add up to low growth of productivity, pressures for tariff protection by the industrial sector and high rates of inflation in the service sector. Large gains in the terms of trade during the Lula years, accompanied by diminishing unemployment, avoided, but did not resolve, the issue.

Gilberto M. A. Rodrigues, professor at the Universidade Federal do ABC in São Paulo and board member of the Coordinadora Regional de Investigaciones Economicas y Sociales in Buenos Aires: The global economic crises affecting Brazilian growth is a problem per se. But the new political scenario in Brazil that arose from the huge street protests created a new demand for better and more accessible public services that could shock against some orthodox economic policies. From a federal perspective, the core of the Brazilian economy is the employment rate, which has not fallen despite foreign economic threats and emerging domestic political changes. The Rousseff administration needs to cut public expenditures, but those cuts would affect the president's ability to govern and her administration's relationship with Congress. One of the main cards the federal government has in its hands is a whole package of transportation infrastructure projects, which will attract new and huge foreign investments in the coming months. Transportation contracts between state and private companies are now under revision, and both the São Paulo municipal and state governments took actions to reduce transportation tariffs. The recent protests were not under the spirit of a 'spring;' rather they were related to Brazil's economic growth in the last years. That growth improved economic human rights for the poor, without the same level of development in political and civil rights. There is an evident crisis of political representation in Brazil at the federal, state and local levels, and this will certainly lead all governments to reduce or at least not raise public tariffs in the short run.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor