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How to fix Brazil’s economy

Oct 04,2018 - Last updated at Oct 04,2018

SÃO PAULO — Brazil is approaching its most consequential election since the end of military rule more than three decades ago. But while the country’s politics are plagued by dysfunction, the election’s outcome will hinge on the next government’s economic reform agenda.

One of Brazil’s most serious economic challenges is anemic productivity growth, which has been undermining the country’s growth potential. With output per employee increasing by just 0.7 per cent per year, on average, since the mid-1990s, more than half of per capita income growth over the last two decades has resulted from an increase in the share of the economically active population. But that engine of income growth will soon stall, owing to rapid population ageing.

Weak productivity growth partly reflects a lack of trade openness, which limits Brazilian firms’ access to foreign inputs and technologies, as well as barriers to effective domestic competition. Moreover, weak logistics infrastructure, differentiated state tax regimes and subsidies to specific firms enable less efficient companies to survive and retain resources, lowering average productivity.

To address this, policymakers must support the private sector by strengthening the adoption and diffusion of advanced technologies, rather than by offering compensation for high internal costs. Moreover, the business environment should be made more favourable for entrepreneurs, including through reform of the complex and imbalanced tax system.

Increased infrastructure investment is also needed, as is reform of financial intermediation, so that financing terms are better aligned with investment projects. And the quality of education and the formation of human capital could benefit from less rigid allocation of public resources and more experience-sharing among states and municipalities, some of which have made progress using measures that could be applied elsewhere.

Brazil also needs significant fiscal adjustment. Even as productivity and economic-growth potential have increased at a snail’s pace, real (inflation-adjusted) public spending has risen sharply. Public expenditure increased from less than 30 per cent of GDP in the 1980s to about 40 per cent in 2017, including 68 per cent growth from 2006 to 2017. And yet public investment (including in infrastructure) has declined, amounting to less than 0.7 per cent of GDP last year. 

With tax revenues affected by the decline in GDP in 2015-2016 and the subsequent fragile macroeconomic recovery, the primary budget balance, relative to GDP, deteriorated by more than four percentage points. This caused public debt to rise from 54 per cent of GDP in 2012 to 74 per cent in 2017.

To address skyrocketing debt, in 2016, Brazil approved a constitutional amendment imposing a ceiling on public spending for the next 20 years. If the authorities manage to adhere to this rule, or combine spending cuts with tax revenues to obtain an improvement of 0.6 per cent of GDP per year in the public-sector primary balance, the trajectory of public debt could become sustainable again within a decade. The key to success, of course, will be smart spending cuts.

The World Bank, where I am an executive director, has already identified areas where such cuts can be made: Social security, public sector payrolls and subsidies and tax exemptions. By easing the strain on the public budget, spending cuts in these areas could even create space for other, more productive types of public expenditure.

Crucially, such cuts would have only minimal consequences for poorer Brazilians. In fact, when it comes to tax reform, there are steps that could not only contribute to improving the business environment, but also help to reduce the social inequities embedded in the current system.

In the quest to improve productivity and achieve fiscal rebalancing, Brazil’s leaders must also reform public sector governance. As it stands, the provision of public services in a wide range of areas, including health, education, violence, infrastructure, transportation and logistics and the management of water resources, is highly inefficient.

The reasons are wide-ranging. Brazil suffers from an excess of rules, which contribute to budget rigidity, fragmentation of service delivery, poor planning, monitoring and evaluation of projects and policies, a lack of positive performance incentives for public sector workers, the judicialisation of policymaking and an increasingly risk-averse bureaucracy.

Brazil thus needs to improve policy consistency, from planning through execution of programmes and projects, and focus more on monitoring and evaluating results. Better coordination between the public and private sectors would also improve the capacity of public expenditure to contribute more to improving socioeconomic outcomes.

Brazil’s future hinges on the implementation of smart, gradual and coherent economic reforms that facilitate productivity growth and put the country on the path toward fiscal sustainability. Whoever wins the upcoming election has a responsibility to address that imperative.

 

Otaviano Canuto is an executive director at the World Bank. Copyright: Project Syndicate, 2018. www.project-syndicate.org

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