To sustain its social, economic and environmental achievements, Brazil needs to confront some long-standing structural problems

May 17, 2016

Martin Raiser Valor Economico

In the past decade, Brazil was an example to the world of how to combine rising incomes and macroeconomic stability with greater social inclusion and a reduced environmental footprint. Between 2003 and 2013 both poverty and inequality were reduced significantly, as a result of rapidly growing formal employment, higher real wages and inclusive social assistance policies such as Bolsa Familia. Access to education, health, water and sanitation improved, particularly for the bottom 40 percent of the population. At the same time Brazil achieved a reduction of deforestation by 82 percent between 2004 and 2014. After decades of uneven development, it appeared that Brazil had finally managed to combine growth, stability, equity and environmental sustainability.

Today Brazil is confronting a deep economic crisis, putting these achievements at risk. What went wrong? Part of the reason is that Brazil’s successes were built on volatile foundations. The end of the commodity super-cycle has taken the wind out of Brazil’s consumption based growth model. Government efforts to boost demand have had little impact but growing fiscal cost. The return of government deficits and growing political uncertainty have sapped confidence, sending the country into the deepest recession in decades.

However, behind Brazil’s current economic difficulties lie deeper structural challenges. In a recent comprehensive diagnostic of Brazil’s development challenges, we identified five broad constraints that Brazil would need to overcome to retake the path to inclusion, growth and sustainability. Overcoming these constraints will not be easy. But in each area, Brazil can build on past achievements and international experience to chart the way forward.

First, large spending commitments to the non-poor – enshrined in law through budget earmarks and indexation rules - undermine fiscal stability, reduce the space for public investment and limit the resources available for socially inclusive policies. For example, spending by the two public pension schemes in 2014 was six times larger than all social assistance benefits, including rural pensions. A reform of the pension system, or a reduction of wasteful subsidies to enterprises would generate savings sufficient both to reduce fiscal deficits and expand transfers to the poor, who are particularly hit by the recession.

Second, public sector governance weaknesses and institutional fragmentation hamper long-term policy design, planning and implementation. For example, while access has expanded enormously in the last two decades, the quality of Brazilian health and education services is still low. Inefficiencies abound but often robust evidence on which policies work and which do not is either not available, or not acted upon. This is true also in flagship infrastructure programs, which have been plagued by cost overruns and delays and have failed to dent Brazil’s infrastructure gap. Yet, as our work with many subnational governments demonstrates, improvements in the quality of service delivery are possible – from education in Rio de Janeiro and Pernambuco, water management in Ceara, to procurement reforms in Amazonas. Learning from these successes and scaling them up could improve public services and save money.

Third, the segmentation of financial markets, lack of long term credit, and high interest rates distort the allocation of capital and may hamper private investment. These distortions have recently increased with the expansion of state credit. Using public sector banks to crowd in private funding by reducing risks rather than subsidizing the cost of credit may be a better way forward.  

Fourth, insufficient competition and a poor business environment sap investor appetite and dampen the creation of productive jobs. Brazil remains the most closed among all major economies in the world, and lags most of its peers in the quality of its business environment. Many Brazilian firms remain small, inefficiently managed and have few incentives to become more productive and to grow. Yet, Brazilian companies such as Embraer have excelled through innovation and industriousness. Brazil’s entrepreneurs need to learn from the best to compete in the global marketplace. A more competitive business environment and improvements in infrastructure to lower the cost of reaching world markets, would help them do so.

Fifth, weaknesses in the management of Brazil’s natural resources hamper efforts to fully exploit Brazil’s green growth potential. The principal problems are related to institutional fragmentation, pricing policies for water and other natural resources, and poorly planned urbanization, with informal settlements at risk from flooding, contamination and other health hazards. But with the right policy framework, Brazil could build on its reputation as a leader in international climate talks to attract green financing and create a new, sustainable growth engine.

Brazil’s structural problems are long standing. Their resolution can no longer be delayed even if the right way forward remains debated. Brazil has produced important policy innovations built on a broad political consensus and strong monitoring and evaluation before – the Fiscal Responsibility Law, the Bolsa Familia program, or the decline of deforestation in the Amazon are prominent examples. There is every reason to hope and believe it can do so again.

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