Factors that have enabled Brazil to become a rapidly developing economy Essay

INTRODUCTION

Brazil is the largest country in the South American continent, and it is amongst the 12 largest economies of the world. It possesses vast natural resources and offers remarkable ecological diversity, majority of its 192 million inhabitants now live in urban areas (Griffiths, A and Wall, S. p 609). The country also possesses a diversified industrial and agricultural sector and In 2001, the contribution of the agricultural sector to GDP was 9.3%, while that for industry and services was 33.9% and 56.8% respectively (Pereira, L 2004). At around the same time, Jim O’Neill, the head of global economic research at Goldman Sachs, coined the acronym “BRICs” to refer to Brazil, Russia, India, and China, the emerging market economies (EMEs) he thought would lead world economic growth for the next fifty years (Griffiths, A and Wall, S. p 594). This essay aims to identify and critically evaluate the key economic, political and technological factors and conditions that have enabled Brazil to become a rapidly developing economy. According to Antoine W. Van Agtmael (1981) the term emerging markets can be broadly defined as nations in the process of rapid growth and industrialization using economic liberalization as their primary engine of growth. Often times, these nations are transitioning to an open market economy with a growing working age population.

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1. POLITICAL BACKGROUND
In order to understand why brazil is an “emerging market” we must first look at what went wrong, why it needed changing and what spurred the change. Brazil’s economic story is long and complex, after achieving its independence from Portugal in 1822 it had the lowest GDP per capita of any new world colony and It wasn’t until the early twentieth century when the economy began to show signs of life. From 1913 – 1980, Brazil grew faster than any other country in the western hemisphere thanks to high commodity prices and industrial production spurred by government spending programs (Williams, S. 2011), however the country wasn’t able to sustain that level growth and it stopped in 1983 as a result of it defaulting on its foreign debt.

The Junta military regime and the imports – substitution policies (ISI’s) they implemented at that particular time (1965 – 1985) was squarely to blame for the debt as they had to borrow vast amounts of money to build the infrastructure (roads, ports, factories, etc.) necessary to support industrial production (Williams, S. 2011). In 1985 the regime finally stepped down and handed power over to a civilian government led the by José Sarney, but unfortunately he too was unable to control inflation and it resulted in country defaulting on its foreign debt again, the failure to reduce and or control inflation levels within its economy coupled with serious corruption allegations within congress resulted in a formulation of distrust towards the government ( Williams, S. 2011) . In 1989, Fernando Collor de Mello, a man who many credit for setting the stage for Brazil’s current growth became the nation’s first democratically elected president and unlike he’s predecessors, he quickly adopted a liberalised view on trade (Shikida, C 2005), however his government also failed to tackle the inflation problem as it reached record high of 7000% (inflation.eu . 2012). It took his successor Itamar Franco and the implementation of the ‘Real Plan’ written by next president Fernando Henrique Cardoso to get Brazil back on track.

2. PLANO REAL (THE REAL PLAN) AND ECONOMIC STABILITY

The main elements of the Real Plan included the introduction of a new currency ( the real ), the de-indexation of the economy (meaning prices were no longer pegged to the rate of inflation), the tightening of monetary policy and the floating of the currency, with a floor specified for its value against the dollar (Gustavo, F 1996). The design and implementation of the Real Plan distinguished it from the earlier plans, unlike previous designs it did not depend on a general price and wage freeze to stop inflation. It was rather centred around the de-indexation of the Brazilian economy, which was accomplished in most part by converting salaries and a number of other prices in the months preceding the implementation of the Real Plan into ‘Real Value Units’ (URVs), which were then linked to the dollar (Ferrari-Filho, F 2001). Source: www.inflation.eu Fig. 1 Illustrates Brazil’s battle with hyperinflation

These policies enabled Brazil to get monthly inflation rates down from 45% during the second quarter of 1994 to an average of less than 1% in 1996 (Inflation.eu 2012). As a result the economy grew by 6% percent in 1994, and by 4.2% and 2.9% in 1995 and 1996, respectively (Clements, B. 1997) as domestic demand increased fuelled by lower inflation and higher real wages. The successful implementation of the Real Plan not only helped stabilize the economy , it also showed real economic discipline necessary to attract the foreign capital and investment.

The combination of bringing inflation down and provoking expansion in demand in the short term resulted in domestic savings dropping sharply to 17.9% of GDP in 1995, from 21.5%, in 1993 (Cinquetti, C 2000), this forced the government to slow the economy down by controlling domestic credit and increasing the real’s interest rate. The result of the high interest rate and capital account liberalization was short term capital inflows resulting in the overvaluing of the real. Though successful in bringing inflation down drastically and raising living standards the Plano Real failed in addressing Brazil’s growing fiscal deficit and the use of an overvalued exchange rate as an anchor of stabilization between 1994 – 1998, this appreciation in exchange rate also led to an increase in trade deficit from a surplus of US$ 13.3 billion in 1993, to a deficit of US$ ?3.2 billion in 1995 (Cinquetti, C 2000).

Although the price stabilization represents the incontestable success of the Real Plan, it again fails when we look at Brazil’s economic activity and the performance of the real from 1994 – 2000, where the average growth rate of GDP was only 3.0% per year, very similar to the average growth rate of GDP of Brazilian economy in the 1980s which was 2.9% per year (Williams, S 2011) . The poor performance of GDP during the period of real can be explained by the fact that the Real Plan was created as a stabilization plan without proposing any strategy for medium and long run development.

3. ASIAN CONTAGION OF 1997-1998

By the end of 1996, the use of the overvalued exchange rate and the high interest rates were straining economic stability – the trade deficit was worsening, public sector debt was increasing while the economy was fairly stagnant (Ferrari-Filho, F. 2001). The Asian crisis of 1997 and the aftermath of the Russian crisis of August 1998 resulted in a speculative attack on Brazil’s currency (the real) this despite it tackling the Mexican Tequila crisis (1994 – 1995) with great effect resulting in a 61.2% increase of foreign reserves. To stave them off and prevent huge capital outflows, Brazil raised interest rates as it did during the Tequila crisis – which makes currency speculation less profitable (Williams S. 2011). The raising of Interest rates further worsened Brazil situation as industrial production fell resulting in a huge reduction in domestic consumption due to higher borrowing costs. Lower production meant Brazil’s exports decreased and therefore its ability to pay for its imports without borrowing reduced as well.

Brazil therefore had to borrow to pay for imports increasing its debt even further and because it had previously defaulted on its debt twice in the last two decades, investors began to fear another default. Before devaluing the currency in January 1999 the government tried to alleviate fears of default and defend against currency speculators, by seeking and receiving a $41.5 billion loan from the IMF (Williams S. 2011), in doing so it had to adopt fiscal and monetary policies as well as accept financial and trade liberalization policies set by the IMF, still despite the rescue package the ‘Real Plan failed to regain the confidence of financial markets and as a result Brazil was not able to defend its currency’ (Ferrari-Filho, Fernando de Paula, L 2003), resulting in huge capital outflows as the general perception was that Brazil was still vulnerable. This sentiment developed because one, the government failed to address key economic fundamentals particularly the large public sector deficit and secondly, the president failed in passing the fiscal restraint legislation through the Brazilian parliament that would have quelled investor concerns about yet another possible default.

However the crisis did not last long, Cardoso’s macroeconomic policies proved to successful, public sector revenues were rising, which gave Brazil more money to pay its debts, privatization reduced the losses brought on by the state and increased agricultural production and helped keep food prices stable. Cardoso also reformed the banking sector, banks now had to keep more cash on hand by lowering acceptable leverage rates which in turn
ensured that they had sufficient capital to pay fleeing investors without causing banks to fail or creating a risk to the entire banking system. In 2002 he successfully handed power over to by Luiz Inácio “Lula” da Silva.

4. TRADE LIBRALIZATION AND INDUSTRIAL FACTORS
At the end of the 1980s, there was a growing consensus to promote some kind of trade liberalization. It was becoming increasingly clear that protectionist policies were affecting the competitiveness of Brazil’s exports to developed countries. (Pereira, L 2004). When , Fernando Collor de Mello came into office in the late 80’s and early 90’s he quickly adopted a liberalised view on trade and begun implementing the necessary institutional changes needed to increase competitiveness, accelerate trade and encourage foreign direct investment (FDI). He was successful in this respect and in 1995 after the successful implementation of the real plan, FDI flows into Brazil increased sharply, interrupting the trend observed over the previous 15 years (See Fig 2 below). The stock of foreign direct investment amounted to US$ 42.530 billion in 1995, while net FDI inflows in 1996 and 1997 amounted to approximately US$ 10 billion and US$ 17 billion, respectively (eclac.org 1999).

Source: www.eclac.org Fig. 2 Illustrates foreign direct investment inflows in Brazil during an 18 year period

In the past Brazil’s industrial policies were integrated in the government’s strategic plans of development, all those plans focused on the industrial sector and were influential in the development and integration of the modern Brazilian industry of today (Griffiths, and A Wall, S 2012 p 612). During the Junta regime targets were related to balance of payments, concentrating on import substitution and on the expansion of manufactured exports. In the 1980’s and 1990’s the development plans were cast aside and replaced by macroeconomic stabilization plans with the belief that sound macroeconomic policies would create the necessary and sufficient conditions for development (Griffiths, and A Wall, S 2012 p 612). In 1992 Brazil reduced its import tariffs opening up the economy and forcing the restructuring of large sectors in the Brazilian industry, at about the same time a programme
of privatisation was started which was continued under Lula’s tenure (Pereira, L 2004). Privatisation and the reduction of import tariffs was aimed at attracting foreign investment and increasing competitiveness as well as industrial and technological modernisation. Trade liberalisation was the most consistent of all institutional change. Also very relevant were new rules that eliminated restrictions for foreign owned firms to operate in information technology sectors, to participate in the privatisation process, to access credit lines of public agencies or subsidies and other incentives, to operate in financial and telecommunications services as well as oil exploration and in pharmaceuticals industries (Ferraz, J, Kupfer, D and Iooty, M 2003). In 2004 Lula’s administration announced its first industrial policy, which was to develop and facilitate entrepreneurship while holding firm to its commitment to macroeconomic stability. The government reduced external restrictions on inward FDI to increase efficiency, that in medium to long term would further increase and attract foreign investment to the private sector. In 2008 the government announced new tax measures and goals for its industrial policy including tax incentives for investments, R&D and exports. At the same time it introduced a $100bn program with the main aim of increasing GDP, stimulating innovation via increase in private R&D and increasing the share of Brazilian exports in world exports (Griffiths, and A Wall, S 2012 p 612).

5. LUIZ INACIO ‘‘LULA’’ DA SILVA

It was under Lula that Brazil truly began to emerge economically, his political approach was far more liberal than previous governments, he sought to appease to foreign investors by promising to honour contracts, protect private property, assert fiscal discipline, and pay off the country’s’ debts (Clements, B 1997). Once in office, he maintained the prudent macroeconomic policies his predecessor had implemented. Lula also gave the Brazilian Central Bank greater operational autonomy, ensuring that it would make policy choices based on what is in the best interest of the economy without political influence (Willams, S 2011). As a result interest rates fell to 6% compared to Cardoso’s tenure, this reduction led to a significant credit expansion allowing Brazilians to borrow money to expand businesses inside
and outside Brazil (Williams, S 2011). Lula also constantly pursued a social development agenda: with the help of the “Bolsa Família” (“Family Scholarship”) program setup by his predecessor Cardoso he managed to lift tens of millions of people out of poverty by increasing social expenditures, paid for not by borrowing but by increased tax collections and revenue (Clements B, 1997) . This cautious approach to economic policy resulted in a steep fall in the public debt/GDP ratio to 35.8% allowing Brazil to repay its debts to the IMF (Griffiths, and A Wall, S 2012 p 612). Under his tenure Brazil also begun increasing its assertiveness on foreign policy, playing a key role in positioning itself as a representative of emerging economies and a staunch defender of poorer countries within the G20, a group of the world’s richest nations (Duffy, G 2009) . Brazil also played and continues playing a key role within the MERSCOUR pushing for the negotiation of free trade among member states Argentina, Paraguay, Uruguay, Bolivia, Chile, Colombia, Ecuador and Peru. To help lessen dependence on the developed world as a source of consumers of Brazilian products Lula and his government also managed to foster close ties with other BRIC powers including Arab and African countries while still maintaining balanced relations with the USA and the EU (Griffiths, A and Wall, S 2012 p 609).

6. BRAZIL AND THE GLOBAL FINACIAL CRISIS 2008 – 2010

Brazil was generally more resilient to the financial crisis than many other developed countries, this was partially attributed to the fact that its banks were less exposed to the U.S. mortgage crisis. Thanks to president Cardoso’s reforms, Brazil’s banks were unable to expose themselves to as much risk as other banks around the world (Kaltenbrunner, A and Painceira, J 2009), Lula decision to give the central bank greater autonomy further benefited Brazil’s banking sector as the central bank became the only central regulator. Critics argue that having one regulator supervise every aspect of banking activities is more efficient and effective than the systems with multiple regulators responsible for supervising different aspects of the banking sector, as in the United States (Dullien, S et al 2009). Brazil also benefited from a low unemployment rate and again thanks to Lula’s foreign policy less dependence on trade with the developed world.
Having a low unemployment rate meant that Brazil had a large number of wage earners to keep demand for Brazilian manufactured products high (Mercopress 2011). Increased trade ties with other developing and emerging economies also helped keep demand for Brazilian goods stable. Having a diversified profile of customers made Brazil less dependent on demand from the developed world, meaning the demand for Brazilian goods stayed high even as developed world demand dropped sharply.

7. SUSTAINABILTY AND GROWTH

Brazil reinforced its macroeconomic policymaking in the late 1990s- the monetary policy framework combined inflation targeting with a flexible exchange rate. A Fiscal responsibility law also established limits and rules to conduct stabilisation policy without disrupting long-term sustainability. These reforms have helped to achieve macroeconomic stability and to improve the capacity of policymakers to respond to external shocks. In the future, these frameworks will need to be refined to help the country to continue to catch up with the GDP per capita enjoyed by high-income countries and to cope with a rapidly changing economy, which will age rapidly and rely extensively on oil revenues in the context of an uncertain and fast changing global environment (Mourougane, A. 2011). Firstly Brazil’s needs to address the issue of its aging population as it will soon enter into an extremely rapid phase of demographic transition, which will drive profound economic changes as key drivers of economic growth tend to vary depending on where most people fall in the life cycle. The speed of population aging in Brazil is going to be significantly faster than what has been experienced by developed economies (except Japan) over the last century (World Bank, 2011). The impact of an ageing population on the economy is that the overall productivity and output will fall resulting in a possible balance of payments deficit as exports will fall. Dependency on welfare provided by the state will also increase as the vast majority of population will be too old to work (Mourougane, A. 2011). The country also needs to address key policy failures as they inhibit economic activity. Perhaps the biggest policy failure is that its government still spends too much money, high spending contributes to high interest rates that make borrowing more expensive, and
currency appreciation that hurts exporters by raising the cost of goods produced domestically. A second major policy failure, is Brazil’s continued dependence on commodity exports to drive growth, this dependency creates inflationary pressure and increases currency appreciation. The appreciated currency negatively affects other sectors of the economy which in Brazil’s case, is the manufacturing sector whose products are now more expensive and therefore less competitive globally. The continuing issues with Brazil’s regulatory and legal framework also affects foreign investments as investors see the country as riskier and more expensive to do business in. Principal among these costs is the high tax, taxes represent 36% of Brazil’s GDP compared to only 8% in China (Williams S 2011), meaning that Brazil relies on and collects huge tax revenues to help fund government projects. Furthermore the cumbersome regulations also make starting a business difficult, according to a World Bank study, Brazil was ranked 128th in the world in terms of ease of starting a new business, as it an average of 152 days to register a business, compared to the world average of just 48 days. Inequality is possibly the most commonly known threat to Brazil’s progress. Despite of the country’s phenomenal growth, inequality still holds it back. It is estimated that for every 10% increase in poverty there is a corresponding 1% reduction in economic growth (Coatsworth. J 2009). For Brazil this means that economic growth could increase by two or three percentage points each year by eliminating poverty. Brazil has indeed come a long way, the prudent leadership of presidents Cardoso and Lula da Silva has resulted in quick growth, reduction in poverty, and an increased say in international affairs. Despite its recent success, Brazil’s goal of becoming an advanced economy has not yet been met, it must continue to diversify its economy, improve its judiciary process and fight poverty through social spending and education.

References
Amanda., R, 2009. A Look at the World’s Largest Stimulus Packages Outside the United States [online] available at:< http://www.usnews.com/news/articles/2009/01/05/a-look-at-the-worlds-largest-stimulus-plans-outside-the-united-states > [Accessed 15 Nov 2012] Cinquetti., C 2000. The Real Plan: Stabilization and Destabilization [e-journal] 28