Why Is Brazil an Emerging Market Economy?
By Sean Williams
In 2001, 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. Since that time many academics, economist, and journalists have written about the idea of the BRICs, and the acronym has become common.
This FAQ seeks to explain briefly why Brazil is an emerging market economy (EME) and warrants being the first letter in BRIC. The FAQ will begin by highlighting and explaining some of the factors that make an economy an “emerging economy” as opposed to a developing, developed, or advanced economy. As EMEs are somewhere between developing and advanced economies, the FAQ will then explain why Brazil is not already an advanced economy before going on to explain what Brazil has done to emerge from the status of a “developing economy.” The FAQ will conclude with a section explaining some remaining issues that Brazil must address to reach the goal of becoming an advanced economy.
I. What Does “Emerging Market Economy” Mean?
There is no fast and simple definition of an emerging market economy, but when reading about EMEs some common themes emerge. EMEs are characterized by fast economic growth, increased foreign investment, and increased international political clout. Fast growth is evidenced by strong economic data, as in rising gross domestic product (GDP), GDP per capita, trade volumes, and foreign reserves. Faster growth generally means higher profits for foreign investors, which encourages more foreign investment in a country, which, in turn, promotes economic growth.
Countries can attract foreign investors by pursuing sound macroeconomic policies and being open to international trade. EMEs are generally more open to international trade than other economies, including advanced economies. This openness is spurred initially by export-led growth models, but it functions to diversify the goods countries export. Some experts argue that diversification and general integration into the international economy help reduce the effects of sudden changes in global prices or other internal or external economic shocks, making the country more stable for investors.
Macroeconomic policies are policies that affect broad parts of the economy. Sound macroeconomic policies help stabilize financial inflows and make foreign investors less concerned about the safety of their investments. Economists that focus on developing and emerging economies typically define sound macroeconomic policies to include privatization of state-owned businesses, liberalization (i.e., opening) of domestic banking systems and stock markets for easier access by foreigners, sound fiscal and monetary policies, and a reduction in external debt. This list is by no means exhaustive.
Fast growth and high rates of investment often lead to increased influence on a regional and international scale. The level of international political clout varies from country to country, but EMEs generally are gaining power and influence internationally, especially compared to other developing countries. They are leaders in their respective regions, and are oftentimes responsible for representing the interests of that entire region in global economic affairs.
The term “emerging” suggests that EMEs have not achieved a level of development on par with advanced economies such as Germany or the United States. One could point to many factors that contribute to the status of an EME, but some of the most important are policy failures, weak institutional structures, and inequality. Policy failures could come in many forms—two common examples are uncontrolled spending and protectionist trade regimes. A policy is considered a failure if it prevents the economy from performing at its highest possible efficiency. Bad policy and weak institutional structures (e.g., regulatory and judicial) raise transaction costs for foreign and domestic investors, which makes doing business in that country more difficult and therefore less inviting to potential investors.
Inequality among a country’s population hinders overall economic potential. Though inequality has many negative side effects that can affect an economy (e.g., more crime), the inefficiency it causes in investment by denying parts of the population the funds needed to start potentially lucrative businesses or otherwise invest in their communities is among the most important. This happens because lending institutions view the very poor as high credit risks, and therefore are not willing to lend to them unless they (financial institutions) are able to charge high interest rates or obtain adequate collateral as security for loans. These requirements prevent the nation’s poor from gaining access to credit or force them to use that credit more restrictively to ensure their ability to repay, both of which prevent the credit from being used as productively as possible. If a whole segment of the population is not fully participating in the economy, the economy does not function at maximum capacity or efficiency.
Some economists argue that the negative effects of inequality are compounded in countries where the people with the money are also the people with the political power. The argument assumes that wealthy politicians are more likely to underfund basic public services (education, housing, public transportation, etc.) that they themselves do not use or need, to lower their own tax burden. These economists suggest that if instead they provided those basic public services, more citizens would be able to participate effectively in the national economy, which would increase growth and widen the tax base, opening the possibility of lowering the tax burden on the wealthy. In other words, all sectors of society would share the benefit of equal economic participation.
With these factors in mind, one can effectively answer the question “why is Brazil an emerging market economy?” Putting aside the problematic aspects of the terms “emerging,” “developed,” or “advanced,” to determine why Brazil is an EME, one must first determine why it is not already a developed or advanced economy.
II. What Went Wrong in Brazil and Why Did it Need to Change?
Brazil’s economic story is long and complex. For our purposes, only the basics are necessary to understand why it is not yet a developed country. When Brazil achieved its independence from Portugal in 1822 it had the lowest GDP per capita of any New World colony. It wasn’t until the early twentieth century that the Brazilian economy began to show signs of life. From 1913 to 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. The growth stopped in 1983 when Brazil defaulted on its foreign debt. This historic low-point is a good place to begin a more in-depth analysis of Brazil’s economic history.
From 1965 to 1985 a military junta ruled Brazil. The regime followed import- substitution policies designed to foster industrialization by protecting Brazilian industries from foreign competition. This required the country to borrow vast amounts of money to build the infrastructure (roads, ports, factories, etc.) necessary to support industrial production. When the Organization of Petroleum Exporting Countries (OPEC) raised oil prices in 1979, Brazil had to double the amount it spent on imported oil—money it borrowed from foreign banks flush with petrodollar deposits from OPEC countries. In 1981, the United States compounded Brazil’s budget issues by raising interest rates, which increased Brazil’s debt service payments, along with those of several other Latin American countries. In 1982, Mexico defaulted on its foreign debt, instantly drying up foreign sources of capital for many Latin American countries, including Brazil. With no access to foreign capital, Brazil was unable to pay its debts and continued spending on its industrialization program. Having defaulted on its foreign debt, it had no other choice but to turn to the International Monetary Fund (IMF)—a lender it had long avoided because of the strict conditions put on loans—for the financing it needed.
The IMF, as Brazil’s lender-of-last-resort, held significant power over Brazil’s economic policies. The Fund required Brazil to devalue its currency, cut public spending, freeze all wages, reduce the level of subsidized credit available, and cut the amount of foreign borrowing by state-owned enterprises as conditions for IMF loans. In 1983, Brazil’s GDP fell 4%, employment fell 12%, and inflation was at 211%. For the next 25 years the country’s economy barely grew at all.
III. How Did Brazil Emerge?
In 1985, the military regime handed power to a civilian government led by José Sarney, but he too was unable to control inflation and ultimately defaulted on the country’s foreign debt again, leading to deep distrust of the government. In 1989, Fernando Collor de Mello became the first democratically-elected president in nearly thirty years. He quickly adopted a liberal international trade regime (i.e., lower barriers to imports) and privatized many state-owned businesses—the first in a decade of reform that set the stage for Brazil’s current growth. Inflation continued to be a problem until 1994, when Collor’s successor, Itamar Franco, announced the “Real Plan,” written by future President Fernando Henrique Cardoso.
Before the Real Plan, the Brazilian government had tried various policies to stop hyperinflation (in 1990 it reached nearly 7,000%) including wage freezes, price freezes, and a fixed exchange rate. The Real Plan was a much more comprehensive plan. The Plan introduced a new currency (the real), de-indexed the economy (prices were no longer pegged to the rate of inflation), tightened monetary policy, introduced a managed floating exchange rate regime, and increased taxes. There were also provisions to lower tariff barriers for foreign importers whose competition, in theory, would prevent Brazilian monopolies and oligopolies from raising prices unilaterally. Tariffs ultimately fell from an average of 51% in 1988 to 14% in 1994.
The launch of the Real Plan was the first time Brazil showed the economic discipline necessary to attract the foreign capital and investment that has propelled Brazil’s growth. It was also successful in raising the standard of living throughout the country by lowering inflation from 45% in 1994 to less than 1% in two years. Lower inflation has the practical effect of raising real wages by reducing prices, and therefore increasing the buying power of wage earners. The success of the Plan is what propelled then Minister of Finance Fernando Henrique Cardoso to victory in the 1994 presidential election.
In his first term in office, Cardoso continued the privatization process President Collor started, stabilized a weak banking sector, and started a conditional income transfer program (the Bolsa Família program) to help the poor. He won reelection in 1998, but in his second term Brazil faced yet another crisis—the 1999 “Real Crisis.”
Though the 1994 Real Plan is widely considered a success, it failed to properly address the country’s growing fiscal deficit. Unfortunately for Brazil, concerns over the sustainability of its debt began to arise right as the developing world experienced a series of financial crises. Brazil was not immune from the “contagion” of the 1997-98 Asian Financial Crisis (discussed in the E-Book), where currency speculators bet against the currencies of several countries, successfully forcing down the values of those currencies. Speculators then focused on Brazil. To stave them off and prevent capital outflows, Brazil raised interest rates, which makes currency speculation less profitable.
As a side effect of raising interest rates, industrial production fell as domestic consumption faltered due to higher borrowing costs. Lower industrial production meant Brazil’s exports decreased, and therefore its ability to pay for imports without borrowing declined as well. To pay for necessary imports, Brazil had to borrow and increase its debt even further. Because Brazil had defaulted on its debt twice in the last twenty years, as its debt level increased investors began to fear another default and began withdrawing capital from the country. Speculators also bet against the currency—betting that its value would decrease. President Cardoso’s inability to pass fiscal restraint legislation through Congress further raised investors’ concerns about a possible default. To alleviate fears of default and defend against currency speculators, Brazil sought and received a $41.5 billion loan from the IMF. The fatal blow came from within Brazil when the state governor of Minas Gerais announced that the state would no longer pay its debts to the federal government. After this announcement, capital outflows skyrocketed from already high levels, forcing Brazil to devalue its currency by 9% and eventually allow the real to float freely in international markets. Then came the great surprise.
The crisis did not cause a long-lasting disruption of the flow of foreign capital into Brazil. Cardoso’s macroeconomic policies had proven successful—public sector revenues were rising, which gave Brazil more money to pay its debts, privatization reduced the losses borne by the state, and increased agricultural production helped keep food prices stable—all of which helped blunt the effect of the crisis. Banking reforms had forced banks to keep more cash on hand by lowering acceptable leverage rates, ensuring that banks had sufficient capital to pay fleeing investors without causing banks to fail or creating a risk to the entire banking system.
The crisis quickly subsided and the real stabilized. Cardoso was able to finish his second term by capping discretionary spending and raising tax revenues—both of which helped address the long-standing issue of ever-rising debt, but failed to bring the dramatic change necessary to put Brazil’s debt problems in the past. Cardoso was constitutionally barred from running for a third term, and was replaced in 2002 by Luiz Inácio “Lula” da Silva.
It was under Lula that Brazil truly began to emerge economically. Though his politics were generally very liberal, he sought to appease foreign investors while on the campaign trail by promising to honor contracts, protect private property, assert fiscal discipline, and pay off debts. Once in office, he eliminated nearly all concerns by following the “orthodox” economic path of his predecessor. He 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. Interest rates fell to 6% (Cardoso had lowered them from 20% to 10% in spite of having to raise them during the Real Crisis), which made it cheaper for Brazilians to borrow money to expand businesses inside and outside Brazil.
None of this prevented Lula from pursuing a social development agenda. He lifted tens of millions of people out of poverty by increasing social expenditures, but he paid for this spending by increasing tax collection, not by borrowing. He also fostered greater ties with other EMEs and developing countries to help lessen dependence on the developed world as a source of consumers of Brazilian products.
Lula had his turn at facing a financial crisis when the 2008 U.S. financial crisis spread globally. A common feature of the EMEs is that they generally handled the 2008-2009 financial crisis better than developed economies. This had not been the case in past crises. For EMEs, a global recession generally meant higher unemployment and a larger contraction of industrial production than in the developed world. Brazil’s GDP shrank slightly in 2009 before returning to booming growth in 2010, while the U.S. economy is still barely growing in 2011.
III. Why Did Brazil Handle the Global Financial Crisis so Well?
Brazil’s strong performance through the global financial crisis is partially attributable to the fact that its banks were and still are less exposed to the U.S. mortgage-backed securities market where the crisis started. Thanks to President Cardoso’s reforms, Brazil’s banks were unable to expose themselves to as much risk as other banks around the globe. Brazil’s banking sector also benefits from having one central regulator—the Central Bank. Some observers 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. Taken in combination, these policies ensured that Brazil’s banks would not need large bailouts to stay afloat, unlike their U.S. counterparts.
Brazil also benefited from a low unemployment rate and 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. Increased trade ties with other developing and emerging economies also helped keep demand for Brazilian goods stable. Those increased ties were a focal point of Lula’s foreign policy. 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 precipitously.
This is not to say that Brazil went through the crisis completely unscathed. The government did have to provide a stimulus package amounting to 1.5% of its GDP to spur the economy, but that paled in comparison to the stimulus packages in Japan (15% of GDP) and the U.S. (7% of GDP). Brazil’s unemployment rate also rose slightly during the crisis, but has since hit record lows while the developed world continues to struggle with high unemployment.
President Lula da Silva’s greatest success may have been his ability to increase Brazil’s influence internationally. He led calls for greater voice for the developing members of the IMF and for a shift from the G-7 to the G-20 (which includes more developing countries, including Brazil) as the main forum for addressing global economic issues. Both of these calls were ultimately successful. The IMF recently agreed to shift more voting power to EMEs (including Brazil), and in 2009 the G-20 became the major forum for international economic cooperation. However, Brazil has not been successful in its demand for a permanent seat on the UN Security Council, though the U.K. recently endorsed its campaign. This failure is due, in part, to Brazil’s opposition to sanctions against Iran for continuing to pursue a nuclear program.
When Lula handed power over to his successor, Dilma Rousseff (the first female president of Brazil), his approval rating was over 80% and the economy had just grown by 7.5% in 2010. He had increased spending near the end of his term, which heightened fears of inflation, but President Rousseff promised fiscal restraint during her term, while continuing Lula’s policy of allowing the Central Bank to operate autonomously to control inflation. The promise to cut spending, along with a promise to cut the nation’s high interest rates, is exactly what investors think is necessary to ensure that inflation does not derail Brazil’s current growth. President Rousseff’s first major political win—getting the Congress to agree to a lower-than-desired raise to the minimum wage—surely appeased investors by showing a commitment to both reducing spending (public pensions are indexed to the minimum wage) and controlling inflation.
IV. What Is Brazil Doing to be so Dynamic?
Four policies have played, and continue to play, an important role in pushing Brazil forward: 1) its emphasis on building the infrastructure necessary to support a diverse and fully developed economy, 2) a commitment to reducing poverty and inequality to ensure the maximum number of citizens can contribute to economic growth, 3) an increasing openness to the world, and 4) its movement to reform domestic institutions to foster efficiency.
No economy will function at its highest capacity if poor infrastructure—bad roads, insufficient sea ports, lack of technology—creates inefficiencies at the various stages of production. Brazil has spent much of its new wealth improving infrastructure hoping that it will facilitate further economic growth. The most important of such projects is the “Growth Acceleration Plan” (known by its Portuguese acronym PAC), authored by current President Rousseff while she was a member of Lula’s cabinet.
The “Growth Acceleration Plan” is an umbrella term for thousands of infrastructure projects across the country. The program started in 2007 with an initial $4.2 billion investment. The main goal is to improve the poor infrastructure that has created a pattern of social exclusion, and thereby expand economic potential in traditionally neglected areas. The poor are more likely to live in areas with bad roads, poor public transportation, few available jobs, limited or no access to credit, and no mail or commercial delivery services. These and other issues prevent the poor from fully participating in Brazil’s economy. PAC seeks to remedy this problem by building or rebuilding homes and roads, and improving sanitation, sewage, water, and electrical services in the poorest areas of Brazil’s cities. To maximize the program’s impact, the government hires the people that live in those neighborhoods to perform the work. This simultaneously creates employment in the short term in areas where unemployment is disproportionately high, while making changes that should help spur long-term economic growth.
Regrettably, there are conflicting reports as to whether the projects are actually being completed. President Lula da Silva denied the negative reports, but admitted that progress had been slower than he hoped, blaming bureaucracy for the delays. This admittedly slow progress did not prevent him from announcing an $880 billion extension of the program in March 2010 (PAC II), when PAC I was only 50% completed. PAC II includes more business-focused investments while continuing the poverty-reduction investment projects of PAC I. The main goals of PAC II are to increase the country’s energy production capacity, build two million new homes (to cut the estimated housing deficit to three million homes), and make infrastructure improvements for the 2014 World Cup and 2016 Olympics to be held in Brazil, including building a high-speed rail to connect Rio de Janeiro and São Paulo—Brazil’s two largest cities. Once completed, these projects will greatly expand Brazil’s economic potential for years to come.
B. Reducing Poverty and Inequality
One of Brazil’s most important policy goals has been to reduce poverty to increase participation in economic activities. It has done so through its well known “Bolsa Família” (“Family Scholarship”) program. President Cardoso designed the program (with technical and financial support from the World Bank) as a way to reduce poverty and break the cycle of poverty. Through the program, poor families receive money each month (about $35) on the condition that they keep their children in school and take them for regular health checkups, with the hope being that those children will grow up to be healthy, educated workers capable of independently supporting themselves and their families. Eleven million families (approximately 46 million people) benefit from the program.
The program has raised income at the grass roots level, with 94% of the funds going to the poorest 40% of Brazilian society—most of whom had never benefited from social programs before. It allows recipient families to consume more (studies show that most of the money is spent on food, school supplies, and clothes for children), which has created a “trickle up” effect, where Brazilians sellers benefit from having more customers, and producers benefit from selling larger quantities of their products. It has given a large boost to rural economies and has increased the federal and state tax bases. From 2001 to 2008, the inequality gap shrank by 6%—the largest improvement in Latin America—and millions of people have been lifted out of poverty, proving that the program is working.
C. Increased Openness to the World
Brazil has further facilitated its economic ascension by opening itself to the world through new international trade and foreign investment policies. Since the mid-1990s, Brazil has lowered its import tariffs while modernizing its overall import system (customs inspections, payments, etc.), making it cheaper and easier for foreign countries and companies to sell their products in Brazil. Due to these changes, Brazil’s imports have steadily increased, helping to balance its current account surplus.
The amount of foreign direct investment flowing into Brazil has steadily increased since President Cardoso introduced the Real Plan in 1994, thanks in part to the high investment returns associated with fast growth and high interest rates. Some of Brazil’s other policies have played a role as well. To begin, there is no legislative difference between treatment of foreign and domestic investors—in other words, Brazil adheres to the national treatment standard. Unlike many countries, Brazil sets no maximum or minimum level for foreign investments and allows foreign companies to fully remit profits abroad. For better or for worse, to draw foreign investment, Brazil does not evaluate the potential effects of investments on the national economy or ensure that the country will somehow benefit before approving investments.
Foreign investment is further facilitated by improvements in Brazil’s capital markets. In 2008, the São Paulo Stock Exchange merged with the mercantile and futures exchange to form the largest exchange in Latin America, and the fourth largest exchange in the world with market capital of $1.167 trillion. Disclosure requirements for listing on this exchange are on par with markets around the world, giving investors confidence that they have all the relevant information available to them to make a prudent investment. All of these efforts have made it easier, safer, and more profitable for foreigners to invest in Brazil.
D. Institutional Reform
As Brazil has grown, it has made a concerted effort to improve government institutions to make them more efficient for both Brazilians and foreign investors. Most important among these reforms, at least as far as encouraging investment is concerned, has been reforming the judicial system. A 2006 constitutional amendment mandated judicial reform and made judicial expeditiousness a constitutional guarantee—an important step for Brazil’s traditionally slow legal system. In 2007, the country passed a new law that allows some decisions of the Federal Supreme Court (the highest constitutional court in Brazil) to have precedential value, meaning certain decisions will bind lower courts on the particular issue of a case whenever it arises in the future. Though this is standard procedure in the “common law” countries like the U.S. and U.K., it is an uncommon practice in so-called “civil law” countries like Brazil. It will prevent the courts from having to decide the same issue over and over again, making the entire system faster. A fast, efficient judiciary is cheaper and more reliable for enforcing property and contract rights—two things with which foreign investors are deeply concerned.
Thanks in large part to these reforms, Brazil is currently experiencing possibly its greatest economic growth in history—averaging GDP growth of 4.5% per year since 2002. The country’s GDP expanded by an estimated 7.5% in 2010, which brought total GDP to almost $2.2 trillion—the highest in Latin America, and GDP per capita to over $11,000 (sixth-highest in Latin America). Furthermore, joblessness is at an all-time low, foreign exchange reserves have soared (sixth-highest in the world), and the country’s sovereign debt received an all-important investment-grade rating in 2008. By any measure Brazil is in good economic shape. But by definition, emerging market economies are not yet fully developed or advanced economies. So what exactly is still holding Brazil back?
V. What Is Holding Brazil Back?
As is the case with explaining growth, there is no one thing that explains why Brazil is not “there” yet. The most commonly mentioned problems Brazil faces are 1) policy failures that inhibit economic activity, 2) a cumbersome regulatory and legal framework that limits efficiency, 3) excessive inequality that prevents full and equal economic participation for all Brazilians, and 4) external factors that inhibit Brazilian economic interests.
A. Policy Failures
Brazil’s biggest policy failure is that its government still spends too much money. Among other things, 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. President Lula da Silva was fairly prudent in not spending too much for most of his term, but he spent more at the end of his term as he bowed to populist pressures during the election cycle. President Rousseff promised to cut spending during her campaign, and so far has shown a commitment to doing so, but it is too early to know if she will ultimately be successful.
A second major policy failure is Brazil’s continued dependence on commodity exports (mainly food and oil) to drive growth, which creates inflationary pressure and currency appreciation. The appreciated currency negatively affects other sectors of the economy—in Brazil’s case, the manufacturing sector whose products are now more expensive and therefore less competitive globally—making the country even more dependent on commodities over time. Excessive dependence on exports may also increase a country’s exposure to external market shocks.
Unfortunately, Brazil appears poised to expand its dependency on commodity exports as it recently discovered huge oil reserves and has made large investments in its ethanol and agricultural sectors. These commodities are currently as profitable as they have ever been for Brazil, but that may have more to do with a global food shortage and over-speculation in the oil markets driving prices up than with any economic wisdom of the Brazilian government. The government plans to put new oil profits in a sovereign wealth fund to prevent increased spending from further pushing up the value of the real, but whether it will adhere to that policy in the long term is yet to be determined.
Corruption is another major policy failure. Transparency International, an NGO that measures corruption throughout the world, ranks Brazil as the 69th least corrupt country out of 178 total. The roots of corruption are far too complex to deal with fully here, but it is important to note how Brazil’s political structure fosters corruption. Brazil’s political system allows more than twenty political parties to participate in elections. These parties are in a constant scramble for government money in the form of welfare benefits, government jobs, payrolls, and contracts that would help influence voters. This system inhibits efficiency and productivity by encouraging corruption, as it is often the easiest alternative to securing funds for constituents when politicians lack voting power, as is often the case in a system with twenty political parties. The government must find a way to stop this corruption and prevent public officials from siphoning funds away from needy individuals and economically beneficial projects, a task that may be more difficult now with enormous potential oil profits looming on the horizon.
B. Failures in the Regulatory and Legal Systems
With the exception of corruption, the policy failures discussed above have little direct effect on foreign investors. The continuing issues with Brazil’s regulatory and legal framework, however, do affect foreign investors by making it riskier and more expensive to do business in Brazil. The National Federation of Industries termed these extra costs of doing business in Brazil the “Custo Brasil” (“Brazil Cost”). Principal among these costs is the high tax burden mentioned above. Taxes represent 36% of Brazil’s GDP compared to only 8% in China, meaning that Brazil relies on and collects huge tax revenues to help fund government projects. But besides the high amount of taxes, Brazil’s tax code is extremely complex, making compliance a lengthy and expensive process. Brazil ranked 152nd in the World Bank’s “Doing Business” ranking in terms of ease of paying taxes. It took the World Bank’s hypothetical company 2,600 hours to fully comply with the tax laws, which makes it a costly endeavor. The tax system desperately needs to be simplified.
Cumbersome regulations also make starting a business an expensive ordeal. Brazil was ranked 128th in the world in terms of ease of starting a new business according to the same World Bank study. It takes an average of 152 days to register a business in Brazil, compared to the world average of 48 days. Brazil’s labor laws further complicate the system by making it nearly impossible to fire workers due to strict requirements for showing cause (employee laziness and employer bankruptcy are not just causes for firing workers) and the costly fines imposed for violations. Though Brazilians take pride in finding ways around these regulatory costs (they have even given the ability to skillfully avoid regulations a name—jeitinho), they surely make investors think twice before starting a business in Brazil, and must be addressed if the economy is to attract foreign companies to Brazil.
A slow and inefficient judiciary adds to the “Custo Brasil.” Brazil’s courts simply have too large a case load to function quickly or efficiently. Though the courts have never been known as exemplars of efficiency, case loads have skyrocketed since the country passed a new constitution in 1988 that granted extensive personal rights that Brazilians have often sought to enforce through the court system. The increase in cases can also be attributable to the highest court’s overly broad original mandatory jurisdiction (meaning the cases it must hear before any other court instead of waiting for a case to come to it on appeal).
Though Brazil has made steps towards strengthening the concept of controlling precedent in its courts, it does not yet apply to all decisions. It is estimated that 90% of the highest court’s caseload still consists of questions that it has already decided, sometimes thousands of times. This not only consumes time and money, but also risks inconsistent application of the law. One former President of the Supreme Tribunal said that judicial caseloads are so high in part because of the government’s bad faith refusals to pay judgments, choosing instead to appeal cases indefinitely to delay payment, knowing that it has no chance of winning the cases. The only reason this is even possible is that the Brazilian system allows for an inordinate number of appeals of all sorts. Appeals can greatly extend court proceedings and therefore court costs as well.
If these issues have not already scared foreign investors away, there are still more concerns. Property rights are poorly defined and not well enforced, there is no pre-trial factual discovery process (making it difficult for parties to gather all the relevant facts for trial), and class actions are becoming more and more common as Brazil leads a movement throughout Latin America to grant shareholders greater rights against the companies in which they invest. None of these issues alone is fatal to Brazil, but combined they make the prospect of investing in Brazil potentially both riskier and more costly.
Inequality is possibly the most commonly known threat to Brazil’s progress. In spite of Brazil’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. For Brazil this means that economic growth could increase by two or three percentage points each year by eliminating poverty. Currently, the top 10% of the population accounts for 43% of total consumption, while the bottom 10% makes up only 1.1%. While CEOs in São Paulo make more money than CEOs in New York City, over 10 million Brazilians live on less than $1.25 per day. The end result is that Brazil is still the eighth-most unequal country in the world and third-most in Latin America.
Brazil’s inequality is not a new phenomenon. It is generally blamed on unequal educational attainment and unequal land distribution, both of which have their roots in the colonial era. During the colonial era, the government saw little need for education in areas that were heavily populated with slaves and lightly populated by Europeans, and therefore there was no educational infrastructure in those areas when slavery finally ended in 1889. Unfortunately, the educational attainment gap has done nothing but grow since that time. Wealthier, whiter Brazilians have continuously dominated politics and have chosen to invest Brazil’s money in the whiter southern part of the country, while generally ignoring the black and indigenous populations of the north. This is a common practice in cities throughout the country as well.
Brazil is not likely to correct this problem in the near future. The education system is inadequate throughout the country. President Cardoso entered the country into the Program for International Student Assessment run by the Organization for Economic Cooperation and Development (OECD, an international organization comprised almost exclusively of developed countries) to compare Brazilian student achievement to student achievement in the developed world. Brazil now ranks 53 out of 65 (initially it came in last place when fewer countries participated), which is mediocre even by Latin America’s low standards. Any marginal improvements that have been made are attributed to President Cardoso’s “Bolsa Família” program and his decision to mandate minimum per-pupil spending and teacher salaries. Brazil could increase spending for education even further if it diverted spending away from generous pensions teachers receive after only 25 years of work for women or 30 years for men, but some observers doubt that throwing more money at the problem is the best solution.
Besides funding, poor quality teachers are an issue in Brazil as well. To become a teacher in Brazil, a university student is not required to take courses on teaching skills or the subject matter he or she is going to teach, but rather he or she will study the philosophy of education. Few people consider this the best way to train effective teachers. Nearly half of all teachers in São Paulo fail to meet the minimum standards required to receive a permanent contract. Until Brazil solves these myriad problems with its educational system, there is likely to be little upward mobility for the poor, and the country as a whole will suffer as it will continue to depend on either imported labor or foreign educational systems to provide it with the skilled labor it needs to continue its economic growth.
A poor education system is also related to Brazil’s land distribution problem. The issue is most evident in Brazil’s largest cities where squatters have taken up residence illegally on any open space they can find. These illegal settlements have grown into entire neighborhoods called "favelas" where hundreds of thousands of people live with almost no government services, including schools. The residents of these neighborhoods (usually minorities) lack title to their land, and therefore lack what for many people is their most valuable asset. The residents also face gross discrimination from employers, banks, and oftentimes the police just based on their address. The favelas are usually overrun by drug gangs and usually lack basic services like running water and electricity. Though the government has made progress in recent years against the gangs, the problems facing the favelas will not be solved any time soon, which will continue to effectively exclude many favela residents from participating equally in the education system and formal economy.
D. External Factors
Brazil’s economic progress is also inhibited by external factors it cannot directly control. Chief among these are U.S. and Chinese trade policies, both of which negatively affect the competitiveness of Brazilian goods globally. Brazil has long criticized the United States government for subsidizing the production of agricultural goods like cotton, sugar, and corn. These subsidies allow U.S. farmers to compete with more efficient and lower-cost Brazilian producers by lowering production costs in the U.S., which reduces the demand for Brazilian goods by increasing the supply of the same goods at similar prices.
In 2005, the World Trade Organization (WTO) ruled in Brazil’s favor in a case against the U.S. regarding a U.S. subsidy for cotton farmers. By 2010, the U.S. had still not complied with the ruling, so the WTO granted Brazil permission to place retaliatory tariffs on U.S. goods. The U.S. and Brazil were able to negotiate a temporary resolution that required the U.S. to compensate Brazil for losses that result from the cotton subsidy, but did not require the U.S. to cut or end the subsidy. Some observers doubt this agreement will serve as a viable long-term solution to the dispute.
Brazil would also like the U.S. to remove tariffs it places on Brazilian sugar-based ethanol to protect its own corn-based ethanol industry. Brazil has spent years developing the technology to produce the cheap alternative fuel, only to have the world’s largest oil consumer place heavy tariffs and effectively deny Brazil’s access to its market. Unless the United States removes these trade barriers, Brazilian producers will continue to lose potential profits to less efficient producers in the U.S.
China also poses a threat to Brazilian economic growth. China, with its enormous appetite for raw materials, is now Brazil’s largest trading partner with huge purchases of Brazilian goods, especially iron-ore and soy beans. This high demand has increased commodity prices worldwide and produced large profits for Brazil. Should China’s demand ever fall, commodity prices would likely drop and Brazil may be left trying to sell its goods at prices that are no longer profitable.
Though China is Brazil’s largest trading partner, it is also its largest competitor. China’s policy of preventing its currency from appreciating has left its value artificially low, which negatively affects Brazil by making Chinese manufactured goods cheaper than they otherwise would be compared to Brazilian manufactured goods. This causes Brazilian producers to lose consumers both internationally and domestically to cheaper Chinese producers. Brazil has placed tariffs on many goods of Chinese origin to ease the problem, but this only addresses the problem of Chinese competition in the domestic market, and has no effect on competition in international markets. If China does not allow the market to determine the value of its currency, Brazil will continue to lose potential profits. Unfortunately, Brazil cannot force China or the U.S. to change their ways and must continue to suffer the consequences.
Brazil has come a long way since its days as home to the Western Hemisphere’s lowest GDP per capita. The prudent leadership of Presidents Fernando Henrique Cardoso and Luiz Inácio Lula da Silva has resulted in quick growth, declining poverty, and an increased say in international affairs. The country can only hope that current President Rousseff will be as successful as her two predecessors.
In spite of its recent success, Brazil’s goal of becoming an advanced economy has not yet been met. It must continue to diversify its economy, reduce regulatory and legal inhibitors to efficiency, and fight poverty through social spending and education. President Rousseff must also find a way to balance the country’s budget without slowing growth. In spite of all these issues, Brazil is still capable of becoming an advanced economy, and certainly deserves its position among the BRIC countries.
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