The strange and misunderstood reasons for the Brazilian crisis

Almost done for the year. So do not expect many posts before the end of the ASSA conference (January 5). But as I promised, here are some brief thoughts on the Brazilian crisis.

Brazil is a mess. The economy is collapsing, with an estimated decline of about 3.5% in GDP this year (perhaps worse), and inflation has accelerated, to two digit levels, way above what used to be the upper limit of the inflation target band. Worse, politically the country is paralyzed, with an impeachment process in course with a very uncertain outcome.

The conventional view is sort of split on why this happened. Some suggest that it was the slowdown of the international economy, and the decline in commodity prices, that forced Brazil to adjust (for example, that would be Simon Romero's story in the NYTimes, if you add corruption to the mix; more on that below). The alternative is more explicit about the negative effects of the Workers' Party (PT in Portuguese) policies, suggesting that they reduced confidence and, hence, investment (something along these lines can be seen in the Wall Street opinion pages; see here; subscription required).

In the policy/confidence variation version the argument is that the government spent too much, in particular, in the second Lula administration, and more so in the aftermath of the Global Financial Crisis. There was an attempt to reduce fiscal spending with Dilma Rousseff's election (in this interpretation mostly disguising the spending with creative accounting, more on that below), but that was temporary, and only after Dilma's reelection did the fiscal problems became unsustainable and required adjustment.

Both stories are flawed. First, even though the global economy is growing slowly, and some peripheral economies like China are also slowing down, Brazil has no clear external problem. Current account is negative, but the country is in no danger of an external crisis or default on its foreign obligations, in particular because it is sitting on a huge pile of international reserves. As I noted before Standard & Poor's actually agrees with that view on the justification that they used to reduce Brazilian grading status (last week Fitch's followed the lead and also downgraded Brazil's debt), since they do not cite the external situation as a problem.

So the notion that Brazil needed a fiscal adjustment, to throw the country in a recession, and reduce imports, and solve the external problem seems unfounded. The same is true for the notion that a huge depreciation of the real was needed. In fact, the depreciation has only contributed to the acceleration of inflation, with no impact on the external accounts. Exports have tanked (since the global economy is not doing well), and so did imports (given the recession). Inflation will also have a significant impact on real wages, and will worsen income distribution (which had improved during the PT administration).

But what about the internal problems (both S&P and Fitch actually do blame the fiscal problems). This arguments is even worse, and has some serious logical limitations. Note that this suggests that fiscal deficits in domestic currency might be unsustainable and that inflation results from excessive demand associated to too much government spending. I have discussed this several times in the blog, so I won't delve too much into it.

There is no way a country can default on debt in its own currency. By definition you can  always print money. And yes inflation might follow, but not because printing money causes inflation. The argument implies that economy is generally, and certainly Brazil is not, at full employment. Hence, money printing might lead to more spending and more output, not inflation. However, another effect might be a fear of depreciation, and a run for dollars, and the depreciation might have an inflationary impact.

In other words, the reasons for austerity are not connected really to fear of domestic default. Austerity could be used to solve a current account problem, which is not the case in Brazil, as we saw, or it might be a way of leading to a recession, increasing unemployment and reducing the bargaining power of workers, as Kalecki noted long ago. It is a way to discipline the labor class. And that is what is going on in Brazil (on the slowdown of the economy essentially following the same argument see this paper by Serrano and Summa).

The government could actually spend itself out of the recession (don't worry, it won't). And by the way, since revenue responds to the level of activity, the fiscal outlook would improve. So if the Brazilian crisis is not external and is not fiscal, what caused this crisis. It is a self-imposed political crisis. The relevant question is why is this policy implemented by a left-of center government.

One has to first remember that on some level PT always accepted the conventional thinking when it came to fiscal issues. Lula famously said in his letter to the Brazilian people that he wanted "fiscal equilibrium to be able to grow," suggesting that he had incorporated the notion of contractionary expansion. But, in all fairness, there was some dissent within the party, and with the Plan of Acceleration of Growth (PAC in Portuguese) and, in particular, after the 2008 crisis, it seemed that PT was ready to use government spending to promote economic development. So why after winning the close election last year, in which Dilma decried the economic program of the Social Democratic Party of Brazil (PSDB in Portuguese) did she essentially adopted it?

It is clear that part of the government accepted that fiscal expansion had gone too far, and that workers' demand, and the real wages, were too high. The political pressure was certainly felt, and in addition the nagging issue of corruption might have also played a role. Also, for some reason the so-called New Economic Matrix (which in my view, I might be wrong) was very conventional, trying to reduce interest rates and promoting a moderate fiscal adjustment was seen as a failure for the wrong reasons. The lower interest rates, and the more depreciated currency should have stimulated growth, while the adjustment should have controlled prices. Obviously this New Developmentalist idea failed, since depreciation fueled inflation (which wasn't high, just at the higher end of the target at around 6.5%) and the economy slowed down.

However, the lesson taken from this experiment was that the government lost credibility, since the fiscal adjustment wasn't strong enough and the delays in the payments to public banks (the infamous 'pedaladas'), in particular the development bank (BNDES in Portuguese), were behind the crisis. In this view all depends on 'confidence fairies.' That is, the lack of confidence reduced domestic investment, and lowered growth. A terrible side effect of the generalized acceptance of this view is that now the political use by the opposition of the delays in payments to the public banks, something that was not new, in the impeachment procedures will create a permanent legacy, reducing the ability of future governments trying to pursue expansionist policies.

Finally, a word on the issue of corruption. Yes, there is a significant corruption scandal in Brazil, and before anybody complains, I do hope they get everybody and that the people that are proven guilty end up in paying the price (jail presumably; by the way, if they had something on the president it would have been used for impeachment, rather than a bureaucratic budget issue). I just want to note that there is no evidence (I haven't seen any credible evidence at least) that corruption is worse now, than say with the military back in the 60s and 70s, when most of the connections with big construction firms started. Also, the problems at the state oil company (Petrobras) being investigated go at least back to the Cardoso government. And corruption is not a problem of the government coalition per se. Members of the opposition are involved too, and an impeachment would actually bring to power some of the most evidently corrupt politicians in the country. In that sense, if corruption has not changed, it can hardly be seen as having caused the economic situation. Corruption is just one of the elements used by political groups to obtain advantages.

The problems of corruption that matter in Brazil are associated to the fact that one cannot govern without basically paying for political favors in congress and that means paying the main political force there, the Brazilian Democratic Party Movement (PMDB in Portuguese). It is well known, for example, that Cardoso payed for changing the constitution and allowing his re-election, to cite an example that is old enough, and not connected to the current government. But the country did grow significantly in the past, in spite of corruption.

And, by the way, the susbtitution in the Finance Ministry, with the appointment of my ex-classmate (at all levels, undergraduate, master's and PhD courses) Nelson Barbosa, is unlikely to lead to any significant changes in policy. The fiscal adjustment will continue as he very clearly announced.

Comments

  1. The meat of it

    "Brazil is a mess. The economy is collapsing, with an estimated decline of about 3.5% in GDP this year (perhaps worse), and inflation has accelerated, to two digit levels, way above what used to be the upper limit of the inflation target band. Worse, politically the country is paralyzed, with an impeachment process in course with a very uncertain outcome."
    "The government could actually spend itself out of the recession (don't worry, it won't). And by the way, since revenue responds to the level of activity, the fiscal outlook would improve. So if the Brazilian crisis is not external and is not fiscal, what caused this crisis. It is a self-imposed political crisis. The relevant question is why is this policy implemented by a left-of center government.
    "
    "One has to first remember that on some level PT always accepted the conventional thinking when it came to fiscal issues."
    "A terrible side effect of the generalized acceptance of this view is that now the political use by the opposition of the delays in payments to the public banks, something that was not new, in the impeachment procedures will create a permanent legacy, reducing the ability of future governments trying to pursue expansionist policies."
    "In other words, the reasons for austerity are not connected really to fear of domestic default. Austerity could be used to solve a current account problem, which is not the case in Brazil, as we saw, or it might be a way of leading to a recession, increasing unemployment and reducing the bargaining power of workers, as Kalecki noted long ago. It is a way to discipline the labor class."

    Why does an exporter have foreign currency liabilities?

    ReplyDelete
  2. Petrobras had a very serious corruption crisis, which led to a difficult situation resulting in investments' cuts (Petrobras' investments are nearly 10% of Brazil's investments). This is one thing. The other reason for the recession and high inflation relies on the fact that Brazil did not adjust some tariffs controlled by the government, such as energy, public transport and fuel prices in 2013 and 2014. In 2015, all tariffs were adjusted because of the high costs to maintain the tariffs' stickiness, and that, combined with the currency depreciation, produced a huge costs shock, which obviously resulted in an even worse recession together with higher inflation. The product was diminishing, and so were the revenues of the government as a result. Therefore, even with the government's efforts to cut expenses the primary surplus was not possible.

    ReplyDelete
  3. Don't you think it is a bit wrong say that all countries can't default on its own currency? How Argentina came to the point it came today?

    And about the print money issue, Brazil may not be in a full employment stage but the increasing of investment due to a increase in demand or a decrease of interest rates couldn't happen since the Brazilian is too much concentrated, with to many entry barriers imposed by the biggest firms and for a poor subsidies policy (like the giants of food industry). It was the same thing when government decreased basic interest rate and the banks did not passed it to consumers or when government exempted industry and service of many taxes and the prices didn't changed.

    My point is: Brazil's economy is too concentrated to respond to fiscal and monetary incentives without inflation and without a direct intervention of state in infrastructure sector to lower cost and improve competition to a healthy standard (belive me, I'm not a liberal).

    On the other hand, keep dollar cheap with the use of central bank reserves wasn't working a while ago and insist in it would only reduce its amount without apparent result.

    As I see, the only way to get out of this mess would pay the most expensive part of debt the is yearly amortized to decrease the cost of debt interests and do a tax reform to a progressive system. But lower basic interests and spend more would be suicide.

    ReplyDelete
  4. Matias, boa tarde! Concordo em grande medida com sua análise. No entanto, creio que seja interessante detalhar mais a situação da Petrobras, posto que é um grande vetor do investimento no Brasil, fonte de enormes externalidades positivas e encadeamentos na nossa agonizante indústria. A Petrobras anunciou sucessivos cortes bilionários em seus planos de investimento e o desligamento de dezenas de milhares de terceirizados, causando um arrasto muito grande em diversos setores. Há algumas interpretações para as causas desse quadro: a política de administração do preço da gasolina, a queda no preço internacional do barril do petróleo e os escândalos de corrupção desnudados na empresa. Embora concorde que a corrupção não é novidade aqui nos trópicos e nem foi criada pelo PT, creio que, desta feita, ela causou grande impacto na economia real, por atingir um núcleo tão dinâmico como a Petrobras. Obviamente, não sendo estes escândalos as únicas nem as mais relevantes causas da situação atual da economia nacional, que, em minha visão, tem raízes, sobretudo, estruturais. É possível uma argumentação neste sentido ou a corrupção não pode ser um dos fatores explicadores da retração atual da Petrobras?

    ReplyDelete
  5. Hello Matías,

    Some studies are showing, by means of input-output matrixes, the growing import coeficient in the domestic industrial production. This kind of studies points to the uncomfortable side of the current account deficit; the exchange-rate adjustment was "ongoing" since late 2013, with the commodities price fall, but was counterveiled by intervention in foreign exchange market.

    I would like to hear from you, if you have time to answer, what do you think about the influence of the exchange-rate in the long-run growth path of the brazilian economy and its industrial sector.

    Sorry for my english

    ReplyDelete

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