Brazil's Infrastructure Challenge

If you ask any Brazilian about the major problems facing their country, one of the first responses (after corruption, of course) will certainly be lack of infrastructure. I have mentioned this issue in previous posts, and there is no doubt that infrastructure has become a major topic of discussion in the national media. With the 2014 World Cup and 2016 Olympics looming (not to mention next month’s Rio+20 summit and the 2013 Confederations Cup), the world is watching closely as Brazil seeks to modernize its airports, roads, ports, and urban transportation systems.

Much of the recent criticism, both national and international, has focused on poor execution and slow implementation, as projects across the country are behind schedule and makeshift solutions such as temporary airport terminals are being proposed. Time is certainly of the essence as the date for the events moves closer. But in fact it is quite normal for infrastructure projects to come in over budget and behind schedule.  In my home state of Maryland, the Inter-County Connector, a major new toll road which finally opened in November 2011, was criticized for years due to ballooning costs and a slow construction schedule. South Africa heard many similar critiques regarding its infrastructure projects in the run-up to the 2010 World Cup. While preparations may not be ideal, I am confident that they will be adequate for Brazil to fulfill its responsibilities as host country for all these events in the years ahead. And if insufficient preparations end up causing Brazil significant international embarrassment during the World Cup, that should serve as a powerful incentive to improve execution of infrastructure projects in the future.

Long term, however, Brazil faces real challenges regarding its infrastructure. At its heart, the issue is not execution but rather financing. Simply put, Brazil needs to come up with a lot of money if it is to pay for the massive reforms needed to update the entire country's infrastructure system and put it on a path to achieve higher rates of economic growth. This represents a major challenge for a country that currently invests only 19% of its GDP.

China serves as a useful foil for Brazil in this regard. Having recently reached middle-income status after years of urbanization and large scale, low-wage manufacturing, China is trying not to hit a wall but rather to unlock a new era of growth to transition from middle-income to high-income country over the next several decades, following in the path of its East Asian neighbors Japan, South Korea, and Taiwan. To achieve this end, the country's leaders have invested massively in infrastructure, creating a new high-speed rail system in addition to numerous other projects. As a result, investment reached 48% of GDP last year. While this extraordinarily high rate was temporarily inflated by the government’s $586 billion stimulus plan to counteract the 2008 financial crisis and has led many to cry panic about an investment bubble, it is not far off from the roughly 40% rates of investment of Japan in the 1970s and South Korea in the 1990s, suggesting that China is following a historical development path that will pay dividends in the future.

Unfortunately, Brazil does not have China’s ability to finance large-scale infrastructure improvements. It has a low domestic savings rate, equivalent to 17% of GDP over the last decade compared with 50% in China. It also does not have a large trade surplus. Whereas China ran extremely large current account surpluses averaging nearly 6% of GDP over the last decade, Brazil ran a deficit averaging -.5%. (Source: tradingeconomies.com) In other words, China saved up the money it made from exports during the last ten years of rapid economic expansion, whereas Brazil spent its earnings. Now, China is able to fund huge infrastructure projects all over the country, whereas Brazil is struggling to find the cash it needs.

President Rousseff’s aggressive focus on reducing interest rates may help in this regard, as falling rates are already lowering the government’s borrowing costs, freeing up money for investment that would otherwise be spent on servicing the debt. However, this step alone will not solve the problem. The Brazilian government’s drive to lower interest rates should improve the country`s macroeconomic fundamentals, but expanding the credit supply will do little to improve the savings rate.

A more important step forward in financing infrastructure projects has been the recent wave of privatizations. Recognizing that the government simply did not have the money to finance much-needed airport reforms, Ms. Rousseff turned to the private sector for help. Infraero, the country’s airport authority, began last year by selling the concession to operate the airport in Natal, a small World Cup host city in the Northeast that has been the most behind schedule in preparations. This February, the agency auctioned off concessions to operate public-private partnerships for three major airports in São Paulo and Brasília. Two more auctions are expected to follow for the airports in Belo Horizonte and Rio de Janeiro. If these projects turn out well, privatizations may become an increasingly important tool in updating the country’s infrastructure.

The downside to privatizations is that investors expect to earn a commercial rate of return, and often end up charging a hefty price tag for use of the infrastructure. I was astounded by the tolls on a recent car trip from Belo Horizonte to the coastal city of Cabo Frio. The road was of remarkably better quality than anything else I had seen in Minas Gerais, but we ended up paying 45 reais in tolls over the course of seven hours in the car, and the price tag was significantly higher for trucks and other large vehicles. Similar fears abound regarding the airline privatizations. After the winning bid to operate São Paulo’s main airport came in at five times the government’s asking price, many have started to worry that the high costs of the concessions will be passed on to airlines and consumers. Private money is desperately needed to improve Brazil’s infrastructure, but the government will have to figure out ways to keep fees from spiraling out of control.

It could start by improving its auction processes. Outside of the problem of keeping bids under control to prevent future spikes in fees, the government should adequately vet proposals at an early stage to ensure that the consortia have the necessary expertise to operate efficiently. The government caused a stir several weeks ago when rumors leaked that it was worried about some of the winning operators’ lack of expertise in operating large airports and history of accumulating unpaid debt, although the transfer of the concessions is still proceeding as planned. In addition to the issues regarding the airport auctions, the proposed high-speed rail project linking Rio and São Paulo has been postponed several times, after three auctions in 2010-2011 failed to yield a single proposal from a national construction firm. The government is currently revising the auction rules, but the project, which was originally supposed to be ready for the 2016 Olympics, now looks to be at least ten years away.

Ironically, Brazil’s ability to attract infrastructure financing may depend on its emerging market foil mentioned above: China. As it has done across the developing world, China is investing huge amounts of money in securing access to Brazil’s export market, due primarily to its appetite for steel, oil, and foodstuffs. China’s massive savings are being used to improve Brazil’s electrical grids, rail systems, and ports. The biggest symbol of Chinese investment in Brazil is the Açu Superport, nicknamed “The Highway to China”, a $2.5 billion project set to open this year that will become one of the main conduits for trade between the two countries.

Yet even with lower interest rates, privatizations and foreign direct investment, it is difficult to see how Brazil will reach the investment levels needed to spring the middle-income trap and become a wealthy country without fundamentally learning to save more and consume less. Brazil has become increasingly reliant on consumer spending, not investment, to finance its economic growth. These three graphs illustrate just how poorly Brazil fares against its BRIC peers in this regard, as it invests little, relies more on consumption, and has experienced a drop in its capital stock per person over the last three decades (courtesy of the Angry Bear Blog):

There is hope that the coming oil boom will flood the state’s coffers, creating a large trade surplus that can then be invested not only in a massive infrastructure program, but also in new health, education, and scientific research and development initiatives. Spent wisely, oil money could be the key to Brazil’s long-term economic success. But the chances are equally high that oil could feed Brazil’s vices, encouraging a bloated public sector, commodity dependence, and lavish, inefficient spending sprees without promoting the key investments needed to put the economy on a more dynamic path. If that becomes the case, Brazilians may have to come to accept dirt roads and sky-high tolls for a long, long time.

Is Brazil “Deindustrializing”?

Several times before on this blog, I have written about the inherent weaknesses in Brazil’s manufacturing base, an important engine for any country’s economic development. Over the last decade, high commodity prices significantly boosted Brazil’s terms of trade, leading to a period of strong growth that led many to claim that Brazil was one of the world’s emerging great powers. Despite its uncompetitive industries, rapid expansion of services, domestic consumption, and pro-poor social spending along with falling inequality gave rise to what local political leaders and international observers dubbed “The Brazil Model”. While I greatly admire the progress Brazil has made over the last decade, I questioned whether this economic success would be sustainable without a comprehensive effort to improve the manufacturing sector. Recently, the failures of the Brazilian Model have become all too apparent, as Brazil’s booming economy has slowed to a crawl.

Economic growth has slowed across the world over the last year, as Europe flirts with recession and China continues to restructure its economy for a “soft landing”. Both developed and developing countries registered weaker-than-expected GDP growth for 2011, but in few places was the shift as dramatic and unexpected as in Brazil. After expanding at a brisk 7.5% rate in 2010, the country slowed dramatically to 2.7% in 2011, barely avoiding recession in the second half of the year. Estimates for 2012 GDP continue to be revised downward, and instead of becoming the region’s shining star, Brazil now lags behind all major Latin American economies in its growth projections.

The culprit of this sudden shift? Weak performance from the industrial sector. After registering robust growth in 2010, Brazilian manufacturing collapsed in the second half of 2011, averaging a monthly -1% contraction, annually adjusted. The situation continues to worsen in 2012 as January and February recorded contractions of -3.4% and -3.9%, respectively. Suddenly, national and foreign observers are worrying about Brazil’s “deindustrialization”. Reviving the manufacturing sector has now become the top priority of the nation’s policymakers.

The biggest reason behind the sudden shift in Brazil’s fortunes has been the rapid appreciation of the real, the local currency. After trading at roughly 2 reais to the dollar for the last several years, the real strengthened to an average of 1.6 reais to the dollar during 2011. This was caused principally by speculative “hot money” fleeing low interest rates in the developed world and attracted to Brazil`s sky-high interest rates, a legacy from past battles against hyperinflation. As the value of the real strengthened, Brazil’s industry found itself struggling to compete domestically against suddenly-cheaper imports, and unable to sell internationally as its products became overpriced. President Dilma Rousseff railed against the effects of this “monetary tsunami” which stimulated growth in rich countries at the expense of emerging economies. To combat the effects of a strong real, the Brazilian government has imposed stricter capital controls and intervened in the currency market, purchasing dollars in large quantities to ease the real back to a rate of roughly 1.87 reais to the dollar.

(An interesting side effect of the strong real: Brazilian tourists flocked to the U.S. in record numbers this holiday season, going on shopping sprees that provided such a boost to the U.S. economy that President Obama has promised to relax visa requirements for the future. And one unfortunate Fulbright scholar had his cost of living shoot up dramatically…)

Exchange rates are incredibly important, and I do not want to suggest that appreciation of the real has not been the main reason behind Brazil’s 2011 woes. A quick look at Germany and China shows just how important a weak currency can be to boosting a country’s manufacturing potential. But the issues behind Brazil’s industrialization go much deeper. The country suffers from an underlying competitiveness problem.

In my previous column on Brazil, I mentioned some of the areas that need drastic improvement in order for Brazil to have more sustainable economic success. These include taxes, interest rates, infrastructure and education.

Lowering taxes should certainly be a priority of the government. While a recent package of temporary, targeted tax cuts to industry is a promising sign, a more long-term, broad-based comprehensive reform will be needed to reduce the negative impact of Brazil’s stifling tax regime.

Incredibly high interest rates, long a scourge on the Brazilian economy, choke the supply of credit for both consumers and producers. The Central Bank has been aggressive in pushing these rates down, and Dilma has made it clear that lowering interest rates is a key part of her government’s economic revival strategy. While taking advantage of a slow international economy to finally push down interest rates to more manageable levels is certainly a good idea, persistently high inflation in the country may limit the government’s room to maneuver in this area.

Infrastructure remains a key concern, but I will write more on this topic in a separate column.

Investment in science and technology has been one interesting initiative of the government. Dilma’s new “Science Without Borders” plan aims to send up to 100,000 Brazilian students to study in top universities across the developed world, principally in the United States. This program represents Brazil’s largest investment in improving its knowledge in high-tech science and engineering in order to build competitive industries in some of the world’s most cutting-edge fields. While the benefits may not become clear for some time, this program could have huge long-term effects on Brazilian businesses’ international competitiveness.

Overall though, the biggest impediment to Brazil’s industrial growth may be the country’s worrying trend of protectionism. With high tariffs and import quotas, Brazil has long been reluctant to force its businesses to compete internationally by promoting more free trade. Fearing that doing otherwise would promote even greater deindustrialization, the government has often been eager to coddle its many inefficient manufacturers. This has resulted in extremely high costs for Brazilian consumers, and an inability to compete even with peers in Latin America.

Brazil’s foil in this regard is the region’s other giant: Mexico. During the 1990s, Mexico opened up its economy to become part of NAFTA. While this did cause a difficult transition process as old, inefficient businesses bowed to competitive pressures and closed, it eventually led to a new generation of efficient manufacturers with a hard-earned competitive advantage. This restructuring eventually turned Mexico into Latin America’s strongest industrial power. The country’s strength lies primarily in assembly, putting together parts manufactured in Asia and exporting the final product across the Americas.

The growing success of Mexico’s car manufacturing industry is a strong example of the country’s strength. While Brazil is most often hailed as Latin America’s most important country, Mexico now enjoys a higher GDP per capita, faster growth rates, lower unemployment, more rapid industrial expansion, and less inflationary pressures than its South American counterpart. (All of this despite a wave of drug-related violence.) It is not alone in this regard. The Pacific nations of South America (Chile, Peru and Colombia), have all embraced free trade in recent years, signing bilateral trade agreements with the U.S. and other nations and lowering taxes and tariffs. All of these countries are now growing faster than Brazil and have experienced industrial expansion, not contraction, over the last year.

If Brazil wants to arrest the tide of deindustrialization, it must force its manufacturers to compete. It should follow the lead of Mexico and Chile and open its borders to more trade, possibly looking to sign a regional free trade agreement. (Mercosur, Brazil’s current free trade bloc along with Argentina, Uruguay and Paraguay, has long failed to promote its goals due to its members’ refusal to lower tariffs.) While this may cause some temporary adjustment difficulties, the industries that emerge will put Brazil on much surer long term footing to maintain and grow its manufacturing base.

The initial signs are worrying. The Brazilian government recently slapped a quota on car imports from Mexico as local manufacturers complained they were unable to compete against their regional counterparts. The immediate worry is that Brazil will cope with recent bad economic news by becoming more, not less protectionist. This is bad news for Brazilian consumers frustrated with absurdly high prices for manufactured goods. It is even worse news for those of us who are excitedly hoping for Brazil to emerge as a global economic power.

Scaling Up Social Enterprises

Talk to a few social entrepreneurs about the principal difficulties they face and one of the most common responses will certainly be the challenge of scaling up their operations. Like most businesses, social enterprises begin small, often involving a single pilot program, with the goal of expanding rapidly over time. For social enterprises, the goal of scaling up is not only to reach a larger target population but also to confirm that the business model is successful and replicable. However, few organizations have been able to achieve this in practice (microfinance institutions being the most obvious exception). This is because scaling up social enterprises usually involves very unique challenges that can be difficult to overcome, especially when it comes to reconciling economic, social and environmental goals. Wastepicker organizations provide a good example of the obstacles one tends to face in the field.

I have written before about the difficult tradeoff between efficiency and social inclusion that occurs in all productive segments of the economy. To scale up, a business must of course be financially sustainable and capable of rapid growth. This of course necessitates a certain level of business efficiency. It also necessitates using the requisite technology to become competitive in the field, such as conveyor belts for sorting. An organization that finds itself with a productive disadvantage against its competitors has little growth potential. Yet an organization that aggressively pursues growth and expansion can have trouble retaining its social purpose, as it finds itself turning into a regular business whose principal goals are increasing profits and revenues.

In trying to implement my proposed business plan for Cataunidos, I have become starkly aware of the fine line separating a regular business from a social enterprise, particularly when I call for greater centralization of management decisions and more operational capital to improve and expand operations (rather than simply dividing all sales revenue among the wastepickers as income). Sometimes I wonder if a better solution would be to simply create a new recycling business that prioritizes hiring of wastepickers as workers. This would certainly allow operations to expand more rapidly. But then, how long would it be before we become just another competitor in the marketplace of middlemen, solid waste management companies, and recycling factories? It would be difficult to keep a focus on wastepicker inclusion when having to respond to market pressure from these actors.

I have begun to believe that social enterprises may have such difficulty scaling up precisely because staying small is the only way for them to easily mix their social, economic and environmental goals. A local wastepicker cooperative certainly seems like a model social enterprise because it can successfully pursue a triple-bottom line by providing income opportunities to an at-risk population while promoting recycling in a community where such services are otherwise lacking. But such small-scale organizations represent marginal activities when compared to the impact of big business. When trying to move into the mainstream through scaling up, the contradictions often become more apparent.

Does this mean that social entrepreneurship has a low ceiling, confined to microbusinesses in underdeveloped markets and marginalized communities with little chance of achieving economies of scale? I would say that the evidence is mixed. Microfinance shows that a successful model that targets marginalized populations can be replicated, making a large difference on an international scale. However, microfinance is, as it name suggests, fundamentally a “micro” activity, based around community organizations and targeted individual or group loans. Waste management, on the other hand, is a macro activity involving sophisticated, high-tech operations and huge government contracts. This may be why it does not lend itself as easily to a social enterprise model.

But that does not mean that there is no space for social enterprises in the world of recycling. There are millions of wastepickers across the world currently eking out a living from waste that often goes untreated, especially in poorer countries. Innovative approaches are needed to improve the productivity and working conditions of these workers while providing a needed public service of waste collection, treatment, and disposal. Numerous organizations across the world, from Peru and South Africa to Egypt and India, are doing their best to provide answers. I am still optimistic that these efforts will lead to solutions.

Is Time Running Out for the Catadores?

Last week I attended a symposium sponsored by FIEMG, the Minas Gerais State Federation of Industries. The event was titled "Urban Solid Waste Management as a Business Opportunity.” The target audience was business leaders interested in investing in the recycling industry as well as waste generators looking at environmentally-friendly methods of disposal. I left the symposium somewhat happy with future prospects for improved waste management in Brazil, yet also concerned about what these changes might mean for the catadores, who might soon be competing in the market against imported, high-tech sorting machinery.

The panel participants stressed their desire to work with, not against, the catadores. They mentioned their desire to improve income and working conditions for this marginalized population, and for cooperatives of catadores to remain in charge of the sorting process across the country. But it is difficult for me to see how this would be achieved in practice. I have discussed at length the operational weaknesses of these cooperatives, especially with regard to creating efficient management structures and integrating automated equipment into the production process. Unless these issues can be resolved, new recycling operations will end up competing against, not working with, the wastepickers.

What worries me is that the window of opportunity might be closing. Brazil has set an international standard for wastepicker integration by developing a favorable public policy framework, providing generous financing for cooperatives, and organizing the support of a wide range of civil society actors. But despite these advances, low productivity remains an Achilles’ heel for this movement. With private sector businesses beginning to move in, the catadores may end up being pushed out of the market. Business as usual will not suffice for much longer.

Brazil's Economic Future

Since I am currently at home in Washington, DC waiting for a visa to return to Brazil, I have no new updates for this blog about my work with the catadores. I did think it would be interesting, however, to write another more general piece about the Brazilian economy, focusing on the country’s potential ascension to “developed country” status.

Industrialization and the "Middle-Income Trap"

In the 1930s, Brazil represented a classic low-income country.  It had a highly agrarian society composed primarily of illiterate peasants. Its income per head was 12% of that in the U.S. and the country was extremely fragmented, with little intranational trade between its geographic regions. Then, Brazil experienced an economic boom. Productivity growth in agriculture resulted in large-scale migration of peasants to cities. In 1945, roughly 33% of Brazilians lived in cities. By 1980, this number was 66%. (Today, about 90% of Brazilians live in cities, making it one of the most urbanized countries in the world, ahead of even the U.S. and Western Europe.) This rural to urban migration led to a surge in industrialization and explosive economic growth. From 1945 to 1980, Brazil’s GDP grew by roughly 7% per year, including a China-like 8.9% growth between 1968 and 1980. GDP per capita grew from under $200 in 1945 to nearly $2,000 by 1980. Brazil was hailed as a “country of the future”, an emerging global powerhouse.

This economy, however, was not built on a sustainable model. Like most of Latin America, Brazil had implemented an “Import Substitution Industrialization” approach that aimed to promote domestic manufacturing by erecting protective barriers to foreign imports and using domestic demand to fuel economic growth. While the policy resulted in rapid development over a long period of time, ISI masked the uncompetitive nature of Brazilian industry with respect to the world economy. Furthermore, the accumulation of debt to pay for imported machinery eventually became too much to bear. The economy collapsed in 1980, leading to a prolonged period of hyperinflation and a rapid decline in income per head. The 1980s became Brazil’s lost decade.

A series of reforms in the 1990s stabilized the situation, bringing inflation under control and creating a stronger foundation for economic growth. Sound fiscal and monetary policy put the country on more even footing to combat future inflationary pressures. And despite the failure of the ISI model, there is no question that the country had made enormous progress during the 1945-1980 period. Brazil had followed the classic path of development originally pioneered in England and the U.S. and currently exemplified by China. Large rural to urban migrations had allowed the country to industrialize and greatly increase its overall economic activity. Then, increases in disposable income combined with huge improvements in basic education and health care shifted power to consumers, creating strong domestic demand to power future growth. Despite the stagnation of the 1980s, Brazil had successfully moved from low-income country to middle-income country.

Ever since this accomplishment, however, Brazil has hit a wall. This is essentially due to a very simple problem. Having already achieved middle-income status, Brazil is too rich to attract large-scale cheap manufacturing. With a minimum wage law and labor regulations in place, it cannot lure jobs away from China or other growing low-wage manufacturing hubs such as Vietnam. At this stage in the game, there is no simple formula for fast economic growth. This phenomenon is what economists refer to as the “middle-income trap.”

What separates Brazil from many of its middle-income peers is its abundance of natural resources. Despite the fact that its industry continues to languish in the middle-income trap, the economy has grown at a respectable 3.7% rate since 2000, mostly due to its exports of agricultural products, minerals and, increasingly, oil. With ample supplies of fresh water and energy sources, Brazil is not likely to encounter any resource scarcity-related roadblocks in the near future. But, as I have written in a previous column, this is not enough to achieve convergence with developed economies any time relatively soon. Brazil needs a different approach if it is to escape the middle-income trap.

To address this issue, Brazil’s economy must become more productive. A somewhat vague economic term, productivity generally refers to how efficiently businesses utilize the labor and capital that they have. Productivity gains are normally the key to economic growth. During the urbanization process that tends to form the first stage of traditional development, productivity increases rapidly as agriculture is consolidated and peasants move to factories and begin working with machines. As population centers expand, a large service sector begins to spring up in health care, education, product delivery (sales), and other sectors. Moving from subsistence agriculture to specialized occupations in concentrated urban areas makes society more productive overall. (Although it is important to note that this process tends to result in the marginalization of unproductive members of society, creating an urban underclass that I have discussed previously.) Once in the middle-income trap, however, productivity becomes more complex, and more elusive.

Identifying Key Economic Reforms

Overall, Brazil’s “total factor productivity” remains extremely weak compared to the developed countries it aspires to join. From 1980 to 2009, productivity actually shrank by 1.13%. A variety of reforms are needed, especially in the areas of infrastructure, tax collection, education, corruption, and ease of doing business.

Brazil’s infrastructure remains woefully inadequate. Only 10% of roads in the country are paved, compared to 78% in South Korea, a country that successfully sprung the middle-income trap. Major commercial roads tend to be narrow and dangerous, with little maintenance. The country’s train network is also highly limited, although a recent line connecting the Southeast and Northeast and a planned high-speed rail project between São Paulo and Rio represent steps in the right direction. On average, the country has slower internet connections than Haiti, Ethiopia, Pakistan and Papua New Guinea. The hope is that the upcoming 2014 World Cup and 2016 Olympics will result in significant infrastructure improvement projects, but the impact of these initiatives is likely to be too limited to create large-scale productivity gains. Plans to privatize the country’s major airports show that the government is willing to raise private capital to assist in this effort, but it still must devote a much larger percentage of expenditures to these projects. It must also cut down on red tape and simplify its policy procedures in order to more quickly execute vital projects in transportation, sanitation, electricity transmission and telecommunications.

Another factor weighing down Brazil’s productivity is its tax regime. While infrastructure investment has stagnated, tax collection has risen rapidly, climbing from 22% of GDP in 1993 to 36% by 2008. This is a tax burden comparable to the U.K. and Spain, and much higher than in peer countries such as Mexico and Chile. Exorbitant taxes on consumer goods, imports, exports, and other business transactions create a complex labyrinth for consumers and entrepreneurs, causing a significant drag on economic activity.

Worse yet, rising tax receipts have not led to greater government investment in the economy. While fiscal spending has increased in recent years, the primary driver of that growth has been wages and pensions in the public sector. Even these benefits have not been evenly distributed among government employees. Recent strikes and protests of police officers, firefighters and teachers in Bahia, Rio and Minas Gerais have highlighted the growing disparity between the wages of low-level public workers such as teachers and police officers and the “super-salaries” of high-ranking officials such as judges and congressional representatives. The latter group, often composed of well-connected insiders with access to privileged government positions, remains the principal beneficiary of Brazil’s current tax structure. The country is in urgent need of tax reform to create a reasonable, progressive tax regime that encourages business transactions and promotes investment in strategic areas of the economy, as well as a salary reform that rewards hard-working public employees who provide important government services while eliminating excessive, unnecessary benefits resulting from rent-seeking behavior by politicians.

The education system remains very weak, although there are glimmers of hope. The Bolsa Familia conditional cash transfer program has helped to increase school enrollment in poor communities. The growing international reputation of top universities such as the federal universities of São Paulo and Minas Gerais is setting a new standard of excellence for tertiary education in Latin America. But overall, the country continues to lag in its goal to achieve OECD average scores in reading, math and science. Increased spending has led to minor improvements, but more comprehensive reform efforts are needed. As in the U.S., the solution may lie in innovative projects pioneered in local school districts. Programs in São Paulo state and the city of Rio have some potential and, if successful, should serve as building blocks for reform efforts implemented at the national level.

Corruption also continues to be a huge drag on the economy, undermining the level playing field needed for businesses to thrive and improve their competitive ability. On this measure, Brazil has not improved noticeably over the last decade, slipping from 4.0 in 2002 to 3.8 in 2011 on Transparency International’s “Corruption Perceptions Index.” (Chile and Uruguay, by comparison, received scores of 7.2 and 7.0, respectively.) There are bright spots on this front. The rise of social media has greatly increased citizens’ ability to mobilize against perceived political corruption, evidenced by a successful online protest campaign against the Belo Horizonte city council’s attempt to raise its own salaries by a whopping 61.8%. President Dilma Rousseff has engaged in an aggressive “cleaning house” campaign, forcing the resignation of 7 cabinet ministers due to corruption charges within her first year. Hopefully, these developments are a harbinger of good news to come in Brazilian citizens’ fight against institutionalized corruption.

Overall, Brazil maintains a complex bureaucracy that weakens businesses’ productivity. The World Bank’s famous “Ease of Doing Business Index” puts Brazil at 126 of 183, well behind its regional peers Chile (39), Mexico (53) and Uruguay (90). Here is a breakdown of Brazil’s ranking, including comparison with the previous year’s analysis:

Starting a Business                                 120^th       (2011: 125^th)

Dealing with Construction Permits         127^th      (2011: 133)

Getting Electricity                                   51^st         (2011: 53^rd)

Registering Property                              114^th       (2011: 109^th)

Getting Credit                                          98^th        (2011: 96^th)

Protecting Investors                               79^th        (2011: 74^th)

Paying Taxes                                          150^th      (2011: 148^th)

Trading Across Borders:                        121^st       (2011: 116^th)

Enforcing Contracts:                              118^th      (2011: 118^th)

Resolving Insolvency:                           136^th       (2011: 137^th)

               

As these rankings show, Brazil’s electricity supply is an area of relative strength, which makes sense given that the country’s natural resources tend to be its strongest economic asset. Tax collection, as mentioned previously, remains the major impediment to the country’s business climate. In general, a variety of reforms are needed to reduce unnecessary bureaucracy and improve the economy’s productivity. Permitting, property rights, access to credit, interstate trade barriers, and judicial contract systems all need to be upgraded.

In the future, I hope to be able to speak more in depth about the business climate in Brazil based not only on statistics and macroeconomic analysis, but also on my own personal experience in trying to build the CATAUNIDOS commercialization network.

Foreign Direct Investment: The Key to Salvation, or a Crisis Waiting to Happen?

Investment has been pouring into Brazil, reaching consecutive annual records of US$48 billion in 2010 and US$65 billion in 2011. However, the “hot money” crises of Mexico in 1994, East Asia in 1997, Russia in 1998, and Argentina in 2001 show that this money can quickly become a double-edged sword. Luckily, Brazil has learned from these lessons and is installing capital controls to lessen the risk of the money flow being able to quickly change directions.

But even if the investment does stay in Brazil long-term, it is up to the Brazilians to figure out how to put it to good use and build a more productive economy. The Southern economies of the Eurozone offer a warning on this front. As this article shows, despite steady flows of foreign direct investment from their Northern European partners, the countries of Portugal, Spain, Greece and Italy actually saw their productivity fall over the last twenty years. (Eastern Europe, on the other hand, has taken full advantage of investments from the North to drastically improve its productivity.) Simply taking in the investment is not enough. Brazil must combine it with a series of reforms to improve competitiveness and put itself on more stable economic footing for the long term.

For now, it is hard to tell if this foreign investment will produce significant dividends for Brazil. Most of it seems destined to reinforce Brazil’s dependence on exporting raw materials; the money is flowing in not to Brazil’s economy as a whole but particularly to the mining, agriculture and oil sectors.  Most of the new cash flows have been limited in particular to developing Brazil’s massive “pre-salt” oil reserves off the coast of Rio and São Paulo. If the oil does not begin to flow quickly and in the quantity expected by the international financial community, the results could be disastrous for Brazil. But nevertheless, the investment could pay off in the long run, if it helps the country to improve its national infrastructure and gain a competitive advantage in offshore crude oil production. It is up to Brazil’s leaders, however, to guarantee that this investment produces the intended spill-over effects that make the economy as a whole more competitive.

Moving Forward – Can Brazil Live up to its Potential?

It has become abundantly clear in recent years that Brazil is emerging as one of the most important countries in a new world economic order. The country has many strengths that will allow it to prosper in the global market:

1. Abundance of natural resources, including energy and water
2. The “demographic dividend”, wherein a rapidly falling birth rate has created a bulge in the working age population relative to dependents (the elderly and children)
3. Stable political climate, resulting from continued strengthening of democratic institutions
4. Enormous size, which allows Brazil to take advantage of economies of scale and a strong domestic market as well as to project its influence internationally

While these factors essentially guarantee that Brazil will play an increasingly important role in international affairs, it is important not to become complacent. The country has many challenges ahead of it, and its past difficulties should serve as a cautionary tale for those who assume that Brazil’s rise is inevitable. As long as the country continues to shirk needed reforms in infrastructure, taxes, education, corruption and ease of doing business, it will operate far below its potential. While the steady 4% annual growth projected by economists is certainly positive (especially considering the economic stagnation of the U.S., Europe and Japan), it is far below the 7.3% annual growth between 1984 and 1998 that turned Chile into the most successful country in Latin America. Brazil can do better.

There are also more short-term threats lurking on the horizon. Recent rises in inflation and a persistent current account deficit serve as reminders that Brazil still has work to do to stabilize its fiscal and monetary situation and prevent a repeat of the financial shocks of 1980 and 1997. Rapidly escalating real estate prices suggest that a bubble is forming in the housing sector, which is often the starting point for financial contagion. Extremely aggressive expansion of credit by public sector banks, especially the National Development Bank (BNDES) is another cause for concern. The period after the 2014 World Cup and 2016 Olympics could be especially dangerous, as construction projects would be likely to slow at that point. Furthermore, recent reports show that Brazil has little wiggle room to employ counter-cyclical measures to stimulate the economy in the event of a global economic downturn caused by recession in Europe, meaning that contagion in the Eurozone could quickly drag down the country’s already sluggish economy. In another scenario, a slowdown in China caused by the country’s “rebalancing” of its economy could cause a drop in demand for raw materials, upon which Brazil's economy is heavily dependent. These foreign and domestic threats could easily hamper Brazil’s economic outlook, and in the short term much remains beyond the control of policymakers in Brasília.

Overall, I remain cautiously optimistic about Brazil’s economic future. The country has made impressive strides over the last twenty years. It has drastically improved its fiscal and monetary policy framework, stabilizing the macroeconomy. It has improved its comparative advantage in agriculture, mining, and, increasingly, oil production, becoming a major commodity supplier in the international market. It has made tremendous progress on its social welfare programs, helping to reduce inequality and elevate millions out of poverty, thereby creating a fairer and more cohesive society. It has grown into a vibrant, diverse democracy with strong political institutions. But much of the hard work remains to be done. For Brazil to take the next step forward in its economic development, it must escape the middle-income trap, improving its productivity in order to become competitive in the global marketplace in a wide variety of sectors. This will require a series of difficult and complicated reforms as well as a strong commitment to full engagement in the international marketplace from both policymakers and the public at large. I am confident that Brazil is up to the challenge.