BRAZIL 2015: A REFORM AGENDA Armando Castelar Pinheiro (based on joint work with Fabio Giambiagi) Seminar at the Inter American Development Bank Washington, October 4, 2005
Outline • First- and second-generation reforms • Why did reforms fail to spur higher growth? • A new agenda of reforms • Macro • Structural • Institutional
Growth: the main motivation for reforms Source: Armando Castelar Pinheiro, “Is Institutional Reform the Key to Brazil’s Accelerated Development?”, 2003, mimeo.
The 1990s reforms • Explanations for growth deceleration • Very high inflation • Semi-autarkic economy • State’s inability to invest in infrastructure due to fiscal crisis • Goal: • Resume growth by attracting private investment and fostering TFP growth through increased competition, private ownership and constraints on policy discretion.
Inflation was brought under control Monthly consumer price inflation (IPCA, %) Source: IBGE.
Comparative Indices of Structural Reform Source: Eduardo Lora, 2001; “Structural Reforms in Latin America: What Has Been Reformed and How to Measure it” Working Paper 466, Inter-American Development Bank.
Reforms failed to bring high growth back Source: Armando Castelar Pinheiro, “Is Institutional Reform the Key to Brazil’s Accelerated Development?”, 2003, mimeo.
GDP growth outlook (%) Source: IMF.
Economia GDP growth: Median market forecasts (%) 4,9 Source: CentralBank.
Why did reforms fail to spur rapid growth? • Washington Consensus – Lack of depth • Augmented Washington Consensus – Lack of breadth • Error in adopting universal policy agendas: insufficient customization (focus, sequencing and institutional arrangements) • Too much market, too little state intervention
Insufficient depth • Government continues to get in the market’s way • Large public deficit and debt • High rates of interest • Low integration into world economy • High taxes
Real interest rates on public bonds (%, p.a.) Sources: Central Bank and IBGE.
Imports / GDP (%, 2003) Brazil 10.3% Source: World Bank, WDI 2005.
Augmented Washington Consensus • Market failures reflect weak or missing institutions • Washington Consensus policies are necessary but insufficient. • Goods institutions are necessary to improve incentives and reduce risk. • AWC = WC + institutional reforms.
Institutional reforms • New competition law and agencies • Regulatory reform and independent regulatory agencies in infrastructure and capital markets • Stronger creditor rights (bankruptcy law) • Judicial reform • Public sector reform • Business and labor regulation reform
Insufficient breadth • Regulation of infrastructure: problems of sequencing and sectors with incomplete (electricity) or missing regulation (sanitation) • Competition and regulatory agencies lack sufficient autonomy • Financial sector: new bankruptcy law, but no change in collateral and procedure codes • Judicial reform: little yet implemented • Barely anything done to improve labor and business regulation
Country-specific agendas “The only constant in development is systemic dynamic change. This would hardly be worth stating, were it not that development theory has been presented as if its propositions are universally applicable, no matter what single feature of development policy they choose to stress and no matter which country its recommendation address. As a result, development policy advice has rarely been specifically tailored to the country’s initial conditions, widely interpreted”. Irma Adelman, Fifty years of economic development: What have we learned?, ABCDE Conference, World Bank, 2000.
Universal Laws • Macroeconomic discipline • Rule of law • Good policies • Right prices and incentives Focus, sequencing and institutional arrangements should be country-specific
The role of the state • Problems • Fiscal crisis and liberal reforms (as well as democracy?) reduced the state’s ability to foster and direct investment • Inadequate balance between carrots and sticks (Latin America vs. East Asia) • Promote state role in leading economic development • State should pick winners and support losers • Greater scope for industrial / investment policies
Growth of GDP and capital stock (% p.a., 5-year moving avg) Capital 9,0% 3,8% 3,8% GDP 1,8%
Savings breakdown (% of GDP) Source: Fabio Giambiagi and Fernando Montero, 2005; "O Ajuste da Poupança Doméstica No Brasil: 1999/2004”.
Improving investment climate Increase competition Raise efficiency Lower risk Greater demand and output Low costs Better risk x return Structural and institutional reforms More investment Lower taxes and cost of capital Macro adjustment Quality of public spending
A reform agenda • Fiscal policy trilema • Trade liberalization • Financial sector reform • Informality: tax, labor and business regulation • Jurisdictional risk
Fiscal policy trilema Reduce public debt/GDP Increase public investment Lower taxes
Public and SOE investment (% of GDP) Decline in public investment lowered annual GDP growth by 0.4 p.p.* (*) Pedro C. Ferreira and Leandro Nascimento, “Welfare and growth effects of alternative fiscal rules in Brazil”, EPGE/FGV, 2005.
Gross tax burden (% of GDP) Rise in tax burden lowered annual GDP growth by 1.5 p.p.* (*) Pedro C. Ferreira and Leandro Nascimento, “Welfare and growth effects of alternative fiscal rules in Brazil”, EPGE/FGV, 2005.
Brazil’s tax burden: out of line with international standards Source: Khair (2003)
Public debt and interest payments(% of GDP) Public debt Interest payments
Net Public debt (% of GDP) vs. per capita GDP (PPP) in 2002 110 Bélgica Itália 90 Japão 70 Brasil Alemanha 50 Áustria Estados Unidos Espanha Canadá França 30 Reino Unido Nova Zelândia Países Baixos Dívida pública líquida (%PIB) 10 Suéci Dinamarca Austrália -10 -30 Coréia Finlândia -50 -70 Noruega -90 5000 10000 15000 20000 25000 30000 35000 40000 PIB per CAPITA (PPP) FONTES: Banco Mundial, OECD e Banco Central.
Fiscal reform • Reduce public debt / GDP ratio: • Sustain a high primary surplus • Lower the cost of debt • Restructure public spending to accommodate rise in public sector investment • Reduce tax burden • Social security reform • Develop a medium-term fiscal framework that lowers political risk
Breakdown of Public Federal Expenditures (net of transfers to states and municipalities, % of GDP)
Social security expenditures versus % population over 65 Sources: OECD, MoF/Brazil and World Bank.
Rate of poverty through life cycle Percentage of poor Age Source: Ricardo Paes de Barros, “O impacto de aumentos reais no salário mínimo sobre o grau de pobreza no Brasil”, apresentação no Congresso Nacional, Brasília, Dezembro 2004.
Social security reform • Minimum (sliding) retirement age for private sector • Elimination of differences in eligibility requirements for men and women • End of privileged retirement rules for teachers • De-linking social security benefits from changes in minimum wage
Macro reasoning Raise exports Lower exchange rate and interest rate risk Increase power of monetary policy’s exchange rate channel Lower cost of capital goods Micro reasoning Greater competition in oligopolized sectors Greater product diversity Access to modern technology Easier negotiations with Mercosur partners Trade liberalization
Sovereign credit ratings and trade flows (2002) Rating = 0.275+ 0.986 * (X+M) /PIB R2 = 0.42 (0.875) (0.175)
Credit ratings and ratio of external debt to exports of goods and non-factor services (2002) Rating = 6.674 - 1.948 * DEL /X R2 = 0.95 (0.085)(0.070)
Average nominal tariff (%, 2001-04) Source: World Bank, WDI 2005.
Bureaucracy in foreign trade: Exports Source: World Bank, WDI 2005.
Bureaucracy in foreign trade: Imports Source: World Bank, WDI 2005.
An Agenda for Trade Policy • Cut tariffs, unilaterally if necessary • Reduce discrepancy in protection and focus on more concentrated sectors • Overhaul import and export bureaucratic controls • Strengthen supporting technological institutions • Align domestic and foreign product specifications and regulations • Improve rail and port performance • Support investment in distribution in export markets
Financial sector: Reforms • Price stabilization • Greater openness to foreign financial institutions • Improved bank supervision and regulation • Privatization of state banks • New bankruptcy law and credit information registries
Financial sector: outcomes • Domestic credit is scarce, expensive and concentrated on short maturities • Pension funds, insurance companies and mutual funds invest mostly in public bonds • Stock markets are smaller and less liquid than in Asian and industrialized countries • Most firms and households finance themselves out of retained surpluses • Impact of financial sector on growth (and equity) well below potential
Domestic credit to private sector(2003,% of GDP) Brazil (34,6%) Source: World Bank, WDI 2005.