By Otaviano Canuto and Philip Schellekens World Bank: Economic Premise
June 2014. Number 148.
Over the last few years, Brazil’s growth has significantly decelerated. Accompanying this slowdown, a change in commentary on Brazil’s economic future has emerged, and is reflected in a recent ratings downgrade of Brazilian sovereign paper and an overall much-bleaker growth outlook both for the near and medium term. This note examines three contributing factors to this change in sentiment: macroeconomic management, the external environment, and microeconomic fundamentals. Among these, this note argues that the relative lack of progress on the microeconomic reform agenda has been far more detrimental to the growth outlook than either the credibility cost of recent macroeconomic management or the negative influence of a less supportive external environment. Against this backdrop, the recent ratings downgrade is not inherently negative: while Brazil is not about to slide down a slippery slope of macroeconomic mismanagement or on the verge of an externally powered economic meltdown, the downgrade can serve as a call to action for government to enact the necessary structural reforms to energize and sustain productivity growth.
Canuto and Schellekens take stock of the developing theses regarding Brazil’s recent return to sluggish growth. Accordingly they offer three lines of argument to explain the growing pessimism, including:
Macroeconomic policy credibility
“…recent macroeconomic management has eroded the hard-won credibility of a macroeconomic policy framework built on fiscal prudence, exchange rate flexibility, and inflation targeting.
External support factors
“This view is intricately related to the hypothesis that the growth acceleration before the global financial crisis was largely the result of external rather than domestic factors. Rapid capital inflows, better terms of trade, and lower global interest rates all played to Brazil’s favor when times were good.”
Microeconomic growth fundamentals
“This strand is of far greater concern than the credibility cost of recent macroeconomic management or the economic impact of the deterioration in the external environment. Indeed, the microeconomic environment is critical for growth, even more so today than in the past. This is because demographic dynamics have reduced the growth of Brazil’s labor force. Higher growth therefore requires first and foremost increased worker productivity.”
Accordingly, Canuto and Philip Schellekens argue that
“…during the recent period of slower growth, little progress was made in tackling long-standing structural bottlenecks, and therefore the structural reform agenda remains long and unfinished (Canuto 2014; World Bank 2014). Unsurprisingly, slow growth has, for that reason, primarily become a supply-side phenomenon of a structural nature.”
This note provides a very concise frame of the major arguments explaining Brazil’s recent bout of slow growth, but also argues that government fiscal and monetary policies are not the prime cause, nor is the slowdown in worldwide demand for Brazilian commodity exports. Rather, these authors identify the supply side as the locus of the challenge and advocate structural reforms that invite greater productive investment and entrepreneurial behavior to raise productivity and expand economic activities in the face of a gradually shrinking labor force.
Clearly Brazil is underinvesting in future growth. Therefore we must focus on those primary reasons that curtail Brazilian private investment, shape the allocation of foreign direct investment, and stymy workforce productivity. Canuto and Schellekens argue that the solutions will be found in structural reforms that provide greater microeconomic incentives for investors. Yet, they fall short of providing a step-by-step reform agenda. Most observers agree with the need for reforms that lead to greater investment and productive innovation, but few have laid out a blueprint for taking this uncertain and politically divisive journey.