Brazil Has Run Out Of ExcusesRudi Dornbusch
Is Brazil headed for trouble again? Two years ago, it finally brought inflation under control. Then, Finance Minister Fernando Henrique Cardoso, who accomplished the feat, was swept into the Presidency. Then, there he sat, doing nothing further. There has been no action on balancing the budget, privatization, decentralizing the state, social security reform, or administrative reform. The excuse? They are "politically difficult."
Brazil, so goes the refrain, is unique among emerging economies. It is a true democracy, and how can anyone expect a democracy to make difficult decisions? Dictator Augusto Pinochet could make them in Chile. Alberto Fujimori could after a coup in Peru. Carlos Salinas de Gortari had a clear path in one-party, autocratic Mexico. But Brazil is democratic, and things just can't be rushed. And why rush, since inflation is under control? Well, because the stabilization of Brazil's inflation is less of a miracle than the government claims. In most other countries, a major effort in fiscal discipline is part of an anti-inflation strategy. Not in Brazil. Instead, Brazil overvalued its currency and sharply raised its high real interest rates. Last year, real interest rates averaged over 50%, and prices in dollars have risen over 40% since the stabilization plan began.
The cost of this policy is heavy: a bank crisis and low economic growth. The government is stepping in with bank bailouts. Meanwhile, big wage increases are making industry uncompetitive. The budget deficit has reached 5% of gross national product, and the public debt has doubled in a single year.
LONG WAIT. There was a time when Brazil moved ahead. In the two decades prior to 1980, Brazil had one of the highest rates of growth in per capita income in the world. True, inflation was always a problem, but indexation kept it from becoming an obstacle to growth and financial stability. As in Latin America and Europe, the shift to democracy made sound economic policy much harder. But that was a decade ago, and excuses are wearing thin. Where Asian per capita income has doubled in the past 15 years, Brazil's has gone nowhere.
Brazil is a large, inward-looking country. It has always done things its own way, often with success. Lessons from abroad are invariably written off as irrelevant. In the past, Brazilians might well have claimed that the strategy served them well. But that is patently not the case today. Losing a decade and a half of income growth is subpar performance by any standard.
For now, overly eager foreign capital, attracted by high interest rates, is helping to keep the show going. Foreign exchange reserves are high, and the currency is stable. But some foreign investors are much less impressed. These investors are wary that the "miracle" is fading and that the bill for procrastination will soon come due. Once capital pulls out, there are few options. Raising interest rates further would stop growth completely and promote even wider bank failures. Letting the currency go means giving up inflation control.
MELTDOWN. Brazilian policymakers, basking in the admiration of the press and the public, misread their situation. They underestimate the internationalization of their economy and their dependence on external capital. Either the government starts reform with big and eager steps, or they should expect major trouble. There won't be an exact replay of Mexico, but even half that experience would be a dramatic setback. It is hard to predict the timing of meltdown, but that makes the prospect no less real and the need for reform no less urgent. The Mexicans didn't hear any criticism until the markets crashed, and Brazil is enjoying the same reticence. The trigger for financial trouble may come from outside Brazil. A rise in global interest rates or a dip in global stock markets will be enough to sour Brazil's financial prospects. It is equally true that aggressive reforms can take Brazil out of the danger zone and make it a dynamic country of the future.
Brazil isn't the only mismanaged economy in the world, but it is unique in that its elite thinks the country is doing well. They should be concerned about stabilization and reform for reasons far beyond financial stability. Brazil has one of the worst income distributions in the world, and poverty levels in the north are comparable to the most backward countries in Africa. President Cardoso has a special responsibility. He is immensely popular. He is an accomplished communicator and a superior intellect. He can make Brazil take the medicine and set it on the right path--or he can do nothing and be another leader who failed to take responsibility for Brazil never taking its rightful place on the world scene.