Latin America

Brazil's Little State That Could

Surrounded by dysfunction, the fourth-smallest state has avoided red ink and prison riots.

Order and progress can be hard to find.

Photographer: Miguel Schincariol/AFP/Getty Images

Success stories are hard to come by in Brazilian public service these days. Hardly a news cycle passes without a new tale of fiscal profligacy, white elephants or elected officials with their hands in taxpayers' pockets. A toxic combination of public overspending, early retirement and tumbling revenues has left state and municipal governments bereft. Soaring state debts, in turn, have become a political battleground, as local leaders shake down the unpopular stand-in government of President Michel Temer for indulgences in exchange for political support.

So what to make of Espirito Santo? Brazil's fourth-smallest state, with 2 percent of national population, also is one of the country's most fiscally fit. While others padded the bureaucracy, it shed jobs and slashed spending by 8 percent in 2016, finishing the year with manageable debt, a modest primary surplus (coming off a deficit in 2014 and breaking even in 2015). Espirito Santo was one of three states to merit a "B" credit rating from the national treasury last year, trailing only Para, which earned a B+.

Honors to Paulo Hartung, a former federal lawmaker, mayor and state governor for three non-consecutive terms, who has managed to parlay parsimony into votes. That was the message of his 2014 campaign, when after four years on the sidelines he returned to the governor's mansion just as Brazil's economy began to tank. He also shook up the police, locked up the most dangerous criminals and cracked down on illegal handguns, cutting homicides in one of Brazil's worst violence "hot spots" by nearly 11 percent in 2015. Once the United Nations denounced Espirito Santo's prisons during Hartung's former mandate as hellholes, every bit as horrific as the overcrowded, mismanaged Brazilian jails that have recently exploded in deadly gang violence. But after a penitential overhaul -- inmate job training, rigorous guards, separating detainees awaiting trial from hardened cons -- the state hasn't recorded a prison uprising since 2013.

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Okay, so the coastal state boasts a bustling port and is swimming in oil, including some of the region's most promising reserves of ultra-deep "pre-salt" crude. But the same bounty hasn't spared neighboring Rio de Janeiro (with a D credit rating), which declared a state of "public calamity" last year and can neither pay its creditors nor meet its payroll and pension obligations. Indeed, Espirito Santo stands in sharp contrast to Brazil's 26 other federal territories, many of which are in dire circumstances; Hartung broke ranks by opposing efforts to renegotiate subnational debts -- heresy in a land where politicians have seen the federal treasury as a credit card. "Our governments are good at spending resources they don't have," Hartung told me in an interview. "It's no wonder we're facing the worst economic crisis we've seen in the last 120 years."

More wonk than political wunderkind, Hartung studied economics at college and moonlighted in the student movement against the military dictatorship. When democracy returned, in 1982, he won a seat in the state legislature, the first stop of a political career that would see him rise to the top tier of Brazilian party politics. An unapologetic technocrat, he has not only balanced budgets but also supported the Temer government's efforts to scale back the bureaucracy.

As admirable as Hartung's individual performance may be, profligacy is hardwired into Brazil's political culture, tax code and national constitution. Despite a model fiscal responsibility law passed in 2000, the central government has frequently caved to local pressures to roll over old debts, and from 2010 made things worse by encouraging states to seek loans abroad. "States aren't in trouble of their own accord, but thanks to the imprimatur of the treasury, which granted credits with few controls," said Jose Roberto Afonso, a public spending expert at the Getulio Vargas Foundation in Rio de Janeiro. The result: Brazil's subnational governments, once recognized abroad "as successful cases of fiscal discipline," as Afonso wrote, are now cases of penury.

Compounding the faulty oversight is a complex and outdated tax system, which forces states to rely even more heavily on a complex indirect levy on mostly manufactured goods in an economy that is increasingly driven by services. "I keep telling governors they need to push for tax reform, not more taxes or debt renegotiation," Afonso said.

And no reform will mean much for revenue-strapped states unless Brazil also rewrites its constitutional rules on pensions, which pile up losses by giving generous benefits to early retirees. Here, Afonso says, "there are no saints." He'll get no argument from Espirito Santo, where benefits for pensioners consumed 31 percent of the state payroll in 2015 -- a burden expected to swell as the population grays.

"During the commodity boom, everything looked great, but the bonanza kept Brazilian leaders from seeing clearly. Now we have no choice," said Hartung. "Either we make difficult decisions, like pension reform, or end up worse-off than some of our neighbors in Latin America," he said, in a veiled reference to crisis-racked Venezuela.

The comparison might sound alarmist. Brazil, while staggered, is far from the plight of its failing neighbor. But unless the country's spendthrift culture undergoes painful change, good managers like Hartung will be punished with the bad.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

    To contact the author of this story:
    Mac Margolis at mmargolis14@bloomberg.net

    To contact the editor responsible for this story:
    James Gibney at jgibney5@bloomberg.net

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