A friend of mine reached out to me regarding Brazil's prospects and potential growth going forward. Instead of the usual, "I just want a few interesting and relevant pieces of information," he was actually looking for a deeper dive on structural problems and opportunities. My eventual suggestion to him was to refer to the MGI's "Brazil's Path to Inclusive Growth" report, albeit with caveats.
In this post I will restructure the key points in a framework that I believe is more straightforward. In the follow-up post I'll list out more explicitly the caveats to my "very highly recommended" for my friend.
Brazil needs a dramatic increase productivity in order to increase the growth rate. The report classifies the three principal problem areas to improve productivity in order to achieve consistent 4% GDP growth as "Inadequate infrastructure, a heavy tax and regulatory burden, and a shortage of workforce skills." I have altered it slightly to trade barriers, human capital, and access to capital. While I believe the tax and regulatory burden are a significant drag, eliminating just the trade barrier portion would be sufficient to allow the economy to jump forward, despite the taxes and regulatory burden in other areas. Also, access to capital is addressed in the report, but I believe the overall impact to productivity should be emphasized further.
Three principal areas to change for productivity improvements necessary to drive economic growth:
- Trade barriers: The MGI nails this point. Every year Brazil's economic isolation hampers growth. The sooner interconnectivity increases, the sooner the productivity will increase and 4% real GDP growth target can be consistently achieved. An appropriate understanding of the full level of trade barriers should be approached from a process perspective. The proper question is "What is the full throughput, time, and cost to push goods through the road, rail, and port system?" (I've touched on Brazil's infrastructure, especially maximum throughput, previously in this post with some English source data points.)
The speed, maximum throughput, and cost of Brazilian port and rail have remained far behind in the world of high-speed just-in-time global standards. Take the example of a firm that receives resources from another country, improves them, then sends the more advanced or finished product to a different country. First, the boat must arrive at port. Depending on the volume and the day, the queue into port could take a week. Second, the boat docks and the goods are unloaded. Because customs and inspection do not work 24 hours a day, this can take another week. Third, the import duties must be paid. Because these taxes are not always transparent and the process is complicated, a third party might be necessary to sort out the paperwork. Fourth, the limited dock space slows this process somewhat compared to best-in-class ports in other countries. Fifth, the rail cars travel slowly, spending an extra day before reaching the stop nearest to the factory. Sixth, because the rail network is limited the nearest rail point is over 200 km away from your ideal point of operations. Seventh, poor road conditions delay and add costs to the transportation. After improving the product at your factory, inverse the order of steps above. For these reasons, it is extremely rare for an intermediate production goods to be made in Brazil. Other significant advantages would need to exist in order to make up for these weaknesses. However, we will see below that these advantages have not yet materialized.
- Human capital - Human capital optimizes the use of physical capital and labor. To understand Brazil's limitation of human capital, it is important to focus on three key areas--education, foreign language skills, and presence of foreign workers.
First, on education and skills, I have written a post previously based on an OECD report of Brazil's educational achievements. In summary, top-notch education within Brazil is both expensive and scarce. Quantity and quality of graduates is below that of developing market peers. One interesting piece to note on in education is IT skill development. Due to trade barriers and tariffs, electronics have been very expensive and outside the reach of the vast majority of the population until just recently. Because of this, one notices the lack of intuitive IT skills from Brazilian employees. Brazilians did not grow up exploring and fiddling with these devices, and it shows everywhere from typing skills to understanding system capabilities and limitations.
Second, few people outside of Brazil speak Portuguese. Language is extremely important in determining trade partners.* English is the standard for international commerce. However, as noted in the MGI report and elsewhere, Brazil lags in language proficiency, especially English. Although English is technically a part of the public school curriculum, the rigor of the public school courses must increase in order for students to at least reach a basic level of reading and writing.
Third, foreign-born individuals make up less than 1% of the workforce. Immigration from a variety of countries can improve economic performance and diversity. However, Brazil's level of immigration is both very low and skews toward countries with lower socioeconomic conditions than Brazil, such as Bolivia and Haiti. Many of the skills lacking in Brazil's workforce could be developed through cross training by greatly simplifying, streamlining, and liberating immigration when there is an employer sponsor. Currently, if a company would like to improve the quality of the workforce by bringing in a specialist from another country for more than three months, the company must justify that a Brazilian with equivalent skills could not be found, all of the bureaucratic process of employee rights and work papers must be developed, and the employee cannot be paid more than a Brazilian counterpart in a similar position. Furthermore, this process is not merely a formality, and requests are rejected for reasons such as, "not enough relevant experience," as if the company does not know what they are doing when it plans to spend large sums of money in order for this cross-training to occur.
In this post I will restructure the key points in a framework that I believe is more straightforward. In the follow-up post I'll list out more explicitly the caveats to my "very highly recommended" for my friend.
Brazil needs a dramatic increase productivity in order to increase the growth rate. The report classifies the three principal problem areas to improve productivity in order to achieve consistent 4% GDP growth as "Inadequate infrastructure, a heavy tax and regulatory burden, and a shortage of workforce skills." I have altered it slightly to trade barriers, human capital, and access to capital. While I believe the tax and regulatory burden are a significant drag, eliminating just the trade barrier portion would be sufficient to allow the economy to jump forward, despite the taxes and regulatory burden in other areas. Also, access to capital is addressed in the report, but I believe the overall impact to productivity should be emphasized further.
Three principal areas to change for productivity improvements necessary to drive economic growth:
- Trade barriers: The MGI nails this point. Every year Brazil's economic isolation hampers growth. The sooner interconnectivity increases, the sooner the productivity will increase and 4% real GDP growth target can be consistently achieved. An appropriate understanding of the full level of trade barriers should be approached from a process perspective. The proper question is "What is the full throughput, time, and cost to push goods through the road, rail, and port system?" (I've touched on Brazil's infrastructure, especially maximum throughput, previously in this post with some English source data points.)
The speed, maximum throughput, and cost of Brazilian port and rail have remained far behind in the world of high-speed just-in-time global standards. Take the example of a firm that receives resources from another country, improves them, then sends the more advanced or finished product to a different country. First, the boat must arrive at port. Depending on the volume and the day, the queue into port could take a week. Second, the boat docks and the goods are unloaded. Because customs and inspection do not work 24 hours a day, this can take another week. Third, the import duties must be paid. Because these taxes are not always transparent and the process is complicated, a third party might be necessary to sort out the paperwork. Fourth, the limited dock space slows this process somewhat compared to best-in-class ports in other countries. Fifth, the rail cars travel slowly, spending an extra day before reaching the stop nearest to the factory. Sixth, because the rail network is limited the nearest rail point is over 200 km away from your ideal point of operations. Seventh, poor road conditions delay and add costs to the transportation. After improving the product at your factory, inverse the order of steps above. For these reasons, it is extremely rare for an intermediate production goods to be made in Brazil. Other significant advantages would need to exist in order to make up for these weaknesses. However, we will see below that these advantages have not yet materialized.
- Human capital - Human capital optimizes the use of physical capital and labor. To understand Brazil's limitation of human capital, it is important to focus on three key areas--education, foreign language skills, and presence of foreign workers.
First, on education and skills, I have written a post previously based on an OECD report of Brazil's educational achievements. In summary, top-notch education within Brazil is both expensive and scarce. Quantity and quality of graduates is below that of developing market peers. One interesting piece to note on in education is IT skill development. Due to trade barriers and tariffs, electronics have been very expensive and outside the reach of the vast majority of the population until just recently. Because of this, one notices the lack of intuitive IT skills from Brazilian employees. Brazilians did not grow up exploring and fiddling with these devices, and it shows everywhere from typing skills to understanding system capabilities and limitations.
Second, few people outside of Brazil speak Portuguese. Language is extremely important in determining trade partners.* English is the standard for international commerce. However, as noted in the MGI report and elsewhere, Brazil lags in language proficiency, especially English. Although English is technically a part of the public school curriculum, the rigor of the public school courses must increase in order for students to at least reach a basic level of reading and writing.
Third, foreign-born individuals make up less than 1% of the workforce. Immigration from a variety of countries can improve economic performance and diversity. However, Brazil's level of immigration is both very low and skews toward countries with lower socioeconomic conditions than Brazil, such as Bolivia and Haiti. Many of the skills lacking in Brazil's workforce could be developed through cross training by greatly simplifying, streamlining, and liberating immigration when there is an employer sponsor. Currently, if a company would like to improve the quality of the workforce by bringing in a specialist from another country for more than three months, the company must justify that a Brazilian with equivalent skills could not be found, all of the bureaucratic process of employee rights and work papers must be developed, and the employee cannot be paid more than a Brazilian counterpart in a similar position. Furthermore, this process is not merely a formality, and requests are rejected for reasons such as, "not enough relevant experience," as if the company does not know what they are doing when it plans to spend large sums of money in order for this cross-training to occur.
- Access to capital - Brazil lacks access to the full benefits of the modern financial sector. Savings rates are low, and government policies further discourage saving. Real interest rates are high and burdensome, especially for capital intensive and small businesses. Many small- and medium-sized enterprises are denied capital altogether, as the limited capital available is sucked up by larger, more established firms. Foreign direct investment (FDI) is regulated and limited, especially in the areas where it is most needed. Simply put, until either regulations and costs on FDI are loosened or savings rates rise, capital available for investment will be limited, and a portion of the increasing compounding economic growth will be left on the table.
As the fifth most populous country in the world and the fifth largest country in the world, Brazil has a great deal of potential. However, productivity determines economic growth, and Brazil has some deep issues regarding productivity growth. Fortunately, other countries in similar situations have overcome similar challenges, and the level of optimism in and about Brazil will change as these structural improvements occur.
* See Language Barrier Index and similar subjects on macroeconomic trade. I am now on the more limited side of the economic journal paywall, but this is a fairly well established subject.
As the fifth most populous country in the world and the fifth largest country in the world, Brazil has a great deal of potential. However, productivity determines economic growth, and Brazil has some deep issues regarding productivity growth. Fortunately, other countries in similar situations have overcome similar challenges, and the level of optimism in and about Brazil will change as these structural improvements occur.
* See Language Barrier Index and similar subjects on macroeconomic trade. I am now on the more limited side of the economic journal paywall, but this is a fairly well established subject.
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