As promised, below are some highlights and caveats to the MGI report on Brazil's growth prospects and potential that I did not specifically address in my previous post.
First, a few highlights in the report before the caveats.
- The report is actually a follow up on a 2006 MGI paper. Unfortunately, not much has changed. If the paper seems a little recycled/updated it's because most of the underlying improvements necessary for stronger growth still need to happen.
- The Executive Summary is quite long, but it contains all of the essential elements. It seems that the Executive Summary was created by taking the report and cutting out non-essential phrases, data, and the weaker examples. There is not much additional value from reading the report in its entirety unless you are analyzing the supporting data.
- Few of those studying Brazil point out or benchmark the tax revenue compared to other developing countries. Brazil is at the top of the list, showing that there isn't much more room to grow from the government's end to resolve these problems. Furthermore, this tax level should be kept in mind with the fact that deadweight social losses are exponential. For example, an increase in a tax from $1 to $2 on a certain good does more than twice the damage to the economy than the initial $1 tax.
- Brazil's demographics is another point that few tie to economic performance. However, as I've stated in a previous post, even fewer notice how quickly and drastic the Brazilian birth rate fell and the potential for a demographic "hard landing."
- Tax revenue from the commodity boom was essentially all spent on income redistribution instead of investment, which could have further increased productivity. This is a delicate point to bring up, and the authors do so superbly in a fashion that is both accurate and diplomatic. One potential comparison on this subject would be to Venezuela and oil rig maintenance. Venezuela expanded social benefits instead of keeping its oil rigs well maintained and in order. Because of this policy, oil output unnecessarily fell, which hurt productivity and social benefits in the future. While Brazil's case is far more complex than this, the same lesson could potentially be applied.
- Brazil has many significant and counterproductive protectionist policies. Reducing protectionist policies anywhere is extremely difficult. There is a painful transition period, a lot of money is at stake, and those with money at stake are few and have eloquent lobbyists. The report does not touch on this area, which is understandable considering the size of the issue and the report's focus on high-level items.
- Due to demographics and "generosity," Brazil's pension system is going to spiral out of control far worse than many developed nations if reforms are not made. This is not a near-term critical issue, but MGI does a favor by pointing it out at this juncture and highlighting the impact.
- This anecdote from the introduction is one of the most concise and illuminating points of data to address Brazil's underlying productivity and potential GDP growth in the report. "Mexican auto plants churn out twice as many vehicles per worker as Brazilian plants, even though a much higher share of their output consists of mid-size and large vehicles, while Brazil's plants typically produce 85 percent of small cars."
- Other illustrative anecdotes were used very effectively, such as the length of rail laid in Brazil amounts to about 10% of that in the United States, even though the two countries are similarly sized.
- There are fewer economic policies as painfully obviously bad as preventing (tariffs+quotas) the importation of food and then creating a commission to limit the planting and harvest of said food. It's a policy that definitely is not unique to Brazil, but the scale was quite large. The report brings up briefly, but in an appropriate fashion, the economic advancements that have arisen from removing some of the worst policies that caused "own goals" on the economy.
Next, my caveats in recommending the report:
- Even though it's been just over a year, the points related to "strong currency" are out of date. The Brazilian real has depreciated 30-40% over this time period.
- The authors use the fact that Brazil has the seventh largest FDI in the world as an indicator of openness in the financial sector. Brazil has the fifth largest population in the world, an extraordinarily low savings rate, high real interest rates, and a history of underinvestment. FDI, in theory, should be much higher. In a world of negative real interest rates, Brazil is offering 8% real returns. Why aren't foreign investors piling in? The answer is that the barriers for foreigners to invest are significant, especially for certain industries and financial structures. Financial openness to enable the limited purchase of some publicly traded shares and bonds is not the same as opening the economy to the capital infusions that innovate and improve the underpinnings of economic performance.
- There are a lot of suggestions, but there is very little sense of priority and impact. As I pointed out in the previous post, the problems are interrelated. However, many of the recommendation are either too vague or they would do little to resolve the big ticket items that need to happen to achieve 4% GDP real growth. For example, improving public sector efficiency could help, but many countries have succeeded well despite public sector inefficiency. Also, in a country where the government controls so much, exactly what falls under the umbrella of public sector efficiency? The report isn't clear. Public sector efficiency could refer to schools, medicine, zoning, permits, customs, police, safety, unions, etc.
- Improving tourism could help a little, but the highest impact / lowest hanging fruit wasn't mentioned in the report. Half of the world's high-spending international tourists are essentially blocked out of the market for a visa. Compare the maps showing the countries that need tourist visas to visit Peru and Brazil. Travelers from Japan, the USA, Australia, and Canada have to go through the bureaucratic visa process to visit Brazil, but not Peru, Argentina, Chile, or a host of other countries in the region. This obstacle alone is usually sufficient to exclude Brazil as a potential tourist destination. If Brazil wants to maintain a sense of reciprocity for moral reasons or leverage, the Brazilian government can emulate the Argentinian reciprocity fee by charging a fee to those from the United States and other countries.
- Embraer is not a great case study. Embraer was a success, but the Brazilian aerospace firm was a result of many contributing factors, favorable timing, and a bit of luck. While lessons such as "remove tariffs so the industry can become an integral part of a supply chain" are more universally applicable, many aspects of the case study seem to encourage industrial policy that picks winners and losers and sound like more of the same government micromanaging that has yielded few benefits. In some parts of the report this seems to be encouraged, while in others this seems to be discouraged, such as the example of the negative impacts of the BNDES development bank. The problem is not a lack of trying to create another Embraer. The problem is that these attempts are performed with favoritism instead of reform and liberalism.
- There are other cases where a large number of words are used to recommend micromanaging marginally effective incentive programs. Brazil is far enough back on the curve that political capital should be focused on the steps that are politically feasible and can move the needle.
- The report's commentary on getting stricter on regulatory compliance to reduce the informal sector is misplaced. Complexity already makes regulatory compliance nearly impossible, putting businesses—especially small and medium sized enterprises—at the mercy and fairness of the regulator. The marginal cost of adding a regulator in the current environment is likely negative. The improvements first must come in regulatory structure and reform. Once that is in effect, the budget and activities of regulators could be tweaked.
Overall, the report is a great snapshot and it is my go-to resource when those in my network reach out to better understand Brazil's medium-term prospects.
First, a few highlights in the report before the caveats.
- The report is actually a follow up on a 2006 MGI paper. Unfortunately, not much has changed. If the paper seems a little recycled/updated it's because most of the underlying improvements necessary for stronger growth still need to happen.
- The Executive Summary is quite long, but it contains all of the essential elements. It seems that the Executive Summary was created by taking the report and cutting out non-essential phrases, data, and the weaker examples. There is not much additional value from reading the report in its entirety unless you are analyzing the supporting data.
- Few of those studying Brazil point out or benchmark the tax revenue compared to other developing countries. Brazil is at the top of the list, showing that there isn't much more room to grow from the government's end to resolve these problems. Furthermore, this tax level should be kept in mind with the fact that deadweight social losses are exponential. For example, an increase in a tax from $1 to $2 on a certain good does more than twice the damage to the economy than the initial $1 tax.
- Brazil's demographics is another point that few tie to economic performance. However, as I've stated in a previous post, even fewer notice how quickly and drastic the Brazilian birth rate fell and the potential for a demographic "hard landing."
- Tax revenue from the commodity boom was essentially all spent on income redistribution instead of investment, which could have further increased productivity. This is a delicate point to bring up, and the authors do so superbly in a fashion that is both accurate and diplomatic. One potential comparison on this subject would be to Venezuela and oil rig maintenance. Venezuela expanded social benefits instead of keeping its oil rigs well maintained and in order. Because of this policy, oil output unnecessarily fell, which hurt productivity and social benefits in the future. While Brazil's case is far more complex than this, the same lesson could potentially be applied.
- Brazil has many significant and counterproductive protectionist policies. Reducing protectionist policies anywhere is extremely difficult. There is a painful transition period, a lot of money is at stake, and those with money at stake are few and have eloquent lobbyists. The report does not touch on this area, which is understandable considering the size of the issue and the report's focus on high-level items.
- Due to demographics and "generosity," Brazil's pension system is going to spiral out of control far worse than many developed nations if reforms are not made. This is not a near-term critical issue, but MGI does a favor by pointing it out at this juncture and highlighting the impact.
- This anecdote from the introduction is one of the most concise and illuminating points of data to address Brazil's underlying productivity and potential GDP growth in the report. "Mexican auto plants churn out twice as many vehicles per worker as Brazilian plants, even though a much higher share of their output consists of mid-size and large vehicles, while Brazil's plants typically produce 85 percent of small cars."
- Other illustrative anecdotes were used very effectively, such as the length of rail laid in Brazil amounts to about 10% of that in the United States, even though the two countries are similarly sized.
- There are fewer economic policies as painfully obviously bad as preventing (tariffs+quotas) the importation of food and then creating a commission to limit the planting and harvest of said food. It's a policy that definitely is not unique to Brazil, but the scale was quite large. The report brings up briefly, but in an appropriate fashion, the economic advancements that have arisen from removing some of the worst policies that caused "own goals" on the economy.
Next, my caveats in recommending the report:
- Even though it's been just over a year, the points related to "strong currency" are out of date. The Brazilian real has depreciated 30-40% over this time period.
- The authors use the fact that Brazil has the seventh largest FDI in the world as an indicator of openness in the financial sector. Brazil has the fifth largest population in the world, an extraordinarily low savings rate, high real interest rates, and a history of underinvestment. FDI, in theory, should be much higher. In a world of negative real interest rates, Brazil is offering 8% real returns. Why aren't foreign investors piling in? The answer is that the barriers for foreigners to invest are significant, especially for certain industries and financial structures. Financial openness to enable the limited purchase of some publicly traded shares and bonds is not the same as opening the economy to the capital infusions that innovate and improve the underpinnings of economic performance.
- There are a lot of suggestions, but there is very little sense of priority and impact. As I pointed out in the previous post, the problems are interrelated. However, many of the recommendation are either too vague or they would do little to resolve the big ticket items that need to happen to achieve 4% GDP real growth. For example, improving public sector efficiency could help, but many countries have succeeded well despite public sector inefficiency. Also, in a country where the government controls so much, exactly what falls under the umbrella of public sector efficiency? The report isn't clear. Public sector efficiency could refer to schools, medicine, zoning, permits, customs, police, safety, unions, etc.
- Improving tourism could help a little, but the highest impact / lowest hanging fruit wasn't mentioned in the report. Half of the world's high-spending international tourists are essentially blocked out of the market for a visa. Compare the maps showing the countries that need tourist visas to visit Peru and Brazil. Travelers from Japan, the USA, Australia, and Canada have to go through the bureaucratic visa process to visit Brazil, but not Peru, Argentina, Chile, or a host of other countries in the region. This obstacle alone is usually sufficient to exclude Brazil as a potential tourist destination. If Brazil wants to maintain a sense of reciprocity for moral reasons or leverage, the Brazilian government can emulate the Argentinian reciprocity fee by charging a fee to those from the United States and other countries.
- Embraer is not a great case study. Embraer was a success, but the Brazilian aerospace firm was a result of many contributing factors, favorable timing, and a bit of luck. While lessons such as "remove tariffs so the industry can become an integral part of a supply chain" are more universally applicable, many aspects of the case study seem to encourage industrial policy that picks winners and losers and sound like more of the same government micromanaging that has yielded few benefits. In some parts of the report this seems to be encouraged, while in others this seems to be discouraged, such as the example of the negative impacts of the BNDES development bank. The problem is not a lack of trying to create another Embraer. The problem is that these attempts are performed with favoritism instead of reform and liberalism.
- There are other cases where a large number of words are used to recommend micromanaging marginally effective incentive programs. Brazil is far enough back on the curve that political capital should be focused on the steps that are politically feasible and can move the needle.
- The report's commentary on getting stricter on regulatory compliance to reduce the informal sector is misplaced. Complexity already makes regulatory compliance nearly impossible, putting businesses—especially small and medium sized enterprises—at the mercy and fairness of the regulator. The marginal cost of adding a regulator in the current environment is likely negative. The improvements first must come in regulatory structure and reform. Once that is in effect, the budget and activities of regulators could be tweaked.
Overall, the report is a great snapshot and it is my go-to resource when those in my network reach out to better understand Brazil's medium-term prospects.
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