An Economic Strategy to End Brazil’s Woes
The Brazilian economy grew by 1 percent in the first three months of 2017, putting an end to the country’s longest recession in history. While this end of recession provides much-needed relief for Brazilian economic policymakers and investors, unless substantial reforms are made—notably in the labor market and unsustainable public spending—the country’s economic future remains uncertain.
Although Brazil is no stranger to financial crises, the country’s recent crisis is a far cry from its strong economic performance during the 2000s. A darling of investors—along with Russia, India and China, the other members of the epithet BRIC—helped to grow Brazil’s economy by roughly five times in the 2000s, from $508 billion in 2002 to $2.6 trillion in 2011.
Despite this economic growth, Brazil’s economic policy in the 2010s left the country debt-ridden and ill-positioned to weather future financial shocks. Former president Rousseff and her-left wing Workers’ Party commenced in 2010 an extravagant spending plan on pensions and tax breaks for favored industries, which caused Brazil to accumulate public debt rapidly. Between 2010 and 2015, the public sector deficit as a percentage of the gross domestic product increased from 2 percent to 10 percent, leaving the economy vulnerable to a potential macroeconomic shock.
That shock arrived in 2015 in the form of a sharp fall in the global prices of commodities, Brazil’s main export. As the debt-ridden government failed to boost economic growth, unemployment and domestic unrest rose. The public sector deficit grew further, and with it shrank investor confidence in the Brazilian economy. At the same time, a major graft scandal broke out at the largest company in Brazil, the state-run Petrobras, involving the country’s most prominent politicians and businessmen. Amidst the ensuing political turmoil, investors left Brazil in droves. As foreign investment dried up and unemployment rose, Brazil’s economy suffered, experiencing eight consecutive quarters of negative growth and contracting by nine percent, the worst in its history.
Given the severity of the recession, it is understandable why policymakers are optimistic about Brazil’s recent economic growth. However, this growth is largely the result of a record harvest of soybeans— Brazil’s main export—rather than the result of structural changes in the Brazilian economy. To ensure that the current growth continues, Brazilian economic policymakers must undertake key reforms, including relaxing Brazil’s labor market regulations, simplifying the tax system, and limiting public spending.
First, despite the recent growth, the unemployment rate in Brazil remains high. 14 million Brazilians are looking for work yet cannot find a job, largely the result of burdensome labor regulations, which make it expensive to hire workers. Brazil’s payroll tax of 35.0 percent is amongst the highest in the world: even in the richer, more economically developed United States, the payroll tax is only 12.4 percent. Employment termination laws are notoriously onerous and complicated: laid-off workers are entitled to compensation and a retirement fund in the event of dismissal. These regulations make it expensive to hire and terminate workers, increasing the cost of doing business in Brazil. The World Bank ranks Brazil 123rd out of 180 countries in its Ease of Doing Business report. Without reducing Brazil’s payroll tax and easing regulatory burden on employers, it would be difficult to entice more investors to Brazil, especially in light of recent political turmoil that involves calls for a second presidential impeachment within a year and three months.
Second, Brazil needs to simplify its archaic and complex tax system, which makes it excruciatingly difficult to trade even within the country. For instance, each state in Brazil imposes its own taxes on goods, which are calculated using a sloth of formula. The World Bank reports that, as a result of cumbersome tax laws, companies in Brazil spend an average of 2,038 hours filing their taxes, about 12 times the average for Organisation for Economic Co-operation and Development (OECD) countries. Doing business in Brazil would be substantially easier with a uniform value-added tax around the country. Along with relaxing labor market regulations, such tax reform would go a long way towards attracting investors to the country.
Third, given the poor state of its public finances and its destabilizing effect on the economy, Brazil needs to rein in its public spending. As a first step, Brasilia should consider reforming pensions, which is one of the key reasons behind its public deficit. Brazil has one of the most generous pension systems in the world, with the present system allowing workers to retire on full pay as early as early as in their 50s, nearly a decade earlier compared to most OECD countries. In a bid to reform the unsustainable pension system, President Temer is spearheading a bill that would reduce generous payouts and raise the retirement age to 65. However, given the antagonism towards pension reform, it is unclear if this bill will pass. Yet, without such reforms, Brazil’s economy will face significantly difficulties, especially as its currently young population ages over the next few decades.
Key structural reforms—relaxing termination laws, cutting pensions, and raising the retirement age—are almost universally unpopular in struggling emerging market economies, ranging from Puerto Rico to Brazil. Yet, without these reforms, Brazil’s long-term growth prospects remain uncertain. If Brazilian economic policymakers wish to see a more competitive Brazil playing a stronger role in the global economy, it is imperative that they undertake the necessary reforms and set Brazil on the path to economic prosperity.