Brazil's State-Made Crisis
By the time the populist, left-wing and charismatic Inácio Lula da Silva assumed the presidency of Brazil on January 1, 2003, he had accomplished a cultural revolution within his own party, the Workers' Party (PT). Indeed, during the presidential campaign, Lula put aside the far-left rhetoric of the PT and promised that he would not unmake the pro-market macroeconomic policy of the outgoing president, Fernando Henrique Cardoso.
That turnaround was not a capricious move; the PT had lost three consecutive presidential contests. At the same time, the policies introduced by Cardoso, first as finance minister and subsequently as president of Brazil, had registered outstanding achievements. His "Plan Real" put an end to the country's endemic inflation. The government checked spending, opened the sheltered industries to competition and facilitated foreign investment. After so many failed experiments involving runaway inflation, fiscal recklessness and self-defeating protectionism, the country was sailing at a steady pace.
In comparison with the accomplishments of Cardozo's policies, the far-left rhetoric of the PT looked old fashioned and unappealing. Hence Lula's change of discourse.
Elected president, Lula paid heed to his promise. His first finance minister, António Palocci, managed to reduce both the budget deficit and the country's sovereign debt. At the same time, money supply grew in line with the inflation target.
Macroeconomic rectitude fostered economic growth, thereby enabling Lula to successfully introduce far-reaching redistribution policies. The proportion of Brazilians living under the poverty threshold was halved, from 31.8 percent in 1993-95 to 15.3 percent in 2009. Yet, by the end of his second term, Lula departed from macroeconomic prudence, expanding public spending and printing money with the aim of enhancing the chances of the PT candidate, Dilma Rousseff, at the presidential election of 2010.
After winning that contest, Dilma Rousseff slipped further into the moving sands of fiscal and monetary profligacy.
A larger public deficit pushed interest rates upwards, which thwarted private investment and consumption. Then, to counter that undesired effect, the central bank increased the money supply. Little wonder inflation has been running above the mean target of 4.5 percent -- currently around 6.5 percent (8.3 percent in non-price-controlled goods and nearly ten percent in services). Price controls have, in turn, squeezed firms' profit margins and cash reserves, thus discouraging local production, investment and natural resource exploration (particularly in oil and sugarcane ethanol).
Furthermore, as government-decreed increases to the minimum wage are not matched by productivity gains, the international competitiveness of the manufacturing sector has weakened.
Then, to address the loss in competitiveness, the state expanded its participation and involvement in ailing industrial sectors, raised trade barriers (25 percent increase on 100 capital goods in 2012), resorted to tax excises to secure a high local content in car manufacturing and forced the state-owned development bank (BNDES) to grant risky loans to domestic firms.
Protectionism and easy borrowing, however, have not made domestic industries any more competitive. Imports have nearly doubled their share in domestic consumption of manufactured goods, making 23.5 percent thereof in 2012, as compared to 12.5 percent in 2002.
To add insult to injury, the increased state's participation in the industrial sector provided the breeding ground for corruption to prosper -- diverting funds that could and should have been destined to public investment in transport, education and health. The usual descent into hell of state interventionism is thus fully at work in Brazil, prompting the wave of protests that have been shaking the cities of that country.
Some have justified Brazil's suicidal departure from macroeconomic prudence on the grounds that Brazil had to change tack because of the Great Recession. This is an ungrounded explanation. The proof that Brazil has not adopted the right policy mix in response to the world economic slump is the fact that it has been underperforming comparable economies confronted with the same adverse environment. Brazil has indeed been showing lower growth and higher inflation than most Latin American countries. It is even underperforming the other countries of the BRIC club (Russia, India and China).
Another argument that is brandished about to justify the spree of state interventionism relates to the alleged need to fight the "currency war" launched by the U.S. Federal Reserve's quantitative easing -- which has lowered the value of the dollar and, correspondingly, raised that of the real.
As a matter of fact, Brazil could have used a relatively strong real to rein in inflation and acquire modern technology so as to enhance the competitiveness of its ailing manufacturing industry. Instead, Brazil's central bank pushed down the value of the real by printing money, thus fueling the inflationary pressures that are the core of the current social unrest.
After a visit to Brazil in February 2012, Nouriel Roubini, the economist who predicted the subprime crisis and the ensuing Great Recession, asserted that Brazil was in need of "significant structural reforms." Brazil's leadership, however, doesn't appear keen to follow the path of structural reform.
With approval ratings in free fall -- tumbling from 57 percent to 30 percent in less than a month -- and with presidential elections scheduled for 2014, Dilma Rousseff gives signs of leaning toward the easy way out; namely expansion of public spending and the money supply, even if that means more inflation, more resource misallocation and, ultimately, more social unrest.