Reference no: EM132681463

Questions

1. What efforts can be made by the government of Brazil to maintain the economy's successful growth? Why or why not?
2. By implementing quotas, tariffs, and measures to devalue its currency, what may be the downside that Brazil would experience?

Reading

BRAZIL has a lot to be proud of. A decade of faster growth and progressive social policies has brought a prosperity that is ever more widely shared. The unemployment rate for April, at 6.4%, is the lowest on record. Credit is booming, particularly to the swelling numbers who have moved out of poverty and into the middle class. Income inequality, though still high, has fallen sharply. For most Brazilians life has never been so good.

That success is partly thanks to good luck, in the form of booming commodity prices. But it is also the result of good policies. A country once known for its macroeconomic incompetence has maintained an enviable stability, deftly navigating the 2008 financial crisis as well as the more recent influx of foreign capital. Not surprisingly, perhaps, many of Brazil's economic officials now have an air of smugness about them, as they argue that the rest of the world has more to learn from Brazil than vice versa.

The timing of such complacency could not be worse. The economy is overheating. The government is stalling on a deeper reform agenda that is essential to boost Brazil's long-term growth and fiscal stability. President Dilma Rousseff's growing political problems do not help: her chief of staff, Antonio Palocci, is under fire over fat consulting fees. All this adds up to a warning: Brazil's economy is heading for trouble.

Inflation is 6.5% and rising. It is driven (as elsewhere) by food and fuel costs, but the tightness of Brazil's labour market suggests that it could easily become entrenched as workers expect higher prices and demand higher wages. The jobless rate is well below the level that is consistent with stable prices. Although professional forecasters' expectations of future inflation have stabilised, the proportion of ordinary folk expecting higher prices has risen. Wage gains in some sectors are already running into double digits. If the labour market remains red-hot, stubborn, and creeping inflation seems all too likely-especially if (as seems probable) foreign investors eventually become alarmed and the exchange rate weakens.

The best way to counter the inflation risk is through tighter macroeconomic policies. Brazil's central bank has been raising interest rates, but monetary conditions are still looser than before the financial crisis in 2008, when joblessness was much higher. Brazilians fret, reasonably, that faster rate rises will attract even more foreign capital. Lured by high interest rates, investors have piled into the country, sending the currency soaring to an increasingly overvalued rate, despite an expanding arsenal of taxes designed to deter them. Brazilian officials are right to worry about the impact of foreign capital flows, but their emphasis on controls and fear of raising rates have distracted them from a more potent tool: tighter fiscal policy.

Ms Rousseff's government brags about its fiscal squeeze. Thanks to strong revenues and a slowdown in investment spending, the primary budget (excluding interest payments) is on track to hit a surplus of almost 3% of GDP. But that is not nearly bold enough. To dampen overall demand growth and reduce Brazil's real interest rates, the government needs far more ambitious fiscal consolidation: with the economy growing strongly, the overall budget (including interest payments) should be in surplus, especially if the government is to have the scope for a fiscal stimulus when the next recession comes. Worse, today's gains are coming from the wrong sources; rather than slowing investment, the state should be squeezing its transfer payments. Nor are the gains likely to be sustained. Under current rules, Brazil's minimum wage will rise by 7.5% in real terms next year-at huge fiscal cost, since pension payments are linked to the minimum wage.

Tighter fiscal policy is Brazil's best defence against short-term economic trouble. An overhaul of government is also the route to boosting longer-term growth. A streamlined state will improve productivity growth as well as Brazil's saving and investment rates. Pension reform is urgently needed in a country that is ageing fast, has absurdly generous pensions and in which the average woman retires at 51. So, too, is an overhaul of Brazil's fiendishly complicated and distortive tax system. Such reforms are difficult and tempting to put off. But without them Latin America's biggest success story will start to look a lot less lustrous.