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Brazil’s Way Out

Summary:
WASHINGTON, DC – Now that impeached Brazilian President Dilma Rousseff is out of office, it is up to the newly empowered administration of President Michel Temer to clean up Brazil’s macroeconomic mess. Can Temer’s government save Brazil’s crumbling economy? The situation is certainly dire. In fact, Brazil has lately been experiencing the most powerful economic contraction in its recent history. Its per capita GDP will be more than 10% smaller this year than it was in 2013. And unemployment has soared to more than 11%, up four percentage points from January 2015. Brazil has no easy route to recovery for a simple reason: the current rout derives from the intensification in recent years of long-standing economic vulnerabilities – in particular, fiscal profligacy and anemic

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WASHINGTON, DC – Now that impeached Brazilian President Dilma Rousseff is out of office, it is up to the newly empowered administration of President Michel Temer to clean up Brazil’s macroeconomic mess. Can Temer’s government save Brazil’s crumbling economy?

The situation is certainly dire. In fact, Brazil has lately been experiencing the most powerful economic contraction in its recent history. Its per capita GDP will be more than 10% smaller this year than it was in 2013. And unemployment has soared to more than 11%, up four percentage points from January 2015.

Brazil has no easy route to recovery for a simple reason: the current rout derives from the intensification in recent years of long-standing economic vulnerabilities – in particular, fiscal profligacy and anemic productivity growth.

Consider Brazil’s fiscal position, which has deteriorated rapidly since 2011, with a 3.1%-of-GDP primary surplus giving way to a deficit of more than 2.7% of GDP, leading to an overall budget deficit of close to 10% of GDP. In fact, the groundwork for that deterioration was laid a long time ago.

Brazil’s primary government expenditures as a proportion of GDP rose from 22% in 1991 to 36% in 2014. Much of that spending can be explained by a commitment to tackling endemic poverty – an effort that included the world’s largest conditional cash-transfer program, among other things – without reducing the privileges enjoyed by Brazil’s better-off citizens.

For some time, Brazil’s government was able to fund higher expenditure with tax revenues, which also rose as a result of levies on rising consumption and labor-market formalization. And high global commodity prices helped sustain GDP growth of around 4.5% per year from 2003 to 2010, which also bolstered government revenues.

But, of course, the formal labor force cannot expand forever, and commodity prices always fall eventually. Unfortunately, Brazil failed to take advantage of the good times to reap productivity growth. Indeed, only 10% of Brazil’s GDP growth in 2002-2014 can be attributed to total factor productivity gains, while two-thirds was the result of an increase in slightly better-educated workers entering the labor force. So when Brazil’s tax-revenue boosters finally collapsed, legally mandated increases in public spending drove Brazil rapidly toward a fiscal cliff.

Today, counter-cyclical policies are not an option; there simply isn’t enough fiscal or monetary space. This leaves Brazil’s government with only one real option...Continue reading here

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Otaviano Canuto
Otaviano Canuto s the executive director at the Board of the International Monetary Fund (IMF) for Brazil, Cabo Verde, Dominican Republic, Ecuador, Guyana, Haiti, Nicaragua, Panama, Suriname, Timor Leste and Trinidad and Tobago. Mr. Canuto has previously served as vice president, executive director and senior adviser on BRICS economies at the World Bank, as well as vice president at the Inter-American Development BankViews expressed here are his own and do not necessarily reflect those of the IMF or any of the governments he represents.

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