Brazil's Burgeoning Crisis Should Matter to Americans

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At a time when Argentina and Turkey are in the midst of full-blown currency crises, it is surprising how little attention is being paid in US economic policy circles to Brazil’s economic challenges ahead of its upcoming general election in October. This is all the more surprising considering Brazil is the world’s eighth largest economy, and the most important market for US exports to South America.

Despite having been a model emerging-market economy in the nineties, Brazil has struggled since then, causing the country to lag well behind its South American economic peers. Between 2000 and 2013, the country’s real gross domestic product (GDP) per capita grew by less than 3 percent a year. Worse yet, Brazil then suffered a three year long recession, which constituted the country’s worst economic performance in the last 100 years.

Other economic indicators also reflect Brazil’s lackluster economic performance. Total factor productivity has fallen steadily by 0.7 percent per year between 2000 and 2016, while its savings rate ranks amongst the lowest in Latin America.

In addition, Brazil has accumulated debt rapidly, and its budget deficit has swelled to almost 8 percent of GDP because of the government’s attempts to stimulate its moribund economy through expansionary fiscal policies. Over the past six years, Brazil’s public debt as a percentage of GDP rose from around 50 percent to almost 85 percent, raising serious questions about the country’s debt sustainability. Without substantial fiscal reforms, the country’s public debt will rise to 120 percent by 2022, which would exacerbate Brazil’s already cumbersome debt servicing costs.

The last thing Brazil needs is a protracted period of political uncertainty at a time of shaky domestic economic fundamentals, rising US interest rates, and a strengthening US dollar. Yet, this has been precisely Brazil’s recent experience. A corruption probe around Petrobras, the state oil company, has implicated one-third of President Temer’s cabinet and led to the impeachment of President Rousseff last year.

Worse yet, Brazil’s upcoming election might exacerbate its political prospects. Leading in the polls is Luiz Inácio Lula de Silva, a far-left former Brazilian president, who is currently in prison on corruption charges. Mr. Silva will most likely be barred if he attempts to run for office. The other leading candidate, Jair Bolsonaro, is a right-wing populist known for his inclinations towards military rule and authoritarianism but unknown for his grasp of economic policy management.

Whoever wins the elections, one thing is certain: Brazil has great economic potential, but it needs substantial economic reforms to address its major public sector imbalances. At a minimum, such reforms should include cuts in fiscal spending, pension reform, and increased infrastructure spending.

In addition to fiscal reforms, Brazil needs much-needed changes to reduce administrative and regulatory costs. Currently, Brazil’s cumbersome regulations impede business creation and economic growth.

According to the World Bank, Brazilian companies spend an average of 2,038 hours filing their taxes, about 12 times the average for Organization for Economic Co-operation and Development countries. Because of such onerous regulations, Brazil ranks 125th in the World Bank’s “Ease of Doing Business” ranking, behind significantly poorer countries like Swaziland and Uganda.

To increase the formation of new businesses and stimulate economic growth, the next Brazilian government would have to overhaul Brazil’s regulatory structure and create a more business-friendly environment. Additionally, Brazil would also do well to increase investment. The country invests only around 18 percent of its GDP, compared to the regional average of 23 percent.

Brazilian leaders would also do well to reform the country’s international trade policy. With its relatively closed economy, Brazil remains over-dependent on its domestic economy for growth. Foreign trade accounts for only 25 percent of GDP, making Brazil the second most closed economy in the World Bank rankings.

Brazil’s lack of openness is exacerbated by its scarcity of formal trade agreements—the country’s relatively few trade agreements give it preferential access to only 10 percent of the global market and include several hundred exceptions, which further diminish their effectiveness. To help the Brazilian economy grow, Brasília needs to prioritize international trade relations and strengthen its economic relations with major trading blocs, like the European Free Trade Area and the European Union.

As Latin America’s largest economy, Brazil has great economic potential. But given the scale of the country’s economic and political challenges, the Brazilian economic leadership would be well advised to commit to deep economic and trade reforms. Without such reforms, Brazil will be all too exposed to the same economic vulnerabilities that are causing turmoil in other emerging markets like Argentina and Turkey. Such an outcome would not be in the best interest of either Brazilian or American policymakers.

Ryan Nabil is a global macroeconomy researcher at the American Enterprise Institute.

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