Brazil-o-nomics – Part 1 – History

In the first of two parts, I’m going to briefly examine the economics of Brazil. Part one will outline the economic history of Brazil, while the second part will focus on the economic future of Brazil. I’m no economist, but what spurred my very amateur interest the Brazilian case was the discovery that Brazil is an expensive country, especially for anything imported. The aim of the import tariffs is supposedly to stimulate domestic industries. However, these tariffs also allow globally uncompetitive companies to develop, which reduce the relative efficiency of domestic consumers and have little success in the export market. So it seems that the critical question is how to use market forces to evolve competitive companies, when those companies are shielded from the market by trade barriers?

But before going any further, lets put recent developments into historical context. Brazil started as an commodity exporter, and over the past 150 years, has worked hard to diversify its industrial base and integrate with the global market. It has not always been successful in these efforts, but recently, Brazil has managed to bring its own economic affairs under control, leading to increased market confidence, and a major surge in growth. The sustainability of this growth will be tackled in the next post, but for now, brazil-o-nomics 101…

Colonial Exploitation

  • Brazil started as a Portuguese colony, exploited for its natural resources. These included sugar, gold, rubber and tobacco.
  • Brazil gained independence in 1833, but still operated under an export model that relied on slaves.
  • Slaves were gradually phased out, leading to a growth in domestic demand for products and services.

The Coffee Years

  • Coffee became a hugely important global commodity, with Brazil as a major producer. Many people emigrated to Brazil to work during the boom years.
  • Coffee production was relatively inflexible, due to its 4 year maturation period. To keep price more constant during dips in demand, the government intervened in the coffee market, subsidising coffee producers.
  • Over-reliance on the state resulted in over-production and subsidies became an unsustainable drain on government funds.
  • A revolution took power away from the old coffee exporters and there were attempts to industrialise, although the macroeconomic conditions imposed by two world wars made genuine progress difficult to realise.

Post-War Diversification

  • A phase of import substitution, designed to stimulate the domestic economy, led to uneven growth in the Brazilian economy. Currency exchange and import duties were used to protect domestic industry from international competition. Some industries, such as steel and automotive sectors, benefited, while a complex bureaucracy and inefficient domestic businesses became a burden on the economy. Some companies did not need to innovate, because their market was assured, leading to few gains in efficiency.
  • An increasingly sophisticated bureaucratic system attempted to streamline the economy and remove the distortions induced by import substitution.
  • The diversification of the economy required foreign investment and imports, which hampered domestic growth rates.
  • Political difficulties slowed the progress of necessary economic reform. Economic responsiveness diminished, and government was in deadlock.

The Economic Miracle

  • A military dictatorship seized power and attempted to restore the dynamism of the economy by simplifying foreign currency exchange, devaluing the currency and creating incentives for direct investment. State owned industries were also promoted, to defend against economic imperialism.
  • Industrial growth, imports and exports all expanded during the late 1960’s. However, growth was concentrated in the southern states, and money was concentrated in the upper levels of society. The boom was also dependent on the inflow of foreign capital via international loans and replied heavily upon petrol imports.
  • The economic miracle continued until the early 70’s. The social cost of this boom was the curtailment of civil liberties. Torture, violent resistance and subversion were commonplace. Dissidents were exiled and sometimes murdered.
  • The oil shock of 1973 caused a jump in the value of imports, relative to exports. However, this cash was made available to Brazil in the form of low cost loans, which caused a large expansion in foreign debt.

Putting the Brakes On

  • •The continued increase in the cost of imports required more and more loans. Eventually, it was necessary to slow growth to rebalance exports with imports.
  • Expanding exports and reduced imports allowed Brazil to service its foreign debt.
  • The devaluation of the cruzeiro decreased foriegn buying power, increasing domestic spending and causing inflation. State-run companies also began to transfer their debt to the government, increasing the public deficit.
  • The economic problems caused the downfall of the military regime

Stagflation and Depression

  • Reform was desperately needed, to enable the public sector to invest, and to stave off inflation. Inflation became more problematic as companies learned to index their prices, worsening the phenomenon.
  • A series of 6 shock economic measures were attempted, but none has the desired effect. The economy grew little and suffered from stagflation and overall depression. Inflation was expected by the population, which caused high levels of inherent inflation.
  • An economic stabilisation plan was developed, called the Real plan, which included a more balanced budget, progressive price indexing, and a new currency loosely pegged to the dollar. The plan was widely anticipated, and progressed gradually, with widespread support in society. Inflation decreased, but international competitiveness was stifled by an over-valued Real.

Regaining Control

  • During the late 1990’s, the economy stabilised successfully, and began to recover its growth trend.
  • Several shocks in other emerging markets limited the growth of the Brazilian market. However, fundamental structural reform led to increased investor confidence.
  • The Brazilian economy received a large IMF support package, and eventually the Real became a floating currency, allowing devaluation. This increased exports, and made imports more expensive.
  • During the first Lula election, international money markets assumed Brazil would default on their international debt, curbing growth. However, the central bank was able to convince the world that Lula’s Brazil would meet their payments, and took domestic measures to prevent runaway inflation. This shows that a new period of fiscal responsibility was dawning, but that growth was not continuous.