Unlocking Brazil's Long-Term Growth Potential

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Includes: BRZU, BZQ, DBBR, EWZ, FBZ, UBR
by: The Financialist

BRzil Brazil has certainly had its share of trials and tribulations lately: the economy is in recession, inflation is on the rise, budget deficits are widening, its sovereign debt rating has been downgraded, and the political environment is challenging. Yet, the country still has a lot going for it. It remains the largest economy in Latin America, and one that is rich in resources ranging from agricultural products to industrial metals. Home to some of the continent's strongest political institutions, Brazil has also made significant strides in improving the economic well-being of its citizens over the past decade: The proportion of the population living in poverty has fallen from 17.3 percent in 2006 to 7.4 percent in 2014, according to the World Bank. What can the country do to leverage its strengths, re-ignite its economy, and regain its position as one of the world's most exciting growth stories?

Experts gathered at Credit Suisse's 2016 Latin America Investment Conference (LAIC) in January in Sao Paulo said that righting the fiscal ship is Brazil's most pressing concern. But they also said that fixing two long-term structural issues - a closed economy and low productivity - is the key to building a strong foundation for solid long-term growth.

How can Brazil increase its labor productivity to stay competitive in global markets? Watch the video to hear Ricardo Paes de Barros, chair of the Ayrton Senna Institute at Brazilian university Insper, discuss what kinds of policy measures the country needs.

Opening to the World

Brazil could have benefitted more from a rapid expansion in global trade over the last few decades if its economy were more open, said former Mexican President Felipe Calderón, a keynote speaker at the LAIC.

Calderón contrasted the experiences of economies in the Mercosur trade alliance (Argentina, Brazil, Paraguay, Uruguay, and Venezuela) and those in the Pacific Alliance (Chile, Colombia, Mexico, and Peru). Pacific Alliance countries have relatively open economies and export mostly manufactured products, while Mercosur countries are relatively closed and rely much more on commodities exports, which left them particularly vulnerable to a commodities rout led by slowing demand in China. Commodities account for 67 percent Brazilian exports, and steep declines in the price of oil and iron ore, of which it is the world's third-largest producer, have hit the country hard. The economy shrank 3.7 percent in 2015, and Credit Suisse's Brazil economists expect drops of 3.5 percent this year and 0.5 percent next - the first three-year contraction since 1901.

When it comes to the openness of its economy, while Brazil can claim significant growth in trade over the last half century-plus, it nevertheless lags other countries in that regard. The difference in the trade openness coefficient (the sum of exports and imports as a share of GDP) between the country and the rest of the world increased from 10.5 percentage points in 1960 (about 14 percent in Brazil and 24.5 percent worldwide) to nearly 33 in 2014 (some 26 percent in Brazil to some 59 percent worldwide), according to Credit Suisse.

Among the reasons: Brazil has the highest customs tariffs in the world on consumer goods and intermediate products, and the second-highest tariffs on capital goods. The country also imposes heavy non-tariff barriers, including state and federal taxes, and it has not signed as many free-trade agreements as other countries. In 2014, the country had just five trade agreements, compared to 20 in the United States, 40 in Colombia, 44 in the eurozone, 45 in Mexico, and 54 in Chile.

And the fact of the matter is that closed economies have a harder time staying competitive than open ones. Trade barriers protect domestic industries, but keeping out foreign competitors also removes incentives for them to become more efficient. For example, said Calderón, Mexico's remarkable post-crisis recovery stemmed partly from new trade agreements and removing tariff barriers throughout the economy. "The more tariff reductions you apply to a sector, the more competitive that sector becomes," the former president said. "The big lesson is: open your market."

Low and Slow Productivity

Professor Ricardo Paes de Barros, Instituto Ayrton Senna Chair at the Brazilian university Insper, put the country's slipping labor productivity in striking terms at the LAIC. In 1980, a Brazilian worker produced about the same amount, in value-added terms, as a South Korean worker; today, it would take three Brazilians to keep up with a Korean. Similarly, in the '80s, a Brazilian worker was 10 times as productive as a Chinese worker, whereas today the two are roughly equivalent.

In recent years, more Brazilian workers have moved out of agriculture and into service professions. Low-productivity, labor-intensive sectors such as healthcare, education, and retail sales have grown the fastest, with the share of workers in this segment of the market rising from 51 percent in 1996 to 59 percent in 2015. While Brazil's overall productivity grew 13.4 percent over the past two decades, workers in industries that are inherently less productive grew 3.7 percent less productive.

Credit Suisse attributes these productivity declines to the concentration of government workers, who earn higher salaries than private sector workers in similar jobs in fields such as health and education. The relentless growth of the country's public sector limits potential productivity growth, the bank's economists say. The higher the public sector's share of the Brazilian economy, the lower the odds that it can grow even a modest 2 percent over the next three years.

Credit Suisse's analysis suggests that Brazil could spend 43 percent less on all public services, 51 percent less on education, and 70 percent less on healthcare and still get the same results. The shortcomings of the country's education system only contribute further to its sluggish productivity growth, Paes de Barros says. The professor thinks Brazil may need to bring in international consultants to help reform its education system, but that it also must do better at gathering and publicizing performance data from its many school districts to learn what works and what doesn't. Brazil is still a young nation, with the share of working-age people set to expand for another six years. Investing more wisely in its youth is critical to the country's future growth prospects.

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