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BRAZIL 2015: A REFORM AGENDA Armando Castelar Pinheiro (based on joint work with Fabio Giambiagi) Seminar at the Inter American Development Bank Washington, October 4, 2005

Outline: 

Outline First- and second-generation reforms Why did reforms fail to spur higher growth? A new agenda of reforms Macro Structural Institutional

Growth: the main motivation for reforms: 

Growth: the main motivation for reforms Source: Armando Castelar Pinheiro, 'Is Institutional Reform the Key to Brazil’s Accelerated Development?', 2003, mimeo.

The 1990s reforms: 

The 1990s reforms Explanations for growth deceleration Very high inflation Semi-autarkic economy State’s inability to invest in infrastructure due to fiscal crisis Goal: Resume growth by attracting private investment and fostering TFP growth through increased competition, private ownership and constraints on policy discretion.

Inflation was brought under control: 

Inflation was brought under control Monthly consumer price inflation (IPCA, %) Source: IBGE.

Comparative Indices of Structural Reform : 

Comparative Indices of Structural Reform Source: Eduardo Lora, 2001; 'Structural Reforms in Latin America: What Has Been Reformed and How to Measure it' Working Paper 466, Inter-American Development Bank.

Reforms failed to bring high growth back: 

Reforms failed to bring high growth back Source: Armando Castelar Pinheiro, 'Is Institutional Reform the Key to Brazil’s Accelerated Development?', 2003, mimeo.

GDP growth outlook (%): 

GDP growth outlook (%) Source: IMF.

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Economia GDP growth: Median market forecasts (%) Source: Central Bank. 4,9

Why did reforms fail to spur rapid growth?: 

Why did reforms fail to spur rapid growth? Washington Consensus – Lack of depth Augmented Washington Consensus – Lack of breadth Error in adopting universal policy agendas: insufficient customization (focus, sequencing and institutional arrangements) Too much market, too little state intervention

Insufficient depth: 

Insufficient depth Government continues to get in the market’s way Large public deficit and debt High rates of interest Low integration into world economy High taxes

Real interest rates on public bonds (%, p.a.): 

Real interest rates on public bonds (%, p.a.) Sources: Central Bank and IBGE.

Imports / GDP (%, 2003): 

Imports / GDP (%, 2003) Source: World Bank, WDI 2005. Brazil 10.3%

Augmented Washington Consensus: 

Augmented Washington Consensus Market failures reflect weak or missing institutions Washington Consensus policies are necessary but insufficient. Goods institutions are necessary to improve incentives and reduce risk. AWC = WC + institutional reforms.

Institutional reforms: 

Institutional reforms New competition law and agencies Regulatory reform and independent regulatory agencies in infrastructure and capital markets Stronger creditor rights (bankruptcy law) Judicial reform Public sector reform Business and labor regulation reform

Insufficient breadth: 

Insufficient breadth Regulation of infrastructure: problems of sequencing and sectors with incomplete (electricity) or missing regulation (sanitation) Competition and regulatory agencies lack sufficient autonomy Financial sector: new bankruptcy law, but no change in collateral and procedure codes Judicial reform: little yet implemented Barely anything done to improve labor and business regulation

Country-specific agendas: 

Country-specific agendas 'The only constant in development is systemic dynamic change. This would hardly be worth stating, were it not that development theory has been presented as if its propositions are universally applicable, no matter what single feature of development policy they choose to stress and no matter which country its recommendation address. As a result, development policy advice has rarely been specifically tailored to the country’s initial conditions, widely interpreted'. Irma Adelman, Fifty years of economic development: What have we learned?, ABCDE Conference, World Bank, 2000.

Universal Laws: 

Universal Laws Macroeconomic discipline Rule of law Good policies Right prices and incentives Focus, sequencing and institutional arrangements should be country-specific

The role of the state: 

The role of the state Problems Fiscal crisis and liberal reforms (as well as democracy?) reduced the state’s ability to foster and direct investment Inadequate balance between carrots and sticks (Latin America vs. East Asia) Promote state role in leading economic development State should pick winners and support losers Greater scope for industrial / investment policies

Growth of GDP and capital stock (% p.a., 5-year moving avg): 

Growth of GDP and capital stock (% p.a., 5-year moving avg) Capital GDP 3,8% 9,0% 3,8% 1,8%

Brazil: Savings and Investment: 1947-2004: 

Brazil: Savings and Investment: 1947-2004

Savings breakdown (% of GDP): 

Savings breakdown (% of GDP) Source: Fabio Giambiagi and Fernando Montero, 2005; 'O Ajuste da Poupança Doméstica No Brasil: 1999/2004'.

Improving investment climate: 

Improving investment climate

A reform agenda: 

A reform agenda Fiscal policy trilema Trade liberalization Financial sector reform Informality: tax, labor and business regulation Jurisdictional risk

Fiscal policy trilema: 

Fiscal policy trilema Reduce public debt/GDP Lower taxes Increase public investment

Public and SOE investment (% of GDP): 

Public and SOE investment (% of GDP) Decline in public investment lowered annual GDP growth by 0.4 p.p.* (*) Pedro C. Ferreira and Leandro Nascimento, 'Welfare and growth effects of alternative fiscal rules in Brazil', EPGE/FGV, 2005.

Gross tax burden (% of GDP): 

Gross tax burden (% of GDP) Rise in tax burden lowered annual GDP growth by 1.5 p.p.* (*) Pedro C. Ferreira and Leandro Nascimento, 'Welfare and growth effects of alternative fiscal rules in Brazil', EPGE/FGV, 2005.

Brazil’s tax burden: out of line with international standards: 

Brazil’s tax burden: out of line with international standards Source: Khair (2003)

Public debt and interest payments (% of GDP): 

Interest payments Public debt and interest payments (% of GDP) Public debt

Net Public debt (% of GDP) vs. per capita GDP (PPP) in 2002: 

Net Public debt (% of GDP) vs. per capita GDP (PPP) in 2002 -90 -70 -50 -30 -10 10 30 50 70 90 110 5000 10000 15000 20000 25000 30000 35000 40000 PIB per CAPITA (PPP) Dívida pública líquida (%PIB) FONTES: Banco Mundial, OECD e Banco Central. Coréia Austrália Noruega Nova Zelândia Dinamarca Reino Unido Países Baixos Finlândia Suéci França Alemanha Espanha Áustria Canadá Bélgica Itália Japão Estados Unidos Brasil

Fiscal reform: 

Fiscal reform Reduce public debt / GDP ratio: Sustain a high primary surplus Lower the cost of debt Restructure public spending to accommodate rise in public sector investment Reduce tax burden Social security reform Develop a medium-term fiscal framework that lowers political risk

Fiscal accounts: Lower public debt / GDP: 

Fiscal accounts: Lower public debt / GDP

Allow for a rise in public investment: 

Allow for a rise in public investment

Breakdown of Public Federal Expenditures (net of transfers to states and municipalities, % of GDP): 

Breakdown of Public Federal Expenditures (net of transfers to states and municipalities, % of GDP)

Size and composition of public social expenditures: 

Size and composition of public social expenditures

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Sources: OECD, MoF/Brazil and World Bank. Social security expenditures versus % population over 65

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Source: Ricardo Paes de Barros, 'O impacto de aumentos reais no salário mínimo sobre o grau de pobreza no Brasil', apresentação no Congresso Nacional, Brasília, Dezembro 2004.

Social security reform: 

Social security reform Minimum (sliding) retirement age for private sector Elimination of differences in eligibility requirements for men and women End of privileged retirement rules for teachers De-linking social security benefits from changes in minimum wage

Scenarios for social security and assistance expenditures (% of GDP): 

Scenarios for social security and assistance expenditures (% of GDP)

Trade liberalization: 

Trade liberalization Macro reasoning Raise exports Lower exchange rate and interest rate risk Increase power of monetary policy’s exchange rate channel Lower cost of capital goods Micro reasoning Greater competition in oligopolized sectors Greater product diversity Access to modern technology Easier negotiations with Mercosur partners

Sovereign credit ratings and trade flows (2002) : 

Sovereign credit ratings and trade flows (2002) Rating = 0.275+ 0.986 * (X+M) /PIB R2 = 0.42 (0.875) (0.175)

Credit ratings and ratio of external debt to exports of goods and non-factor services (2002) : 

Credit ratings and ratio of external debt to exports of goods and non-factor services (2002) Rating = 6.674 - 1.948 * DEL /X R2 = 0.95 (0.085)(0.070)

(Exports + Imports)/GDP (%, 2003): 

(Exports + Imports)/GDP (%, 2003) Brazil

Average nominal tariff (%, 2001-04): 

Average nominal tariff (%, 2001-04) Source: World Bank, WDI 2005.

Bureaucracy in foreign trade: Exports: 

Bureaucracy in foreign trade: Exports Source: World Bank, WDI 2005.

Bureaucracy in foreign trade: Imports: 

Bureaucracy in foreign trade: Imports Source: World Bank, WDI 2005.

An Agenda for Trade Policy: 

An Agenda for Trade Policy Cut tariffs, unilaterally if necessary Reduce discrepancy in protection and focus on more concentrated sectors Overhaul import and export bureaucratic controls Strengthen supporting technological institutions Align domestic and foreign product specifications and regulations Improve rail and port performance Support investment in distribution in export markets

Financial sector: Reforms: 

Financial sector: Reforms Price stabilization Greater openness to foreign financial institutions Improved bank supervision and regulation Privatization of state banks New bankruptcy law and credit information registries

Financial sector: outcomes: 

Financial sector: outcomes Domestic credit is scarce, expensive and concentrated on short maturities Pension funds, insurance companies and mutual funds invest mostly in public bonds Stock markets are smaller and less liquid than in Asian and industrialized countries Most firms and households finance themselves out of retained surpluses Impact of financial sector on growth (and equity) well below potential

Domestic credit to private sector (2003,% of GDP): 

Domestic credit to private sector (2003,% of GDP) Brazil (34,6%) Source: World Bank, WDI 2005.

Interest rate spreads (percentage points, 2003): 

Interest rate spreads (percentage points, 2003) Brazil (45.1%) Source: World Bank, WDI 2005.

Spread decomposition (%) : 

Spread decomposition (%) Source: Ana Costa and Márcio Nakane (2004), 'Revisitando a metodologia de decomposição do spread bancário no Brasil', paper presented at the seminar Economia Bancária e Crédito, Banco Central do Brasil.

Financial sector diagnosis: 

Financial sector diagnosis Incomplete macro adjustment raises interest rates, market volatility and jurisdictional uncertainty State role in mobilizing and allocating savings dampens the impact of financial intermediation on capital productivity There is insufficient competition among financial institutions High tax burden penalizes financial intermediation, encourages companies not to go public, and fosters fiddling with company accounts Information available to creditors and minority shareholders is very poor

Informal firms: Services considered important: 

Informal firms: Services considered important Source: IBGE.

Informal firms: Bookkeeping (%): 

Informal firms: Bookkeeping (%) Source: IBGE.

Financial sector diagnosis (cont.): 

Financial sector diagnosis (cont.) Legal and judicial protection to creditors and minority shareholders is weak Repossession of collateral is slow and uncertain Low protection against public and private expropriation raises the preference for short-term and liquid financial assets, discourages financial intermediation and raises the cost of capital Savers often either reinvest their savings or keep them abroad in safer jurisdictions

An agenda for the financial sector: 

An agenda for the financial sector Complete macroeconomic adjustment Reduce taxation on financial intermediation (and overall) Foster competition among financial institutions: Improve quality of information, facilitate repossession of collateral, give clear mandate to competition agencies Reform judicial procedures and educate judges Reduce role of the state in mobilizing and allocating financial savings

Informality: 

Informality High tax burden Complexity of tax system Labor market regulation: excessive employment protection and high social contribution charges Too much bureaucracy in business regulation

Tax rates as a major investment constraint: 

Tax rates as a major investment constraint Note: Measures the share of senior managers interviewed in World Bank–sponsored Investment Climate Surveys who ranked tax rates as a major or very severe investment constraint. Source: World Bank, WDI 2005.

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Note: Measures the effective tax that a medium size company must pay in the second year of operation (except for labor taxes) as well as time spent to comply with tax requirements. The total amount of taxes is the sum of all the different taxes payable after accounting for deductions and exemptions. The taxes withheld but not paid by the company are not included. Burdensome and complex tax system Source: Doing Business 2006.

Labor regulation as a major investment constraint: 

Labor regulation as a major investment constraint Note: Measures the share of senior managers interviewed in World Bank–sponsored Investment Climate Surveys who ranked labor regulations as a major or severe constraint. Source: World Bank, WDI 2005.

Labor market regulation: 

Labor market regulation Source: Juan BOTERO et al., 'The Regulation of Labor', NBER Working Paper No. 9756, 2003.

Average time spent on (in calendar days): 

Average time spent on (in calendar days) Source: Doing Business 2006. (*) Procedures required for a business in the construction industry to build a standardized warehouse. These include obtaining all necessary licenses and permits, completing all required notifications and inspections and submitting the relevant documents to the authorities. Doing Business also records procedures for obtaining utility connections, such as electricity, telephone, water and sewerage

Informal firms: Municipal or state license (%): 

Informal firms: Municipal or state license (%) Source: IBGE.

Jurisdictional uncertainty: 

Jurisdictional uncertainty The 'risk of acts of the Prince changing the value of contracts before or at the moment of their execution', which, as is the case with court rulings, 'manifests itself predominantly as an anti-saver and anti-creditor bias'. Raises risk, shortens maturities, increases the preference for liquid assets and encourages savers to keep their wealth in safer jurisdictions Discourages investment in transaction specific assets

Agenda to increase jurisdictional certainty: 

Agenda to increase jurisdictional certainty Reduce policy uncertainty Complete regulatory reform in infrastructure Strengthen regulatory agencies in infrastructure and financial markets Central Bank (formal) autonomy Reduce judicial activism Strengthen competition

Policy uncertainty as major investment constraint: 

Policy uncertainty as major investment constraint Note: Measures the share of senior managers interviewed in World Bank–sponsored Investment Climate Surveys who ranked economic and regulatory policy uncertainty as a major or very severe investment constraint Source: World Bank, WDI 2005.

Summing up: 

Summing up Low investment due to: High cost of capital Heavy taxation Substitution of current for capital spending in public sector High macro and jurisdictional risk New problems: higher taxes and weaker property rights (judicial activism, crime etc.) Structural and institutional reforms remain incomplete

Summing up: 

Summing up Macroeconomic adjustment remains critical Reforms are interconnected: complementarities and synergies are important (tax, judicial etc.) Politics matters Role of bureaucracies in fostering reform and developing institutional framework Can a mid-term reform framework play the coordination role expected from 'leaders'?