Luíz Inácio “Lula” da Silva won the presidency of Brazil on his fourth attempt, in an overwhelming victory in October 2002. His Workers’ Party (PT) ushered in a new era for the country’s previously disenfranchised majority, with the economy from 2004 to 2010 more than doubling its rate of growth of the previous 23 years. Poverty declined by 55 percent and extreme poverty by 65 percent from 2003 to 2012. Unemployment hit record lows, the real (inflation adjusted) minimum wage doubled, and the gains from growth were more equally distributed than in previous decades.
A large majority of Brazilians are still vastly better off today than they were before the PT came to power. But the economy slowed sharply from 2011 to 2014, with GDP growth returning to the rates of the pre-PT era. Job creation in the formal sector — regular employment covered by taxes and legal benefits, as opposed to the underground economy — fell from an average of 1.46 million jobs annually for 2004 through 2010 to just 829,000 for 2011 to 2014 and just 152,000 in 2014. Economic growth was about zero last year and will turn negative this year.
Approval ratings for Lula’s successor, Dilma Rousseff, have plummeted, and most of the news about Brazil is woefully pessimistic — corruption scandals, including one involving the state-run oil company, Petrobras; Standard and Poor’s lowering its outlook for the country’s bond rating after downgrading it to one notch above junk; the real falling about 35 percent against the U.S. dollar over the past year.
What went wrong? Many analysts have blamed external conditions. The growth of the world economy and trade plummeted after 2010, and the price of Brazil’s commodity exports also fell. However, as Brazilian economists Franklin Serrano and Ricardo Summa explain in a new paper on the slowdown, this is only a relatively small part of the story. Brazil’s exports are not that big a part of its economy and didn’t change that much — from 11.9 percent (2004 to 2010) to 11.3 percent (2011 to 2014).
The problem is that on top of the worsening external conditions, the government piled a series of policy decisions that weakened the economy. Beginning in February 2010, the Central Bank began to raise short-term interest rates, from 8.5 to 12.5 percent the following August, just as the economy was slowing. (This rate, called the Selic rate in Brazil, is analogous to the U.S. Federal Reserve’s benchmark federal funds rate, which has remained at 0 to 0.25 percent since December 2008). The government tightened consumer credit, which had expanded considerably in the previous years. Some of these measures were reversed the next year, with interest rates coming back down, to 7.5 percent in October 2012, but the changes were too little and too late.
Then the government began another cycle of raising interest rates in April 2013, which has continued through last week, with the Selic rate at 14.25 percent — one of the highest in the world — in spite of the forecast recession for this year. Beginning in 2011, the government tightened its fiscal policy — for example, by cutting public investment by 18 percent in real terms.
Not surprisingly, these policy changes sent private investment and consumer spending plummeting. Although the government threw a lot of money at private investors in the form of tax breaks and public-private partnerships for infrastructure, most investors aren’t attracted by an economy in which the growth of disposable income and consumer spending is plummeting.
Unfortunately, Brazil hasn’t even gotten the benefit of lower inflation from the slowing economy: Its consumer price index is rising at a 9.25 percent annual rate. This is partly due to the fall in the real, which raises the price of imports, and a steep rise in government-set electricity prices. The increase in inflation has eroded real wages and has been seized on by the opposition, some of whom have called for Rousseff’s impeachment — although there is no legal or constitutional basis for doing so.
How can Brazil get out of this mess? The private sector clearly cannot lead an economic recovery at this time, any more than it can in Greece. The government is going to have to create the climate for increased private investment and consumption the way it did before 2011, by increasing its spending, especially on public investment in badly needed infrastructure.
One way to free up money for this is to lower Brazil’s debt service. The Brazilian government is spending more than 6 percent of its GDP — about 20 percent of its national budget — on net interest payments. This is one of the highest rates of debt service in the world. The International Monetary Fund has pointed out that this “exceed[s] the typical volume of spending on education.” There is absolutely no sane reason for this, and it is relatively easy to change by simply lowering the Selic rate to a level comparable to those of the rest of the Americas.
The cripplingly high interest rates that the Brazilian Central Bank maintains, for long periods, are a plague on the whole economy. They set a floor for exorbitant rates of return that investors expect for productive investment, contributing to Brazil’s highly unequal distribution of income — one of the worst in the world.
Brazil has $369 billion in reserves and is not yet facing any external financial constraints. There is no reason to let Brazil’s powerful domestic financial sector determine policy for the government. Rousseff was re-elected last year on a program of standing up to the oligarchs and continuing the economic and social progress that the PT delivered in prior years. Instead, she gave them more of what they wanted, and their program has clearly wrecked the economy. Now it’s time to get back to what Brazilians voted for.