From The Economist print edition
The biggest enemy of Brazil's promise is an overbearing state
IN 2002 Caio Mesquita and Marcelo Ferraz quit jobs in finance and publishing respectively to start Wraps, purveyors of "healthy and tasty" meals at seven restaurants across São Paulo. Sometimes they wonder why. Their competitors evade taxes (one trick is to put individual eateries in the names of friends and relatives to qualify for small-business tax breaks). The labour laws, they say, "are almost impossible to comply with" (although they do): people who wash dishes are not allowed to clean tables, and vice versa. Of the seven staff in Wraps' corporate headquarters, two do nothing but ward off lawsuits from former employees. The readers of water and electricity meters sought bribes to cut their bills. A policeman who came to investigate a robbery was more interested in selling his private security service. "I felt like I was in Baghdad," says Mr Ferraz.
To experience the state as meddlesome, covetous, inefficient and corrupt is no rarity in Brazil, and no novelty either. Marcos Fernandes of the Fundação Getulio Vargas, a business school, traces the origin of a "rent-seeking state" to 1808, when Napoleon chased Portugal's royal family to Brazil. Mussolini helped inspire the Estado Novo of President Getúlio Vargas in 1937, whose system of labour and industrial syndicates is the basis of today's labour relations. The 1988 constitution was politically liberating but economically stifling. Indeed, Brazil's modest growth is a triumph over state-sponsored adversity.
The Brazilian formula is to crowd out enterprise or drive it underground with excessive spending and taxation, then to harass it further with capricious, nonsensical regulation. Last year the state's tax take set another in a series of records, at 35% of GDP, much higher than the average of its developing-country peers (see chart 3). No surprise, then, that the grey market accounts for a much higher proportion of the economy than in Mexico, China or India, according to the International Finance Corporation ( IFC), part of the World Bank. Informal firms underinvest and weaken their formal-sector competitors. McKinsey, a consultancy, thinks this is the biggest drag on productivity. Infrastructure investment, now shy of 2% of GDP, should be at least 3%. To match South Korea's infrastructure Brazil would have to treble that, according to the World Bank. Despite its free-spending ways, the state cannot afford to do that, yet it has discouraged the private sector from filling the gap. Overall investment, though growing, is an underpowered 16.7% of GDP.
| | |
 | |
The political left blames the central bank for keeping interest rates high. But most of the responsibility lies with the state's excesses, which have built up a net public debt running at 45% of GDP and are now stoking demand while restraining supply. The solutions lie in a long to-do list of reforms which has been around for years without making much headway. The tax system, pensions and labour laws are all in need of redesign; trade needs to be liberalised further; spending should be more flexible; and the central bank should be given formal autonomy (in practice it gets a free hand to hit inflation targets).
All this is part of a more ambitious project that is not on the political agenda: a thorough review of the role of the state, which would reconsider how it taxes and spends, how it makes and enforces rules and to what extent it should be directly involved in finance and infrastructure.
Apart from debt service, the federal government spends its money mainly on three things: pensions, transfers to lower levels of government and its own bureaucracy. In none of these areas is spending efficient or equitable. Take pensions. Brazil is a young country with the pension costs of an old one. With 6% of its population over the age of 65, Brazil spends 11% of its GDP on publicly financed pensions. A big chunk of this goes to workers in the formal sector, who can retire after contributing to the system for 35 years (30 for women) regardless of their age. More than 60% of workers who benefit from this scheme retire by the age of 54. Besides Brazil, only a few big oil-exporting countries have such an indulgent system, says Fabio Giambiagi of IPEA, a think-tank with links to the government. In his second term as president Mr Cardoso tweaked the rules to discourage early retirement, but that provoked an explosion of claims for disability benefits, which trebled between 2001 and 2005.
Two-thirds of all pensions pay out the equivalent of the minimum salary (now 380 reais a month), which has doubled in real value since 1994. Many of these go to beneficiaries who have not paid into the system. This encourages people to work in the informal sector, because if they will get that pension anyway they have no incentive to contribute. Demographers have noticed an unusual upsurge in marriages between pensioners and much younger partners in the countryside, probably provoked by this benefit. Spending on pensions in the private sector has risen from below 6% of GDP in 1996 to 8% now.
On top of that comes the cost of public servants' pensions, which is about half that of the private-sector scheme but benefits a group of people only one-eighth the size. One of the Lula government's first—and bravest—acts was to raise the minimum retirement age for public servants and to tax people on high earnings who had previously retired with a pay rise.
| | |
 | |
The federal government's second big task is to transfer revenue raised primarily in the rich states of the south-east to state and municipal governments mainly in poorer states. These transfers more than doubled in real terms between 1995 and 2004. Such redistribution is justified by Brazil's regional inequalities, which persist despite the spread of industry beyond its São Paulo heartland. Average income in the north-east is only two-fifths that in the south-east.
Transfers play an important part in holding the country together; they are "why we don't have separatism", says José Roberto Afonso, a specialist in public finance. But the money, spent mainly on health, education and administration, rains down on 27 states and 5,564 districts that differ vastly in their capacity to spend it well. Despite the redistributive intent, some of the criteria applied militate against justice and efficiency. Brazil's federal system makes no distinction between forested provinces and the metropolis of São Paulo with its population of 10.8m. "Every municipality has competence to do everything, which is absurd," says Raquel Rolnik, the national urban secretary. "Most don't have capacity." More than half rely for most of their revenue on transfers from federal and state government.
Revenue without responsibility is a bad idea. The more that municipalities depend on transfers, the more they spend on administration and the less they invest in infrastucture and social programmes. States that get a lot of their revenue from the central government pay bureaucrats more relative to private-sector workers. A minimum grant for municipalities was supposed to help the poorer ones, but also encouraged hundreds of them to break themselves up into smaller and less efficient units. It also disproportionately benefited the rich south and south-east, which has most of the smaller districts. The constitution stipulates that health spending must rise with GDP, guaranteeing that much of it will be wasted.
The bureaucracy, the third big spending category, is neither lean nor agile. On average, public servants earn more than twice as much as workers in the private sector and have an easier life. The constitution protects them from dismissal. Merit tends to be measured by the number of training courses they have attended rather than by their competence. Some 20,000 federal jobs are filled by political appointees. Nelson Marconi, of the Fundação Getulio Vargas, believes that public employment could "easily" be slashed by 30% without making services worse.
Successive governments have, in effect, built a fiscal escalator that mainly goes up. Presidents can, and often do, speed its ascent, for example by raising the minimum wage, but have enormous trouble slowing it down. Financial catastrophe has been avoided by raising taxes and squeezing investment. But, says Raul Velloso, an expert on public finance, investment has a floor and taxation a ceiling. The government's "growth acceleration package", announced in January, tries harder to lift investment than to lower taxes, and allows for the possibility of a lower primary surplus to pay for it. That can work as long as interest rates are falling. But if the balmy financial weather changes, the government will face hard choices.
What Brazil loses in efficiency it does not gain in poverty alleviation. Because most revenue comes from consumption taxes, a Brazilian earning less than twice the minimum wage pays out nearly half his income in tax, whereas someone on 30 times the minimum wage pays only about a quarter in tax. Such benefits as pensions and free tuition at public universities flow disproportionately to the well-off. In a recent study comparing the redistributive effects of taxation and spending in 16 countries, most of them rich, Brazil came last by a long way.
Government bureaucracy can be damaging too. In a league table of the ease of doing business in 175 countries, the IFC ranked Brazil 121st. The average firm takes 2,600 hours to process its taxes, a world record. Opening a business, on average, requires 17 procedures and 152 days, putting Brazil in 115th place. Hiring people is expensive because taxes add 60% to salaries and workplace rules are an invitation to conflict. At Unibanco, a big private-sector bank, the turnstiles are programmed to keep workers out of the building until a minute after their allotted lunch hour; a minute too soon and they could demand extra pay. Despite such precautions, the banking sector alone is embroiled in 160,000 cases in the labour courts, which are faced with a total of 2m new cases a year. The solution? "Try to have as few people as you can," says Pedro Moreira Salles, the bank's boss.
Investing in infrastructure is a legal and regulatory adventure. Investors do not trust the supposedly independent regulatory agencies. Brazil's finance minister, Guido Mantega, insists that "it's not true that the government is hostile to regulatory agencies." But the World Bank maintains that "the majority of the agencies do not have full autonomy and are subject to interference from other [government] organs." Courts can delay projects for years at the behest of angry environmentalists or disappointed bidders. "It always takes twice as long as you estimate to implement an infrastructure project in Brazil," says one financier.
Brazilians yearn for a state that behaves like the servant of its citizens. Raymundo Magliano, the president of the São Paulo stock exchange, ended a recent interview by recalling a trip to the Antipodes, where bureaucrats in New Zealand have no job security and the tour guide at the parliament in Canberra knows exactly how much the institution costs each Australian citizen. Brazil is not ready for that. Too many lobbies have an interest in keeping the system as it is.
Despite the grumbling, there have been some successes. Judicial reform was "one of the few that advanced", says Joaquim Falcão, a member of a council newly created to oversee the judiciary. It cracked down on nepotism, resulting in "thousands" of dismissals over the past two years. The súmula vinculante, a new mechanism under which lower courts have to follow the Supreme Court's decisions, will strip "millions of cases" out of the clogged court system, Mr Falcão predicts. State governments are speeding up procedures for opening businesses. The federal government recently ended the monopoly of the state-owned reinsurance underwriter. A new regulatory framework for sanitation should encourage private investment.
Lula's critics indict him as a lucky bumbler who may have kept Brazil out of trouble but has done nothing to improve its prospects. That is not entirely true. But his second term may be less productive than his first. His main economic initiative aims to simplify an incredibly cumbersome system of state-based sales taxes, laying the groundwork for a national value-added tax. That would be wonderful, but it depends on the government buying off the potential losers. The government has started to tackle fraud in the pension system and has created a forum with business and labour representatives to deal with knottier pension problems, but this looks more like a device for avoiding the issue. Other high-profile plans, such as labour-market reform and central-bank autonomy, seem to be off the agenda. Dilma Rousseff, Lula's chief of staff, describes the growth acceleration package as "public money direct to the vein." That, not reform, is the government's passion.
In spite of everything, Wraps is prospering. It is talking to a German entrepreneur about opening a branch in Frankfurt. Its habit of paying taxes and obeying the rules is making Wraps attractive to private-equity funds. Last year the chain's profits exceeded the return on investing in government bonds. That is big news.
