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World Cup Aside, Brazil's Economy Stinks

If Brazil wants to attain ambitious development goals, it needs radical reforms to its insular economy and inefficient public administration.

Not all is beautiful
Not all is beautiful


SAO PAULO — In late January, a mass of black foam — the result of untreated sewage — covered 800 kilometers of Brazil's coastline. It looked particularly shocking in Guanabara Bay, which has become an unfortunate receptacle for floating chairs and washing mashines. Some of the Brazilian and foreign sportsmen training there for the 2016 Olympics have complained about this, especially whenever they crash into such objects and sink. Others use their dexterity to avoid floating animal carcasses.

This lamentable spectacle outside Rio de Janeiro is a metaphor for the current state of Brazil itself. The pretty postcard picture of a dream country is, well, starting to stink.

Brazil's economy grew 2.3% last year — hardly breathtaking, especially considering which sectors fueled that growth. Farming grew 7%, and public investments, including state financing of housing projects, grew 6.3%. The Sao Paulo-Rio axis grew just 1.7%, much less than many other regions. The growth target this year is 2.5%, though analysts expect it to be closer to 1.9% and the IMF is forecasting 1.8%.

Why is this happening? Amid differing opinions about the causes, there is at least agreement over an increasing discrepancy between consumption, investment and the economy's overall productivity. At the consumption end, family debt has risen sharply. On average, families must devote 20% of their income to repayments and interest. Between 2008 and 2012, the greatest growth and investments were seen in raw materials (44.5% growth), health and social services (21.3%) and construction (20.5%).

One problem is that production costs remain high in Brazil, and many sectors are relatively isolated from global production chains. Overall investment is low outside the agro-industrial and oil sectors. The country's acquisition of factories, machinery infrastructures and housing, or improvements to them, was less than several neighboring countries in 2012.

The government of President Dilma Rousseff has sought to revive this with public work projects, but excessive regulations and bad incentives have made this a stop-and-start initiative. The effectiveness of infrastructure investments varies wildly between sectors in Brazil, as the state of Guanabara Bay shows.

More filth than money

A $1 billion water cleaning project began in 1992. Two decades later, the job wasn't finished, but the money was gone. Authorities promised that 80% of waste water would be treated by the time the Olympic Games began. Two years before the deadline, that plan is only about 30% complete, and it will require another $824 million.

The state of the semi-public energy company Petrobras seems to be another reflection of the state of Brazil. Its shares are worth half what their price was in 2009, and it has become the world's most indebted oil firm, owing $144 billion in late 2013. Its debt has grown 64% under Rousseff, even if its investment plans, at $237 billion, are the largest for any company of its kind. Its potential is huge, but government interventions and its use as an anchor against inflation have harmed its profits and threatened its investment rating.

It would be difficult to find anyone who wishes Brazil ill, and yet it hobbles. The recipe needs to change. The political cycle begun in 2002 by former President Lula da Silva is ending. The country deserves credit for the beneficial growth of the middle class and inclusion of the poor through the Bolsa Familia plan, which has not been a drag on growth. Total social expenditures, however, are very high — 23.5% of GDP in 2011-12, and not sustainable in the long run. Pensions alone cost 12% of GDP, and Brazil's population is aging.

Brazilian society, politics and the economy need rebooting. Tax reform is desperately needed, as is pension reform, a military police overhaul and some reform of the vast, aged prison system. Polls indicate Rousseff is likely win the next presidential election in the second round. The lowest unemployment rate in 50 years (4.7%) makes a turnaround unlikely. Neither she nor her rival Aecio Neves has promised a change of direction. The only notable changes Neves has promised are a vigorous shift toward the free-market-oriented Pacific Alliance, forcing public firms to present results without losses, and boosting investment in education to 10% of GDP (from the current 5.5%).

Brazil needs more than this if it wants to recover growth rates that bring development closer, and to achieve complex but not impossible goals — like cleaning up the sewage-infested Guanabara Bay.

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