Sunday, June 15th, 2014

Is Brazil Still the Country of the Future?

Not long ago, Brazil was riding high. It was feted as one of the “BRIC” nations destined to be the next world economic powers. The commodities boom had its natural resources and agricultural sectors humming. The press – for example, Monocle magazine’s swooning over Brazil’s push to boost its diplomatic presence – was adoring. And Rio was awarded the 2014 World Cup and the 2016 Olympics, two events that were intended to both serve as a catalyst for further development, and also as a coming out party of sorts for the country.

The World Cup is underway, but otherwise things haven’t quite worked out as Brazil thought they would. The average citizen of the country is upset at the vast sums being spent on international events that don’t benefit them. The last two years have featured riots, strikes, and various other expressions of unrest. Economic growth in the country has collapsed. In a special section last September, the Economist asked, “Has Brazil Blown It?

Late last month the McKinsey Global Institute issued a major report on the country called “Connecting Brazil to the World: A Path to Inclusive Growth.” At 104 pages, it’s massive, but a must read for anybody interested in South America’s giant.

And it’s a somewhat depressing read as well. Though there are immense strengths and opportunities for the future, Brazil has big problems too, most of them longstanding, and which hobble its aspirations.

Brazil is the 7th largest economy in the world and the 7th leading destination for foreign direct investment. But it’s 95th in per capita GDP, 114th in the quality of its infrastructure, and 124th in its level of ease in trading across borders. Its export sector is also heavily commodity dependent, particularly oil. Ranked only 43rd in global connectedness on McKinsey’s index, they estimate a potential boost of 1.25% (presumably percentage points) to annual GDP growth from improvements on that measure alone.

Three particular items jumped out at me from the study. One is the “custo Brasil” – the Brazil cost, so notorious it gets its own Wikipedia entry. A variety of factors from bureaucracy to the tax regime to an uncertain legal climate, poor infrastructure, crime, and corruption make the cost of doing business in Brazil very pricey indeed.

The second is the very low rate of investment in the economy. Brazil’s gross investment rate as a percentage of GDP is 18%, compared with 26% in Chile, 29% in Mexico, 40% in India, and 49% in China. Conversely, government consumption is at 22% in Brazil vs. 12% in Chile and Mexico, 13% in India, and 14% in China. Private consumption is similar in the countries except for China, which is notably lower. This probably helps explain the poor state of the infrastructure in the country.

The third is something I have personal experience with, namely protectionist trade barriers designed to create and sustain domestic industries in sectors like autos and computers. I suspect these rules were modeled on Japan, and more lately China, which used rules and business practices to build successful local champions. But in Brazil this has rendered its industry sclerotic. In effect, cars sold in Brazil have to be made in Brazil, ditto for computers, etc. This is where my personal experience comes in. When we were doing global PC procurement, Brazil was always a special case and our vendors had to have special Brazil made PCs for domestic use. This may not be an actual rule, but tariffs produce a de facto barrier. While this technique may have worked in Japan, it’s clear that it failed in Brazil. As the exception that proves the rule, McKinsey uses the example of regional jet manufacturer Embraer as a counterfactual. That company was privatized and opened to global competition. The result is that its got tough itself and is now an industrial champion for Brazil.

There are tons of statistics in the study that are worth scanning just to see. Brazil is consistently benchmarked against Chile and Mexico in Latin America, as well as fellow BRICs India and China. The comparisons aren’t pretty.

Reading a lot about the country in the last year, I put its problems into three categories: poor governance, geographic disadvantage, and scale disadvantage.

1. Poor Governance
Most of the issues pointed out by McKinsey fall squarely under the heading of poor governance. The contrast with nearby Chile could not be more plain across every dimension: corruption, the rule of law, investment, public sector debt, tax burden, infrastructure, regulation, etc.

Latin America seems to prefer two sorts of governments these days. One is a right wing nationalist heir to the military juntas of the past, best exemplified by the Kirchner regime in Argentina. The other are left wing populist-nationalist movements like Venezuela that tend to feature a streak of anti-Americanism. Both of these have produced pitiful results.

Brazil is a sort of lite version of the latter. Lula da Silva was a charismatic labor activist who led strikes and was jailed by the previous military dictatorship in his youth. Post-democratization, he went into politics. After moderating some of his more radical views, he was elected president on a reform agenda. While he had some success and was arguably and improvement on his predecessors, he ultimately failed to deliver on material changes in governance. His hand picked successor Dilma Rousseff has not been as effective and is in an electoral struggle for another term.

In line with the nationalist streak of this governing type, one of Da Silva’s primary concerns was Brazil’s amour-propre. As one of the world’s largest countries, he found it self-evident that Brazil should be treated as a great power. He lobbied for Brazil to have a permanent seat on the UN Security Council. He and others responded in kind to any affront to the nation’s pride, such as requiring American and only American visitors to be finger printed after the US imposed a fingerprinting requirement on foreign visitors. He sought out diplomatic coups where ever he could find them, which included cozying up to unsavory characters like Mahmoud Ahmadinejad who thinks Israel should be destroyed and that Iran has no gays (presumably because he has them executed when he can find them).

Da Silva forgot that there’s more to being a great power than being a big country – you’ve got to earn it. And as a very popular politician he did not seize his moment of opportunity to truly grasp the nettle of reform.

Meanwhile nearby Chile is one of the Latin American governments that’s followed a different model. It’s been run by center-left governments more or less the entire time since the restoration of democracy, and they’ve delivered on a good governance model that has taken them to effectively developed country status. Chile is now even a member of the OECD. Chile is basically the Minnesota of Latin America, and the results demonstrate it. This should show Brazil the size of the prize if the get their act together.

2. Geographic Disadvantage
Brazil is simply a long way from major developed markets. This puts it at a geographic disadvantage versus many other countries. Current airplanes cannot make a non-stop flight from Brazil to East Asia, arguably the most important emerging part of the world. It’s even a long haul from the United States, with relatively few gateway cities vs. say major European capitals. Brazil is time-zone advantaged with the US, however. It also speaks Portuguese instead of Spanish, which imposes a linguistic handicap.

3. Scale Disadvantage
Brazil is a big country, geographically and in population. Size can be an advantage, but it also makes reform difficult as it’s hard to turn a battleship. Brazil’s population of 200 million is more than ten times that of Chile.

Brazil’s two principal cities, São Paulo and Rio de Janeiro, are also megacities. São Paulo in particular is huge, and at north of 20 million people (more than the entire country of Chile) is the 10th largest city in the world. I recently wrote that it’s unlikely the world’s emerging megacities will turn the corner in eliminating dysfunction. Their problems are just too huge and their national growth rate too low. Though I’d consider this more hypothesis than conclusion at this point, my rule of thumb is that a megacity can only achieve escape velocity from pervasive dysfunction if they are a major city in a country that is the world’s current rising economic (or historically imperial) power.

Brazil is not that country, and two mega cities will be a drag on growth. Although São Paulo is an important emerging global city – 23rd in the world in a forthcoming report I helped create – I’m told that both São Paulo and Rio are growing more slowly than secondary cities in the country. A previous McKinsey study threw cold water on the idea that megacities are an advantage, noting their under performance by saying:

It is a common misperception that megacities have been driving global growth for the past 15 years. In fact, most have not grown faster than their host economies, and MGI expects this trend to continue. Today’s 23 megacities—with populations of 10 million or more—will contribute about 10 percent of global growth to 2025, below their 14 percent share of global GDP.

In contrast, 577 middleweights—cities with populations of between 150,000 and 10 million, are seen contributing more than half of global growth to 2025, gaining share from today’s megacities.

So I’m not surprised that it’s Curitiba, not one of the megacities, that’s where the innovative BRT revolution was begun. If I were looking to invest in Brazil, I’d be looking at this next tier of cities. Nor is it surprising that Santiago, Chile (population 5.4 million) has had great success in modernizing given its more moderate size.

Plain and simple the degree of difficulty is higher in Brazil because of the size.

Brazil is also a very racially diverse country with a number of challenges resulting from its history of oppression. Brazil had more slaves than any other country in the world and was the last New World colony/nation to abolish it. If slave reparations are on the agenda in the United States, how much more so similar issues in Brazil? Again, contrast with Chile, which never had very many slaves and abolished slavery in 1818. With the exception of a relatively few indigenous peoples on reservations, Chileans largely perceive themselves as ethnically homogenous, though with some skin tone based status (moderately sized…historically racially homogenous…Minnesota?)

Which is to say that it’s tough to entirely fault Brazil for not living up to the example of Chile. Its degree of difficulty is much higher. And its geography hamstrings its global interaction.

Nevertheless, solving the governance challenges to address the real issues Brazil faces remains the top agenda item. McKinsey has laid out a number of good suggestions, the real question is whether or not Brazil’s socio-political system can produce the ability to implement them.

7 Comments
Topics: Demographic Analysis, Economic Development, Globalization, Strategic Planning, Sustainability, Transportation, Urban Culture
Cities: Rio de Janeiro, São Paulo

7 Responses to “Is Brazil Still the Country of the Future?”

  1. Josh Lapp says:

    Slightly off topic, but it is sad to me to see the state of affairs that brings FIFA & IOC to award the games to corrupt and inefficient host countries that make a mockery of the stature of these events.

    Sochi Olympics, Brazil WC, Rio Olympics, Russia WC, Qatar WC. The last two were clearly bought with bribes and paid for with money that could have been invested in infrastructure, education, ect. Rio can’t even clear the trash out of the water of Copacabana. I personally couldn’t even travel to the last two for fear of ending up in prison. Obviously this is coming from an American perspective, but I believe it is valid one nonetheless.

  2. Brazil has some of the worst income inequality in the world, especially considering its size. I won’t pretend to know enough about the country to speak on the reasons for this, but it seems to be a factor in many of their problems. The economic malaise caused by a huge underclass of people with few opportunities or spending power, the resulting crime targeted at the more wealthy, and a highly fractured and polarized society with very visible haves and have-nots doesn’t bode well future prosperity. It certainly hasn’t helped them so far. Sadly the USA seems to be racing at breakneck speed towards the exact same situation.

  3. Alon Levy says:

    I think you’re deeply misunderstanding Latin American politics and society here; at several spots, you’re analyzing Brazil too much like an American.

    First, the following paragraph is extremely wrong:

    Latin America seems to prefer two sorts of governments these days. One is a right wing nationalist heir to the military juntas of the past, best exemplified by the Kirchner regime in Argentina. The other are left wing populist-nationalist movements like Venezuela that tend to feature a streak of anti-Americanism. Both of these have produced pitiful results.

    The Kirchners are actually left-wing populist-nationalists: Kirchner himself wanted the Justicialists to join the Socialist International. If you want a right-wing nationalist example, Colombia’s Uribe actually was right-wing. But on top of those two sorts of political movements, there are non-populist social democrats; both Chile and Brazil’s recent governments have been of this form, and Argentina is really an intermediate between Chilean or Brazilian social democracy and Venezuelan, Ecuadorian, and Bolivian populism.

    In both Chile and Brazil, there were major efforts to reduce poverty. In neither was there any wave of nationalization, unlike in Venezuela. Argentina is again a hybrid case – populist monetary policy, but no nationalization. In Brazil, Bolsa Familia and Fome Zero are generally considered successes. Brazil’s poverty is down. Its inequality is also down, although that’s also true of nearly all Latin American countries, even ones under right-wing governments.

    Lula’s foreign policy is where you start erring by analyzing it like an American and not like a Brazilian. Of course Americans find him offensive: he wants the US to have less power than it does. So do most people who aren’t American. In Latin America he is a consensus figure rather than a polarizing figure, to the point that in Venezuela, the right-wing opponent of Maduro said that he favored an economic program like that of Lula. (Lula endorsed Maduro anyway.) It’s wrong to conflate him with Chavez, who went for polarization.

    The real reason Brazil’s getting negative press is that the favela protests suddenly reminded people that Brazil still has huge problems with poverty and police brutality. Previously, Brazil was basically the consensus country that everyone could find something promising about. Suddenly, people noticed that its economic growth was never all that great. That is what the recent political risk is all about; it’s not about fingerprinting Americans – after all, nobody says that the US is introducing political risk by fingerprinting foreigners.

    What you say about megacities is flawed in terms of pure economics. The reason megacities aren’t going to grow much is that at the current stage of development of developing countries, including China and India, they’re so much wealthier than the rest of their respective countries that future growth is going to reduce their advantage. This was true historically as well – Shanghai’s GDP per capita went from 6.52 times as high as the Chinese average in 1978 to 2.13 in 2013, Beijing’s went down from 3.3 to 2.2, and Tianjin’s went down to 2.97 to 2.33. Meanwhile, the non-city coastal provinces from Guangdong to Shandong all saw large increases, creating a new megaregion around Guangzhou and Shenzhen in the process, which like Shanghai and Beijing can only go down in relative terms. None of this means that very large cities are a weakness in terms of future overall growth, or in terms of national growth. In fact, in Latin America, Argentina has had very fast growth since 2000, even faster than Chile; Buenos Aires is a megacity. Going back a couple decades, Seoul, Osaka, and Tokyo were all megacities as well.

    The last Americanism is your take on race in Brazil. Brazil doesn’t have the same white/black division as in the US. Historically it did, but there’s much more intermixing in Brazil than in the US, and American-style segregation simply did not exist. There’s an entire ethnic identity in Brazil, Pardo (i.e. brown), that comes from racial mixture, and is a near-majority of the population.

    In Chile, your take on racial demography is even wronger – Chile has a bare white majority, with a large minority identifying as mestizo; it is far from homogeneous. In Latin America, the whiter areas – Argentina, Uruguay, southern Brazil, Venezuela, Cuba – were the ones that could attract European immigrants from the late 19th century to the middle of the 20th. Everywhere in Latin America, the white elites wanted to encourage European immigration, but they were only successful in areas that were richer than Southern Europe and had an Atlantic coast. This created a whiteness-wealth correlation that plenty of racists think is causal in the wrong direction, where in reality it was the wealth that allowed those countries to become whiter in the first place.

  4. Brian M says:

    Alon: THanks for the information! Have to admit that as an American I had assumed that Chile was mostly “white” (whatever that means)…partly because except for remnant Maipo populations the natives were largely wiped out.

    Interesting history.

  5. ARC says:

    Alon: You’re not joking when you say you “prefer cross-national comparisons” on your blog. You put into words a lot of things I have been feeling about this and the previous article.

  6. Alon, appreciate the comments. A few things.

    I’ve only really had personal experience with Argentina, where I had a team of people working for me. BA is one of my favorite cities. I’ve read that the Kirchners are considered left-wing Peronism, but they don’t seem to behave like left-wingers to me and it looks like there are more people to the left than to the right of them in opposition. Their populism seems entirely opportunistic compared to say Evo Morales type people.

    I would not say race in Brazil is exactly like that in the US by any means. But Brazil is a racially complex country and its history clearly complicates development.

    With Chile, I think I said “perceive themselves.” My reading is that Chileans have a fairly homogenous self-identity. See this, for example: http://countrystudies.us/chile/38.htm Are there some racial divisions there I haven’t heard about? I think I noted their center-left government.

    The issue with Da Silva is not that he’s polarizing, it’s that his nationalist conception of Brazil as a great power led him to make this push for the global trappings of that and he took his eye off the ball closer to home on development.

  7. Alon Levy says:

    Kirchner’s policies included investment in social security and education, a repudiation of the IMF’s preferred economic policies, and prosecution of military officers who committed war crimes in the junta years. Indeed there are people to his left, but he was very much a leftist. His policies weren’t even that different from those of Lula and Bachelet, he was just more personally polarizing like Chavez.

    What you say about Lula is still not really true; you’re focusing on his style more than his actual policies, which were largely identical to Bachelet’s. The worst trapping of a country that’s too concerned about geopolitics is high military spending. Lula actually slightly reduced Brazil’s military spending, which was already lower than Chile’s (link). Of course, the US spends more on the military as a percentage of GDP than any Latin American country… but this is never taken to be an example of political risk or of how the US cares too much about being a great power and too little about its own economic development.

    Finally, when asked about their ethnic self-description, Chileans are split between those who say white and those who say mestizo (plus the smaller indigenous minority). They may not perceive themselves as as heterogeneous as Brazil, but they don’t all have the same self-perception, either.

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