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The Lula Years

SAO PAULO – A recent article in a Brazilian newspaper described a day in the life of President Luiz Inácio Lula da Silva as he campaigns in the October election that will choose his successor. Lula’s day started before sunrise at the gates of an automobile plant in São Bernardo do Campo, part of Sao Paulo’s industrial belt, where he rose to prominence as a union leader defying the military dictatorship 30 years ago.

The purpose of Lula’s visit was to support his personally appointed presidential candidate, Dilma Rousseff, who was formerly his chief of staff and the main architect of the government’s investment program, designed in 2007 to accelerate growth. Later that day, Lula met with infrastructure industrialists in a luxury downtown hotel. He addressed them as “fellows,” just as he had done a few hours before with the autoworkers.

Brazil’s bosses are cheering as loudly as its trade unionists for Lula nowadays, which is no surprise given the huge sums being spent on infrastructure, owing to massive public spending, the lavish capital-expenditure program of Petrobras, Brazil’s state oil company, and credits provided by state-owned banks to low-income housing.

But Lula’s popularity reflects his political skill as much as the success of his social and economic program. His government can claim to have reduced poverty from 35% to 22% of the population, and also to have maintained a trend towards lower inequality, with the Gini coefficient – a 0-1 scale of wealth concentration – declining from 0.583 in 2003 to 0.548 in 2008.

Poor people have had their incomes complemented with a monthly allowance under a conditional cash-transfer program called “Bolsa Familia,” which now reaches more than 12 million households. In the same vein, pensioners’ real incomes increased more than 30% on average over the past eight years, reflecting aggressive minimum-wage increases.

Brazil’s economic success during the Lula years stems from the decision to maintain the previous government’s macroeconomic policy framework, which meant resisting more radical views within Lula’s Workers Party’s. Success grew partly from confidence-building in the first years, but also owes much to the favorable international environment up to 2008. China, with its huge demand for Brazilian commodities, was a key factor here. Brazil’s terms of trade are now 18% higher than in 2002.

During Lula’s tenure, growth accelerated relative to previous periods, and inflation was kept within its targets for most of the time, though it remains slightly higher than elsewhere. But this year’s 7% growth rate, which puts Brazil nearly on par with China and India, cannot be sustained, as it exceeds potential growth by a wide margin. Consumption is being spurred by record-low unemployment rates, below 7%, and by credit growth, which has doubled, from 22% to 45% of GDP, between 2002 and 2010.

But, even if Brazil cannot keep growing as fast as China, it still looks likely to race ahead. Investment growth has resumed its pre-crisis record pace but, at 19% of GDP, investment remains far too low to support higher sustained growth. Balance-of-payments disequilibria have been eliminated in the past decade, but threaten to resurface if demand continues to outpace output growth.

In the short term, however, financing should not be a problem: foreign-exchange reserves have reached more than $250 billion; foreign direct investment, which has fallen elsewhere, still looks promising. World monetary conditions seem to point to a protracted period of high liquidity and low international interest rates. In Brazil, the basic real interest rate hovers around 5-6% per year, the lowest level since Brazil introduced the modern real in 1994 (yet still among the highest in the world).

Domestic savings, however, remain a major constraint. Fiscal austerity helped to reverse the rising trend in public debt, and then reduced it to more manageable levels (debt nonetheless remains comparatively high). The tax burden has increased by ten percentage points of GDP in 15 years, to a level (35%) that puts Brazil at odds with countries with similar per capita income levels.

Earmarking of taxes caused current expenditures (especially on social-security benefits) to increase along with revenues, reducing the scope for a higher public-sector contribution to domestic savings. A recent decline in primary surpluses has added to the problem. Over the longer term, population aging represents a major challenge for a social-security system that already spends, as a share of GDP, as much as developed countries, where the share of the population 65 and over is twice that of Brazil.

Although public investment has been on the rise, the country’s poor infrastructure remains a barrier to higher growth. So, too, are frequent changes of rules and weakening of regulatory agencies, reflecting a disregard for stability and the consequent need to strengthen the country’s institutional framework.

Moreover, state intervention is on the rise, a trend marked by greater reliance on public banks, especially BNDES, to support investment at subsidized interest rates. Long-term productivity growth, however, depends on educational improvements, adequate provision of public goods and infrastructure, and a healthy business environment that stimulates entrepreneurship and innovation. That means, in part, reforming a tax system that is widely perceived to be a source of inefficiencies and distortions that penalize domestic production.

In these areas, Lula’s government has underperformed. But popularity has so far not spelled populism, at least to the degree that future social and economic development is jeopardized. But one day it might, if the new government does not reverse recent trends.

Paulo M. Levy is an economic researcher at IPEA, the applied economic research institute of the Brazilian government.

Copyright: Project Syndicate, 2010.

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