By Ilan Goldfajn.
Is a new economic model evolving? Brazilians like to think we’re always facing a new model — about to break with the past and change everything, for the better, of course.
The truth is that changes tend to be more continuous. The new model is an extension of the old one, the result of past and present efforts and the global reality.
There are several uncertainties, as always. But is it possible to perceive trends in the Brazilian economy and form a coherent picture? To answer this question, here are some guidelines.
Additional investments are needed if the country is to keep growing. It is not possible to continue to grow only by adding labor to production. In the last decade, employment has climbed steadily, and companies have faced a shortage of workers. Unemployment reached a new all-time low. Now, it’s necessary to accumulate more capital to keep these jobs and grow more. Investment is now around 19% of GDP, a low figure by international standards. The symptoms of this phenomenon are visible to the naked eye: lack of infrastructure, limited productivity, high labor costs and loss of market share in the world.
The investment rate does not look low only when compared with the savings to finance it. The government dissaves, the new middle class is a spender, and Brazil has relied on external savings to complement investment.
I believe the government is committed to spending more on investments and less on current expenses (personnel, for example), which is equivalent to saving more. But there are implementation challenges, as demonstrated by the current labor strikes in the public sector and by the difficulty of increasing federal investment.
It is critical to increase private investment. The public-private partnerships and the recent announcement of the auction of new concessions for infrastructure (roads, railways, airports, ports) are a solution. But the private sector will need adequate returns if it is going to increase its investment. Production costs are high and represent a real bottleneck.
There are several initiatives to reduce costs. It is becoming clear that a significant share of cost reduction involves, to some extent, the government sacrificing its revenues. The package to reduce energy costs in Brazil requires lower taxes and contributions. Reducing labor costs requires some relief in payroll taxes. Petrobras’ investments will require fuel prices in line with the rest of the world, which may lead to additional tax cuts for gasoline and diesel.
These measures will ultimately lead to the reduction of the tax burden, which currently stands at around 35% of GDP – very high for a developing country.
It seems to be the ideal solution. The reduction of the tax burden could shrink production costs and encourage private investment, which is essential for further growth in the medium term.
But, in this “new model,” do fiscal accounts add up? Could public accounts withstand a more significant drop in revenue?
Despite government best efforts to restrain primary spending, it doesn’t seem Brazil is about to face savings of such magnitude that could finance the “new model”, which requires reducing costs enough to boost private investment and growth in Brazil.
But fiscal accounts are not made only of primary expenditures. The question is also whether interest rates will be lower in the future and whether they will open up fiscal room for the reduction of the tax burden. Unlike the primary budget target, the nominal public deficit includes an interest account. A permanently-lower interest expense could lead to a lower nominal deficit and allow a more favorable debt dynamics, opening up fiscal room.
I am not one of those who believe in the sustainable decrease of the benchmark Selic interest rate through a simple government decision. But I believe in the convergence of Brazilian interest rates to international standards in the medium term, enabled by macroeconomic stability and the consequent drop in risk spreads. The trend has been a decline in interest rates, although at a slower-than-desired pace. Looking ahead, more moderate growth in government spending and credit may allow a more sustained drop in interest rates (avoiding a return to double-digit interest rates, even after the economic recovery).
This point is not trivial, nor is it assured. High growth in public spending has been matched in the past by a heavy tax burden and also by higher interest rates. If current spending grows more slowly (or are re-allocated for investment), the consequent drop in interest rates may allow for a lighter tax burden. For every 1% of permanent drop in the Selic rate, we estimate a possible reduction of the tax burden by 0.5% of GDP, without worsening public accounts (nominal deficit).
But there are doubts, risks and challenges. First, we may be mistaken about the speed of the convergence of the Selic rate to international levels. Inflation has stopped falling and may go up, demanding higher interest rates. We hope it will reach a level lower than in the past, continuing the long downward trend. But this is not certain.
Second, the room for a decline in interest rates, if available, should be used to increase public investment and to encourage private investment. The temptation to increase government spending and encourage private consumption (with deductions) may derail the sustainability of falling interest rates, disrupt public accounts and cause higher inflation. The “new model” would then no longer exist.
The existence of a “new model” with lower interest rates, lower taxes, more investment and sustainable growth is auspicious, but getting there remains a challenge.
Source: Itau BBA