Interview:
Eduardo Giannetti

 
INTERVIEW: EDUARDO GIANNETTI

Overview of the current political and economic landscape in Brazil

W e invited economist Eduardo Giannetti to give us an overview of the current political and economic landscape in Brazil, as well as point out the challenges the Brazilian society will face and routes it can take over the next few decades. A graduate from Universidade de São Paulo (USP), Giannetti holds a doctorate in Economics from Cambridge University, where he was also a professor, as he has at the Economics and Administration School at Universidade de São Paulo (FEA-USP). He is currently a tenured professor at Insper, a Brazilian research and learning institution. He is the author of 12 books, among them Vícios Privados, Benefícios Públicos? [Private Vices, Public Benefits] (1993); As Partes & o Todo [The Parts & the Whole] (1995); and O Elogio do Vira-Lata [The Mutt’s Compliment] (2018).

Q: Thinking about the current economic scenario in Brazil, what business opportunities are there?


A: Business opportunities will always be around. Even during the Great Depression, some sectors managed to do very well and that was a mega depression. The difference is that, when the economy is growing, it is like a rising tide that sweeps away all the ships. When the economy is in flux or there is a dead calm, it is obvious that economic growth will not take place automatically. Much more is required of businesses in terms of efficiency and innovation.

Warren Buffett used to say that it is only when the tide goes out that we discover who has been swimming naked. That counts for businesses. When the tide is out, companies which are not in a solid position can find themselves in an embarrassing position and a lot of them end up disappearing. They face judicial recovery, bankruptcies, etc.

Efficiency is the name of the game; making more with less, improving the input-output ratio – this is really important –, increasing efficiency and, at the same time, innovating. Doing what others aren’t. That is true for processes, products and finding new market niches. A great deal of entrepreneurship is needed, as is a great deal of creativity and a solid perception of reality.

 
 

Q: In a State that needs to cut costs, does the supply of credit that is also linked to it interfere in investments?


A: At the moment, with demand quite low, low growth and no foreseeable favorable outlook on the horizon, the question of credit to finance investment is not an operationally limiting factor. It will become a factor when confidence returns and there is demand for investment.

There is a lot of change underway. The role of the BNDES [Brazilian Development Bank] and the way it is inserted in the country’s economy are changing, in a positive and correct way, I think. It will concentrate more on infrastructure, natural gas, sanitation and that really is the role of the BNDES. We will have to create financing mechanisms for productive investment through voluntary credit from the banking system and other instruments, like the capital markets.

However, at the moment, this is not directly affecting companies because they are not, yet, excited about getting their investment projects back off the shelf. When these projects begin to be considered as real possibilities that can be implemented, that is when the question of investment will become a very relevant factor. We will have to change the pattern, leaving behind all that dependence on the BNDES as we have done up until recently, in order to move to a much more voluntary and natural financing system.

Q: What impact will the ending of the cycle of tax expansion and public spending growth have on Brazil’s future?


A: Tax in Brazil is a multi-faceted issue that can be approached from a variety of angles. But, for me, the essential thing, which should be clear to each and every Brazilian citizen, is that for every 100 reais they generate with their work, the government collects 33 reais, when accounting for federal, state and municipal taxes. That is 33% of the GDP. It is a tax burden that is well above what is considered normal for an average income country. Other average income countries in Latin America have tax burdens of approximately 25% of the GDP, while Brazil’s is 33%.

But, that’s not the end of it. The Brazilian government spends more than it collects, with a nominal deficit of about 7% of the GDP. What is a nominal deficit? The private sector, families, don’t spend all their income; they save part of it. The government, which needs to pay off more than it collects, takes part of those savings from households and companies and gives back public bonds, which are promises to pay you back in the future at high interest rates.

Therefore, the government collects 33% of the GDP in taxes and absorbs 7% of private savings to spend more than it collects. This is a fundamental figure: we live in a country where 40% of the gross domestic product makes its way through the public sector. It is an extremely high figure.

There was a cycle of tax expansion in Brazil, not a very sharp one, but one that began –together with the creation of the Federative Republic, after the military dictatorship – in 1988. In that year, the country’s tax burden was similar to that of other average income countries around the world, of about 24% or 25% of their respective GDPs. Since then, it has grown in every administration and has even been higher that it currently is, reaching 36%, but it is now at 33% of the GDP. However, this movement of the tax expansion cycle has finished. There is no more room to solve the tax problem by simply increasing them. I think that this route has come to an end.

What we will need to improve is the quality of public spending in Brazil. Because, it really is unacceptable that a country in which 40% of the national product moves through the public sector does not invest in the pertinent areas of the State, does not have quality public services for its citizens and, to top it off, also has a nominal deficit that is worrying and could end badly if left unchecked.

Q: Tell us about the tax burden, which leapt from 24% in 1988, to 33% right now.


A: What is behind this cycle of tax expansion and tax unbalance in Brazil? There are several things. I will list the main ones: the first is social security. We are a relatively young country with the expenditure of a mature European country. Of that 40% of the GDP, 13.5% is spent on social security benefits, including both social security (INSS) and government employee welfare.

Today, in Brazil, we have 7.5 people of working age for every Brazilian over the age of 64. This is a demographic that is still favorable, but it will not last for long. By 2060, we expect that figure to drop to 2.3.

If we are already spending 13.5% of the GDP with a demographic where the elderly account for a reasonably small proportion of the population, it is inconceivable to imagine what it will be like in 2060. So, things will have to change. If they do not change for the better, reality will assert itself. You will see the same thing that has already happened in states that have been broken, like Rio de Janeiro, Rio Grande do Sul and Minas Gerais, but across the entire country.

The second issue is the interest rate. We have a very high debt because the debt itself is high and the interest rate in Brazil is also chronically high. This figure has fallen somewhat in recent years, thanks to competent work by the Central Bank, as well as the recession, which allowed for a fall in the base interest rate, but it is still high.

Another factor that I consider to be of the first order has to do with truncated federalism. Instead of switching from the centralized military regime model to a genuine Federative State, what happened was that they were brought together, merged. If everything had gone well from 1988 onward, the growth of the states and municipalities would have corresponded to the fall in spending in Brasília: you move from one to the other, leaving behind individual, centralized State and entering into the decentralized Federative State.

Let us look at the numbers: the three levels of government in Brazil came to grow at the same time. The net spending of the Union increased, the net spending of the states increased and so did the net spending of the municipalities. Brazilian society, which was carrying one State, now has two States on its back. This is very expensive. For example, more than 1,500 municipalities have been created in Brazil since 1988, each one with its own city council. We have 5,570 city councils, paid for by Brazilian taxes, and many of them cost more than is spent on their respective cities’ health or sanitation.

Q: Are we in the midst of a federal centralization or a decentralization of public administration?


A: If you look at Brazil’s history, you can see an instability as regards the federative model. It is as if there were a pendulum that swings from one side to the other. Let us consider things since the country’s independence. The First Reign represents a moment of strong centralization of the central government. There was a great concentration of power at the hands of the Emperor. With the Regency, there was a movement toward decentralization. In fact, it was a period in which Brazil’s territory came under great risk, with many separatist movements arising and the country barely made it through as a whole, such was the threat of these separatist movements during the Regency. With Emperor Dom Pedro II taking the throne, centralization reestablished itself – the pendulum swung back to a great concentration of power in the central government.

The Republic of Brazil was created in the name of the federative State and it is no coincidence that the country is called the Federative Republic of Brazil. The republican banner was decentralization. More power to the states and municipalities, with an emphasis on the former, and less power to the central government. Brazil is, surprisingly, perhaps the only country in the world where a Federative Republic was created by a gesture from the central government, instead of a federation of states coming together to create it. It was decreed from the top down. This led to the Old Republic – of the governors of Minas Gerais and São Paulo, the protagonist states – that ended with the Revolution of 1930, in which you have a very violent movement of recentralization.

The New State resulted in the centralization of political and fiscal power in Brazil to a paroxysm in the hands of the federal government, which was still based in Rio de Janeiro. Everything passed through the central government, with Getúlio Vargas, the then president, theoretically responsible for appointing postal workers in Amazonas. The return of democratization, in 1945, sees the pendulum swing once again, this time to decentralization. The states gained autonomy, the conditions to determine their own finances, including the option to get into debt abroad. It is a federative movement of decentralization.

The Coup of 1964 centralizes things once more. Brazil found itself in a moment where, to nominate a secretary of finance or security in a state, approval was first required from Brasília – it was the pairing of security with development. The states no longer enjoyed the autonomy to nominate their own secretariats. It was a very strong moment of centralization.

With the Constitution, in 1988, re-democratization swings the pendulum back to decentralization. A series of attributes were transferred to the states and municipalities that had been concentrated in the hands of the central government, such as transport, education, safety, health and so on. Only, there was a problem: they decentralized the government’s functions, but did not decentralize the authority to tax. Tax collection in Brazil, which is very high, continues to be strongly concentrated in the hands of the Federal Government. Therefore, a system was created in the country whereby money is collected through federal taxes and then distributed to the states and municipalities. This generates a series of distortions and allocation issues. So, since 1988, in Brazil, you have this system that I call truncated federalism, where the government’s functions have been decentralized, but the federative bodies were denied the financial and tax autonomy to be able to fulfill the new roles attributed to them by the new Constitution.

 
 

Q: What is the balancing point for State intervention for economic recovery?


A: Brazil needs to recover its capacity for investment in areas that really need it and that, if they are ignored, will not get done. Sanitation, for example, is an area where there is a role for the private sector to play, but much of it is unprofitable and will be left to the State.

Now, I think that the main focus of public sector investment should be human capital, especially basic education. Honestly, it is very difficult to imagine a positive, favorable future for the Brazilian economy if we do not drastically improve the quality of primary education.

Brazil’s future will not be decided at Central Bank meetings, or by the BNDES, or the Stock Exchange, for that matter. The future of this country will be decided in the classrooms of primary schools. If we do not create a solid base of human education, there is no economic system or rules of the economic game that will be able to take us to prosperity. The whole historic process of development in Brazil has been very focused on the formation of physical capital: industrialization, urbanization and the government’s big investment projects.

Renowned English economist Alfred Marshall said that the most valuable of all capital is that invested in human beings. This is not a statement born of humanitarian concerns, it is strictly economic. Since the second industrial revolution, and much more so now, in the third and fourth industrial revolutions, it is human resources and human competencies on which a nation’s growth and prosperity depend.

Q: We have had some economic growth cycles driven by the Real Plan, then consumers and commodities, among others, but that is over, now. What can we glimpse for the next cycle of economic growth? What will it be based on?


A: The next growth cycle in Brazil, if it is to be sustainable, has to be much more grounded on investments, on the formation of capital, than on consumption.

We will have to increase the proportion of resources allocated to the formation of production capacity, in the physical dimension – infrastructure for vehicles, energy generation, public transport, railways… the modernization of Brazil’s infrastructure, investment in companies’ physical capital, like machinery, equipment, factories, buildings, civil construction –, but I would also say that, essentially, into human capital.

The formation of human resources is what Brazil currently needs most to become a productive economy, all in tandem with greater economic freedom. The increase in the exportability of Brazil’s GDP is a vast avenue of growth that still lies ahead. There is no precedent of an average income economy that has overcome the average income trap without a greater integration with global trade and Brazil will be no exception. To overcome this trap, we will have to greatly improve our capacity to sell to the world, while at the same time selling a greater share of our GDP abroad. We will also have to import more than we consume. It is a two-way street. It is not about achieving a mega trade balance surplus, but about increasing imports and exports.

So, I believe that investments in infrastructure and human capital, along with an increase in the exportability of the GDP – strongly focused on external markets –, are what will actually sustain growth and increase production in Brazil.