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Orthodox Economic Policies of the Lula Administration

The Lula administration has essentially continued with the orthodox economic policy of the past; high real interest rates impede economic growth. Whether an agenda of growth with a progressive redistribution of income and wealth is implemented during a possible second term in office, only time will tell.

Orthodox Economic Policies of the Lula Administration

The Lula administration has essentially continued with the orthodox economic policy of the past; high real interest rates impede economic growth. Whether an agenda of growth with a progressive redistribution of income and wealth is implemented during a possible second term in office,

only time will tell.

MARCELO DIAS CARCANHOLO

C
ontrary to general belief, be it liberal or would-be modernising, be it within academic or propagandarelated circles, the degree of internationalisation (openness) of the Brazilian economy has always been compatible with, and even on rare occasions superior to economies traditionally considered to be “open”. Both in terms of trade, as well as in financial and real-productive openness, Brazil has never been even close to being fairly classed as a closed economy.

Nevertheless, at the turn of the 1980s and in to the 1990s, Brazil opted to follow the neoliberal policies proposed by the Washington Consensus, which further increased the degree of openness of the country’s markets and its processes of deregulation and privatisation. Adherence to the Washington Consensus, was not however a mere acceptance of a technical conditionality in relation to the renegotiation of foreign debt but much more than that, it represented an option for a long-term project, which in addition to including a stabilisation policy, also encompassed structural reforms in the economy, in the state and in the way the country positioned itself within an international context. This slow neoliberalism of the 1990s has however left its mark on Brazil’s very recent past and left it with an inheritance of structural problems that without a new international insertion policy option will eventually have to suffer at the most some kind of formal change.

The Backdrop

The results of these policies repeated those of previous Latin American experiences. Between 1995 and 2000, the trade deficit totalled US $ 25.5 billion, which added to the US $ 148.1 billion services account deficit in the period resulted in a final current account deficit of US $ 158.3 billion between 1995 and 2000. This chronic external deficit led to a growing need for external financing, which in turn led to a substantial growth in the nation’s external debt (foreign debt rose 184 per cent between 1989 and 2000) and to a considerable differential between domestic interest rates and those practised abroad, a differential that was necessary to attract foreign capital flows into the country. This last aspect, aside from contributing to an increase in public sector debt (net public sector debt expanded 267 per cent between 1994 and 2000), also imposed a constraint on the country’s economic growth potential.

These balance of payments problems combined with the government’s inability to balance its accounts in turn reduced the country’s credibility abroad, which then resulted in a capital flight situation in the second half of 1998, and finally led to the foreign exchange crisis of January 1999. During 2000 and 2001, the economic policy adopted by the Fernando Henrique Cardoso government was limited to administrating recurrent pressures from abroad, maintaining high rates of interest in order to guarantee the permanence of foreign capital in the country, and at the same time trying to face inflationary pressures head on. In line with this orthodox monetary policy, fiscal policy was forced into maintaining sizeable primary budget surpluses which seemingly, at least in the eyes of orthodoxy, were the only tool available to control public sector debt. A neoliberal strategy, orthodox economic policies, insignificant economic growth and the maintenance of a significant concentration of wealth and income; it was against this backdrop that the electorate gave a resounding and unquestionable victory to the opposition presidential candidate, Luiz Inácio Lula da Silva at the end of 2002.

Continuity in Economic Policy

The Lula administration took office and announced an initial transition period, necessary according to it to “calm the markets” and guarantee credibility so as to avoid or minimise speculative attacks. In order to achieve these goals, it was, according to the new government’s discourse, necessary to maintain orthodox economic policy for a time and only later break away from this development strategy.

Economic and Political Weekly February 25, 2006

As time has passed however, it has become clear that the new government has not only maintained the orthodox character of its economic policy administration in the short-term, but also has every intention of strengthening promarket structural reforms within a neoliberal framework. It is now clearer than ever that the development strategy and economic policy adopted by the new government are exactly the same as those adopted by the last government. Consequently, the traps, pitfalls and imbalances in flows and stocks inherited from the last government, are now being increased or worsened.

The financial trap of the country’s external accounts has not been dismantled. The vicious circle constructed on the foundations of ever-growing current account deficits financed by debt accumulation and inflows of direct foreign capital, which have in turn increased external liabilities and resulted in growth of the services account deficit, thus pushing the ever more voluminous current account deficit forward, remains in place. The improvement in exports, which rose from around US $ 48 billion worth in 1999 to around US $ 96 billion in 2004, has helped the trade balance shift from a deficit of US $ 1.3 billion in 1999 to a surplus of US $ 33.6 billion in 2004; sufficient to compensate the services account deficit (structurally in deficit, with this services account deficit hitting US $ 25.3 billion in 2004) and, apparently, a solution to the problem of external financing requirements to cover the current account balance. The government seems to be tireless in its publication of these figures as evidence of its success.

However, these results on the export front have only been achieved thanks to, a favourable combination of factors in external markets (including high international prices of commodities), the effects of the national currency’s devaluation in 2002 resulting from the shortage of external financing availability, and to the stagnation of the domestic economy, caused by high rates of interest. More than reflecting an improvement in the Brazilian economy, these numbers are rather a consequence of the trajectory of instability and crisis that was inherited from the last government, and has been followed and extended by this government. One should also point out that prospects in the international markets are not overly positive, given the tendency for still higher interest rates in the US and the declared intention of the Chinese government to put the breaks on that country’s phenomenal growth performance, all of which impose a major barrier on the government’s export expansion strategy.

The fiscal trap has not been disarmed either. Contrary to orthodox thinking, the public sector debt/GDP ratio has continued at extremely high levels,1 even after achieving substantial primary budget surpluses which are already exceeding 4.5 per cent of GDP. The need for high interest rates, caused by external imbalances and inflationary pressures resulting from a supply squeeze increases the cost of rolling over public sector debt, and consequently its servicing (interest payments) which at the same time requires that new debt notes be issued to cover these extra costs. In this way, high interest rates have direct implications on increased financial expenditure, which in turn boosts the operational deficit and indirect implications on the level of debt as this deficit needs to be financed.

Finally, the classic stop and go mechanism continues to prevail in the Brazilian economy. Any “breath of air” in terms of economic growth ends up being cut off by external restrictions, as this implies growth of imports and a worsening in the trade balance, which given the structural deficits that exist in the services account pushes up the current account deficit and ends up forcing the need for the economy to slow down. The 5.18 per cent GDP growth in the Brazilian economy in 2004 following stagnation in the previous year has been unsustainable for 2005.

With regard to the distribution of income and wealth, it is important to highlight at least three points. The concentration of income in recent times has been related to the destructuring of the labour market and the poor quality of the jobs created. Therefore, labour and union reforms which have extended this destructuring and informality of the labour market looking to make negotiations between management and workers more “flexible”, have not contributed anything to progress in this area. Secondly, income redistribution policies do not resolve the structural problem if the growing concentration of wealth (ownership of assets) remains untouched. Finally, implementing redistribution policies without altering the degree of external openness (financial and trade) of the Brazilian economy is to assume the compensatory and recurrent form of the same. The main component of the growth of wealth concentration over the last 15 years has been the brutal expansion of financial assets, which are generally deregulated and internationalised, and which provide exactly the kind of assets that are largely owned by the wealthier layers of the population.

High Real Interest Rates Impede Growth

In terms of the economic debate within Brazil, there is a general consensus that high real interest rates (after discounting inflation) are the main stumbling block to a trajectory of sustainable growth. Even a large part of economic orthodoxy considers high real interest rates as a barrier. What distinguishes orthodox concepts from the more critical concepts are the actual reasons that lead to high interest rates. According to orthodox thinking, the relationship between country risk and the real rate of interest is basically founded on the capacity of macroeconomic policies to achieve fiscal solvency, which is expressed by the public sector debt/GDP ratio, and price stability, that is, the so-called economic fundamentals.

Thus, country risk is a function of the ratio of public sector debt to GDP, which in orthodox terms depends on the achievement of a public sector primary budget surplus and, longer-term, on institutional reforms that can guarantee fiscal solvency and price stability. Based on this idea, Brazil’s high real rates of interest have therefore originated from the growing need to finance public sector accounts. The only way forward, the right way from a technical economic policy standpoint, would be to obtain consistent primary budget surpluses that stabilise/reduce the public sector debt to GDP ratio, and therefore reduce the demands of the markets for higher interest rate yields at the time of rolling over or renewing this debt.

This argument only holds water because it assumes that the financial obligations of public sector debt (servicing this debt, including interest payments) should be honoured, particularly as a form of guaranteeing the credibility demanded by foreign capital to ensure that it continues to cover the country’s external deficits. Given the commitment to financial expenditure, stability in relation to the public sector debt/GDP ratio can only be obtained

Economic and Political Weekly February 25, 2006

through primary budget surpluses in public accounts.

If this is to have any validity however, high interest rates have to be related to the capacity of the Brazilian economy to honour its obligations and to its influence on capital flows. As the Brazilian economy is very highly dependent on external capital to cover its balance of payments, by definition it requires high domestic interest rates in comparison to other international interest rates, in order to attract capital to finance these external accounts.

The orthodox argument therefore crumbles in two stages. In the first place, public sector debt increases, essentially because interest rates are very high (and not the other way around as conventional thinking tells us). Secondly, the Brazilian economy has a floor for its interest rates because of structural external restrictions, given the need for external capital inflows to maintain a certain degree of foreign exchange stability.

The control of capital flows and a reduction in the degree of external openness would thus be necessary and unavoidable preconditions to gain back a degree of autonomy in determining monetary policy, and to provide the possibility of reducing real interest rates.

On the other hand, there is also an “inflationary” floor for interest rates. A drop in this floor would certainly have an inflationary impact, but not for the reasons put forward by the authorities. The problem would not be one of an apparent excess of demand resulting from the reduction in interest rates and consequent increase in spending. Since in the last 25 years rates of investment have been insignificant, the productive capacity of companies has grown very little in this period so that even with two decades lost in terms of growth, they are utilising high levels of installed capacity. This structural straightjacket on the supply side means that demand cannot be increased without putting upward pressure on prices.

Whether the Lula administration does indeed implement an agenda of growth with income and wealth distribution, during a possible second mandate in 2007, only time will tell. For the time being however, all we are seeing is the maintenance of a neoliberal development strategy under which stabilisation is a precondition for growth, only however attainable through the implementation of pro-market reforms and the use of economic policy instruments favoured by a conservative agenda, such as monetary policy being used only for the purpose of stabilising inflation, through the implementation of the highest real interest rates in the world2 and using fiscal policy to achieve mega primary budget surpluses. These surpluses are however insufficient to control public sector debt, primarily because of the high interest rates themselves.

EPW

Email: mcarcanholo@uol.com.br

Notes

1 In March 2005, the public sector’s total debt was at 50.75 per cent of GDP, whilst 44.95 per cent of GDP corresponded to domestic public sector debt alone.

2 Following an increase in the benchmark Selic interest rate, in April 2005, to 19.5 per cent pa, real interest rates in the Brazilian economy (around 12.8 per cent pa) were the highest in the world and equivalent to more than double the next placed in the rankings, Turkey, with

6.7 per cent pa.

Economic and Political Weekly February 25, 2006

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