The Brazilian government is expected to propose two different measures in the coming weeks that are symptomatic of the difficulties in doing business in Brazil. The first is legislation to be submitted to congress this week to substitute a previous presidential veto to the so called “Amendment 3”: legislation that would have restricted the authority of the revenue service to determine whether taxes were being evaded by a firm’s recurring use of one person service providers. These single-person firms are often created to circumvent Brazil’s labor taxes and the vetoed legislation would have conditioned tax authority interventions to court decisions. The government’s motivation seems to be to guarantee contribution levels to social security and the expected legislation will likely address this concern.
The second expected measure is a reduction in taxes paid by three labor intensive sectors: textiles and apparel, footwear and furniture. These sectors, as several other labor intensive sectors in Brazil (construction, domestic services) are largely informal, low productivity sectors. Here the government’s motivation seems to be to protect labor intensive sectors from foreign competition, expected to intensify with the appreciation of the national currency with respect to the dollar (an increase in import tariffs to 35% is also being pursued for the first two sectors).
Both the growth in single-person firms and the difficulties of labor intensive sectors can be traced in some measure to how Brazil’s firms’ and workers’ high taxes, bureaucratic burdens and restrictive labor legislation raise the costs of doing business under the existing rules, while inefficient courts and poor law enforcement reduce the incentives of doing so. The World Bank’s Doing Business indicators have called attention to Brazil’s poor performance in various of these issues. Among the 175 countries of the latest report, Brazil is 151st in ease of paying taxes, 139th in dealing with licenses and 120th in enforcing contracts, making its 99th rank in employing workers actually not look too bad.
The importance of calling attention the continuing environment is not to shed a negative light on prevailing conditions, but rather because high informality is likely a consequence. Roughly half of Brazil’s workers do not fully comply with labor legislation and some 10 million small businesses are estimated to operate in violation of some commercial law. To the extent that unfair competition in domestic markets reduces the incentives to invest, informality should have a hampering effect on productivity growth. Not too long ago, in a broadly circulated study, the McKinsey Global Institute attributed to informality responsibility for roughly 40% of the productivity gap between Brazil and the United States (www.mckinseyquarterly.com). Since informality is largest in labor intensive industries such as construction, textiles, footwear, furniture and various types of services in which unskilled labor dominates, improved competition and investment in these sectors should raise productivity of relatively poor segments of the population. In other words, reduced informality should not only foster growth, but it is likely to be “pro-poor.”
I would be interested in further discussing the extent to which informality, not just in Brazil, but in Latin America in general, is or not a serious obstacle to productivity growth. Reform towards formalization is not easy, since it requires an agreement around what is fair and feasible and will likely affect the distribution of rewards. Moreover, it requires enforcing rules where they have so far been broken and where transgressions have been seen as legitimate. In Brazil, some recent measures have been taken, such as last December’s Small and Medium Enterprise General Law, that will enter into force later this year. It will be interesting to follow policies, as successes and failures should be revealing of the possibilities and difficulties of reform in Latin America.