Recently I posted a blog titled Underperforming Latinos where I asked the question whether Latin American countries were growing at par, or where just not growing fast enough. Several of the comments and emails asked me to explain my rationale regarding Brazil…. So, here it is.
First, and foremost, thanks for all your comments – even the ones that insult me, which I have to admit, my wife just loves reading them. Second, it is important to start by stating some facts: Brazil is growing right now (around 4 percent) and it is growing more than what it used to grow half a decade ago (roughly 2 percent). Furthermore, they have improved their primary fiscal surplus slightly. So, all this is good. I know, this is obvious, but at least I want to state some relevant facts.
The question is why they are growing faster? Is it because policy has been conducive to achieve so (overperforming), or because they have been lucky, or actually policy has hampered growth (underperforming)?
In the case of Brazil I’ll discuss two aspects: interest rates and external accounts.
Interest rates: interest rates today are around 12, with inflation expectations of 3 to 4, which implies a large real rate of at least 8. But not far ago they had 19 with inflation expectations of 5 to 6. That is a much larger real rate. This reduction in real rates has happened to all countries in the emerging world. The risk premium in international financial markets has plummeted and all developing countries – irrespectively of how badly or well managed they have been – have experienced drops in real rates of about 4 percent. Hence, as to all those countries, I assign a lot of this reduction to external factors (luck) and not good internal policy.
What is the impact of this interest rate? Can you imagine Brazil today increasing the policy rate by 400 basis points? Can you envision a slow down in the real economy? By how much? I actually think the economy will completely stall given how sensitive demand has become to interest rate movements. Therefore, returning the economy to its recent past will produce a much lower growth rate than what it used to have. And that “returning” is mainly due to changes in something Brazil has little control of.
The second aspect is the price of exports in Brazil. Brazil has certainly improved its external accounts. In recent years exports have increased significantly. From an average 300 dollars per-capita in the last decade of the 90’s to almost 600 dollars per-capita in the last couple of years. Very impressive, no? Well, the question is not if this is impressive or not, the question should be is this the outcome of prices of exports going up, or the result of gains in productivity in the exporting sector. From 2000 to 2005 exports per-capita have increased by 10 percent, and during the exact same period the price of the average basket of Brazilian goods exported to the US has increased by 12! Unfortunately I do not have the exact price of Brazil’s export basket – only very few countries on earth compute this properly (the US and Germany, by the way) – so, I cannot say anything about 2006. In any case, with the US data we can look at the exact same items through time and compute their price increases. Hence, there is no problem of product substitution. In that data set, all the export improvement is explained by price increases!
This is why I am not overwhelmed by Brazil’s performance. It seems that policy has not make the economy better, but just get by. Again, I am willing to be convinced of the contrary. However, I would like to point out also to Marcio Garcia’s blog where he criticizes the conduct of monetary policy.
Finally, let me say something about Chile. I got an email and actually it convinced me that I should put Chile in the passing grade. So, we have two, Peru and Chile. The email highlighted the fact that in recent years the Chilean government has followed a counter cyclical fiscal policy to stabilize the economy – policy that is healthy when you can afford to pursue it. And indeed, there has been a substantial improvement in the fiscal accounts and a significant contraction. The email asks how much can that explain the “low” performance of Chile, and it can explain a sizeable proportion of it. So, in this case, the lower growth is a choice and therefore, I am convinced that Chile should have a passing grade. In fact, see “Is Latin America Blowing It? The Case of Chile” by Thomas Trebat for further discussion and a more positive assessment of Chile, than the one I had before. .
Lastly, I checked other countries in the region and very few are following a contractionary fiscal policy. The most pathetic example is Venezuela; that with these oil prices has a fiscal deficit larger than when prices where at 20! Talking about irresponsibility! Well, maybe that I should leave to the another blog.