Empirical evidence suggests that savings rise after economic growth takes off. Economic reform and stabilization in Brazil seem to have triggered just such a growth take-off. However, in order for the virtuous cycle to be sustained at an ever higher level of 5% (or more), the government would need to allow domestic savings to rise. Officials frequently point to the significant levels of inequality and poverty and Brazil’s democratic political system in an attempt to rationalize why a reduction in government expenditure is neither desirable nor feasible. A look at India’s experience in the 2000s suggests that this view is overly pessimistic.
Comparing Brazil with European countries, the United States and Japan, countries with vastly higher per capita incomes and mature demographic profiles, President Lula in a recent speech suggested that a high tax burden was necessary to finance public policies. This is debatable. By improving the efficiency of public expenditure, the government could almost certainly afford to reduce both expenditure and taxation without compromising its social and economic objectives. This is critical for if the government fails to rein in current expenditure growth, Brazil will be passing up an opportunity to raise its potential growth rate to 5% (or more).
Empirical evidence suggests that savings typically rise after economic growth takes off. In other words, the causality runs from higher growth to higher savings, allowing for a permanently higher level of investment, rather than the other way around. This begs the question of what ignites economic growth in the first place. The answer is likely to vary from case to case: political stabilisation, economic liberalisation, structural reform etc. In the case of Brazil, economic reform and stabilisation under the FHC and Lula governments seem to have triggered such a growth take-off, lifting potential growth to 4% plus, compared to 2.5% previously. However, in order for the virtuous cycle to be sustained, the government needs to allow savings to rise.
Brazilian household and government consumption has been virtually flat (as a share of GDP) during the past few years, although the acceleration in economic growth should have lowered the consumption share in GDP. In countries like China and India, both government and household consumption declined following the growth acceleration over the course of this decade. In Brazil, both households and the government seem to have a much higher propensity to consume. This propensity has been underpinned by strong growth in government consumption and transfers.
Raising private sector savings through public policies is not straightforward, neither politically nor economically, and certainly not in the short term (e.g. pension reform). The government has far greater control over its own consumption and savings behavior. It should therefore rein in the growth of government consumption (and transfers), that is, raise government savings. Whether higher savings are then best utilized to boost public investment, reduce the fiscal deficit (and crowd in private-sector investment) or finance tax cuts, thus raising the appropriable returns on private-sector investment, is a separate debate. If the government fails to rein in expenditure growth, the virtuous cycle of higher growth, investment and savings may be undermined.
Officials frequently point to the significant levels of inequality and poverty and Brazil’s democratic political system in order to rationalize why a reduction in government expenditure is either not desirable or feasible, or both. It is no doubt a fascinating debate to what extent, for example, the ability of the East Asian economies and more recently China to “extract” savings and limit current expenditure growth was conditional on the authoritarian nature of their political systems. The example of India, on the other hand, is more difficult to dismiss. India managed to lift its savings and investment ratio substantially during the course of the last decade, even though India suffers from much higher levels of absolute poverty than Brazil. India is also a democracy that, due to the fragmented nature of its parliamentary system, should find it at least as difficult, if not more difficult, to resist political pressure for higher government spending.
Indian investment and savings ratios increased on the back of both declining household and government consumption. While the contribution to domestic savings from declining household consumption was more marked, government consumption also declined. By contrast, government consumption in Brazil remained conspicuously high (as did current expenditure, including transfers). It may be easier to raise savings on the back of very high economic growth: Indian real GDP growth averaged nearly 8% compared to 5% in Brazil. But Brazilian real GDP growth also almost doubled in recent years, yet government consumption and current spending remained stubbornly high.
The snag is that even if politicians accept the need to raise public-sector savings, it is not in their short-term political interest to rein in electorally rewarding current expenditure growth. With the economy humming along nicely, social security reform is not a viable political option, even if stubbornly high household consumption strongly points to the necessity of encouraging greater household savings. However, a multi-year commitment to slowing current expenditure growth to below the rate of nominal GDP growth should be possible, expenditure rigidity and revenue-earmarking notwithstanding, politically and economically.
Such a reform would probably have to take place at the very beginning of a presidential term (Brazil will hold a presidential election in October 2010) and against the backdrop of significant growth, allowing for a continued solid increase in real expenditure; and it would probably have to go hand in hand with increased public sector investment, allowing the government to reap electoral rewards by way of “pork barrel”-type spending. All said and done: 2011 may be remembered as the year Brazil managed to lift economic growth onto a 5-6% growth path. Or it may simply be remembered as the year when Brazil passed up a tremendous opportunity.