Brazil’s medium-term economic prospects underpinned by solid fundamentals, favourable demographics and strategic natural resource exports are bright. Nonetheless, while per-capita income growth has picked up tangibly over the past few years, it remains way below that of Brazil’s East Asian “peers”. Per capita GDP in China and Korea, as a share of Brazil’s, increased from 7% and 62% in 1980 to 60% and 270% in 2010, respectively. Even if Chinese growth declines a couple of percentage points from current levels, its per-capita income will exceed Brazil’s by 2020.
Brazil is doing well. It weathered the 2008-09 global crisis largely unscathed (except for a significant growth slowdown in 2009). It is once more attracting record levels of capital inflows, including very significant FDI. Record-high terms-of-trade and a strong exchange rate are supporting a consumption boom. Unemployment is at all-time lows. Major oil discoveries carry the promise of turning Brazil into an important energy exporter over the next decade and generate windfall revenues for the government. Large FX reserves, a flexible macro-framework (however, imperfectly adhered to in practice), a stable political system, a favourable demographic outlook and an expanding middle class, underpinned by a solid banking system and an increasing number of internationally competitive companies, bode well for medium-term economic growth.
Brazil thus has legitimate grounds for optimism. But everything is relative. Per-capita GDP growth accelerated from less than 1% in the 1980s and 1990s to 2.4% during 2001-10 (or 3.5% since 2004). While this represents a significant improvement, it falls way short of star performers like China and Korea, both of which experienced dramatically higher per-capita growth for any given level of income. As a result, per-capita GDP in China and Korea, as a share of Brazil’s, increased from 7% and 62% in 1980 to 60% and 270% in 2010, respectively. Even if Chinese growth declines a couple of percentage points from current levels, its per-capita income will exceed Brazil’s by 2020.
East Asia’s rapid economic development can be attributed to a number of (causally) difficult-to-disentangle factors, including high investment and large domestic savings, favourable demographic developments (falling dependency ratio) and an outward-oriented, export-led industrialisation strategy, resulting in a high degree of trade openness, which, in turn, offers access to advanced technology and fuels productivity gains. Brazil shares next to none of these characteristics. It has remained a relatively closed economy with merchandise trade accounting for a mere 20% of GDP (compared with 3-4 times that share in China and Korea). The share of commodities in total exports is high (and has actually been increasing). National savings and domestic investment remain relatively low.
Investment is a major driver of economic growth, and investment is largely financed by domestic savings. This means that unless an economy runs a significant current account deficit (imports foreign savings), its investment capacity is limited by its domestic savings. Worryingly, economic stabilisation, an improved outlook and extremely favourable international conditions have not yet had a tangible impact on domestic savings. Especially the terms-of-trade shock should have had a positive, if typically only transitory, impact on savings. Brazil’s domestic savings rate averaged 16.9% of GDP in 2001-10 and a mere 17.8% during the second half of the decade, compared with 17.5% of GDP during the “lost decade” of the 1990s.
This is a problem, for not only has the savings rate barely budged (so far) but it remains a stunning 30 percentage points below China and more than 10 percentage points below Korea’s. High savings rates in EM Asia and low savings rates in Latin America are generally attributed to a varying combination of historical (hyper-inflation), economic (growth), demographic (change), (fiscal) policy and even cultural factors. The difference in investment rates is slightly less pronounced given Brazil’s greater reliance on foreign savings to finance domestic investment. It is likely that marginal capital productivity, especially in infrastructure, is higher in Brazil than in its Asian peers, given the very limited investment in Brazil in this sector over the past three decades. Brazil should therefore get more “bang for its buck”, but an investment rate of 20% of GDP will be insufficient to sustain a growth rate of more than 5% annually. Micro-economic evidence suggests much the same. Brazil’s infrastructure has come under heavy pressure.
Similarly, a number of industries are struggling to find qualified staff. In short, a relative lack of investment in physical infrastructure (e.g. getting commodities to ports, for example) and human capital (e.g. engineers capable of implementing large-scale infrastructure projects) is creating bottlenecks that are driving up prices. In short, if Brazil wants to raise its sustainable rate of economic growth, it needs to raise its investment in a sustainable manner, that is, without running too large a current account and fiscal deficit. The IMF projects the investment to rise from just below 20% of GDP today to an average of 21% of GDP during 2016, assuming an almost unchanged savings rate of around 17.5% of GDP. This compares poorly to China and Korea, which will invest more than 45% and 30% of their respective GDP during 2011-16.
The most likely scenario is one where Brazil settles onto a medium-term growth trajectory of 4.5% per year. This will be politically and economically sustainable. The government faces very limited incentives to pursue major, growth-enhancing structural reform: from an electoral point of view, the short-term political costs of reform would outweigh the political benefit of higher medium-term growth. Smaller, incremental reform less prone to encounter political opposition is much more likely. This is not a catastrophe, but it won't allow Brazil to grow anywhere near Asian levels. Hence Brasilia should not be surprised if China overtakes Brazil in terms of per-capita income soon.