$Unique_ID{bob00132} $Pretitle{} $Title{Brazil Chapter 3B. Policies} $Subtitle{} $Author{Darrel R. Eglin} $Affiliation{HQ, Department of the Army} $Subject{percent federal inflation government growth labor public year budget taxes} $Date{1982} $Log{} Title: Brazil Book: Brazil, A Country Study Author: Darrel R. Eglin Affiliation: HQ, Department of the Army Date: 1982 Chapter 3B. Policies In addition to investing taxpayers' money directly, the federal government had more powerful, although indirect, tools for influencing economic development. Exchange-rate policy, tariffs and other import restrictions, subsidized credit, and tax exemptions all affected private investment decisions and the profits from such investments. Government authorities have used all of the policy measures available to stimulate and manage economic development. A liberalization of import restrictions after World War II had to be reversed by the late 1940s as foreign exchange reserves quickly dropped. Subsequent controls greatly restricted imports. Multiple exchange rates were instituted, which favored some industries and sectors and discouraged others. Various incentive measures encouraged private investment, including large inflows of foreign capital, in the late 1950s. Government investment was added, particularly in energy and transportation. When the economy overheated from the expansionary policies, wage and price controls attempted to control inflation. By the mid-1950s problems began to appear, reaching crisis proportions by the early 1960s, even though high rates of growth had been attained. The policy measures adopted favored industry over agriculture, capital-intensive investment over job creation, and import substitution over exports. Rural-to urban migration increased, although unemployment was growing in the cities. Rising coffee prices through most of the 1940s and until the mid-1950s provided much of the foreign exchange needed to pay for essential imports and growing debt payments. By the late 1950s overproduction of coffee depressed world prices and reduced foreign exchange earnings. Increasing budget deficits contributed to inflation, which prices and wage controls did not suppress. By the early 1960s profound imbalances nearly halted economic growth while civil disorder spread. In 1961 and again in 1964 the country was unable to meet its foreign debt obligations. By 1964 inflation at times was running above 100 percent a year, and many dislocations and shortages existed throughout the economy. The military government that seized power in 1964 faced a monumental task. Between 1964 and 1968 economic growth was subordinated to controlling inflation, instituting a stabilization plan for the economy, and imposing public order. The external debt was rescheduled. Tax reform was instituted, and government deficits were reduced. Labor unions were suppressed and wages squeezed. An inflation adjustment was added to wages, rents, taxes, bonds, and other monetary units, called indexing. A single exchange rate was established, and it was adjusted frequently by mini-devaluations to compensate for differences in inflation rates between Brazil and, largely, the United States. Import restrictions were relaxed, and incentives were provided for exports, particularly manufactured products. In brief it was an opening of the economy compared with the import substitution policies of the 1950s. The stabilization policies were effective, judging by the rapid economic growth that occurred between 1968 and 1973. Brazil became one of the fastest growing economies in the world; GDP increased an average of more than 11 percent a year, more than 8 percent a year on a per capita basis. Industrial growth averaged 13 percent a year with manufactured exports increasing by 38 percent a year. Over the period the increase of the foreign debt was modest, and inflation had dropped to 15 percent in 1974. Unused industrial capacity diminished quickly in the rapid growth of the early 1970s. Large, costly projects were planned and started in mining, electric power, metallurgy, and machinery to meet projected demand. The rapid jump in the world price of crude oil in 1973 and 1974 hit the Brazilian economy at perhaps its weakest point. Growth strategy had depended considerably on the internal combustion engine and particularly the manufacture of cars and trucks, including parts. In the mid-1970s imported crude oil accounted for the bulk of the supply of petroleum products and a large share of the commercial primary energy. The pinch was immediately felt in the balance of payments. Beginning in 1974 tariffs were increased, some by 100 percent. Other restrictions further limited the growth of imports, which declined relative to GDP from over 10 percent in 1973 to under 8 percent by 1978. Export incentives were largely retained. The balance of payments difficulties of the mid-1970s coincided with growing concern about the recession in major developed countries (which were resorting to greater protectionism) and popular Brazilian nationalistic feelings about the country's dependence on imports and multinational companies. The result was renewed interest in import substitution as the strategy for continued economic development. Energy policy pressed conservation and development of domestic sources. Coal mining was to be expanded, and hydroelectric sites were to be developed. A major program to substitute alcohol distilled from domestic crops for imported oil was begun in 1975 without a real understanding of its potential costs. Substantial protection and subsidized official credit was provided, along with other incentives, to stimulate the possibilities of import substitution, which was largely confined to capital-and intermediate-goods industries. Large public investments in mining, steel, petrochemicals, and other basic industries were started. Official and popular concern has long existed over the large and obvious disparities in incomes and living standards between regions and between groups. In 1976, for example, the Southeast accounted for 65 percent of the nation's industrial establishments, 70 percent of industrial employment, and 77 percent of the value added by industry. The state of Sao Paulo alone, which had only 19 percent of Brazil's population in 1970, employed 48 percent of the industrial labor force, contributed 58 percent of industrial value added, and supplied nearly half of major export crops, such as coffee, sugar, cotton, rice, and corn. Per capita income in Sao Paulo was more than double the national average in 1970. In comparison the Northeast, North, and Center-West were undeveloped and poor; most of the population of these regions had an income a small fraction of the national average (see Rural Society, ch. 2.). To combat the obvious unequal regional development and living conditions, the government maintained several programs intended to benefit poorer regions. Two of the earliest were the agencies to plan and guide development in the Northeast (SUDENE) and the Amazon (SUDAM). Liberal fiscal incentives were added for investment to foster growth. The federal government, for example, built a large petrochemical complex in the Northeast to encourage additional manufacturers to locate there. Such measures were a start, but regional disparities are not likely to disappear for generations. A variety of subsidies intended to help poorer elements of the population created a fiscal drain. Many forms of transportation were subsidized. Bottled gas was sold at low prices because of its widespread use as cooking fuel by low-income city dwellers. Wheat was subsidized at the farm level to encourage production and at the retail level to provide low-cost food in cities. In the 1970s subsidized credit to farmers was introduced to compensate for the higher price farmers had to pay for domestic inputs under the import substitution strategy; the use of this credit increased rapidly and became extremely costly, although it reached only a small proportion of farmers (see Agriculture, this, ch.). Observers questioned the cost effectiveness of the various subsidy programs and whether they even reached the very poor in the society. The government's response to the 1974 oil crisis was to try to maintain reasonably high growth rates while making substantial adjustments in the economy. The result was lower, although still substantial, growth rates between 1974 and 1978 compared with 1968 to 1973, but they were accompanied by increasing inflation and a rapidly expanding foreign debt. In 1978 the rate of inflation was 39 percent and rising. By the end of 1978 the medium-and long-term external debt amounted to US$46 billion, up from US$12.6 billion at the end of 1973. At the beginning of 1979 a series of policy changes was announced. Export incentives were to be reduced in stages while import restrictions would be liberalized. The domestic currency, the cruzeiro (for value of the cruzeiro-see Glossary), was to be devalued more rapidly to compensate for inflation and the effect of changes in trade policy. Adverse weather that hurt exports derived from agriculture, worsening inflation, and a near doubling of oil prices seriously eroded the basis of the policy changes announced at the beginning of the year. Labor disputes increased. By late 1979 the balance of payments had deteriorated seriously. In 1979 and 1980 important reforms were taken to provide federal authorities more control over investments and borrowings of public enterprises, more flexibility in the use of budget revenues, and more ability to reduce subsidies to producers and consumers (see Fiscal Management, this ch.). In addition, reforms were made to control monetary expansion and the cost of credit (see Banking and Monetary Policy, this ch.). Meanwhile, the cruzeiro was devalued by about 30 percent in December 1979, and other changes were introduced in late 1979 and early 1980 to improve the balance of payments situation and curb inflation. Some of the rapid and numerous changes canceled the effects of earlier measures. In 1980 aggregate demand continued to grow, however. The pressure on prices raised the inflation rate to 110 percent in 1980. The pressure on the balance of payments increased, requiring additional use of foreign exchange reserves. In 1981 officials used the improved institutional controls to contract aggregate demand. Government expenditures, including investments, were trimmed, credit was reduced, and interest costs on nonsubsidized credit were allowed to rise, reaching 150 percent for a period during the year. Monetary correction (indexing) and exchange rate devaluations fully reflected inflation after being allowed to lag in 1980. Some tax incentives for exports were restored. The contraction of demand brought on Brazil's sharpest recession since national accounts were started in 1947. GDP fell by 3.5 percent and industrial production, the sector most affected, dropped 9.6 percent. Unemployment grew rapidly in the major cities. The inflation rate reached an annual rate of 121 percent in March but declined the rest of the year, averaging 95 percent for the year. Exports rose 32 percent, as manufacturers sought sales abroad to replace the shrinking domestic market, producing some improvement in the balance of payments. External Debt After 1973 Brazil increasingly turned to foreign borrowing. Part of the debt financed large investment projects in both the private and the public sectors. In spite of official policy to slow development, after 1976 public enterprises obtained many of the credits. Borrowing abroad also postponed the necessity of some difficult economic adjustments. Brazil's international credit standing was high, however, and officials obtained favorable long-term repayment schedules. At the end of 1981 Brazil's medium- and long-term external debt amounted to about US$61 billion, 69 percent of which was guaranteed by government organizations. Gross foreign borrowing during the year was about US$19 billion. Interest payments amounted to US$9.2 billion, an increase partly caused by high international interest rates. Small adjustments in world rates induced significant changes in Brazil's interest payments. In 1981 oil imports and interest payments accounted for nearly all of exchange earnings from commodity exports. In 1982 international bankers became cautious about lending to developing countries, particularly those with a large outstanding debt. Both Mexico and Argentina were on the verge of defaulting on international obligations during the year. Brazil was second only to Mexico in the largest external debts among Third World countries. Brazil's gross foreign borrowing requirements in 1982 were probably close to US$20 billion. A substantial portion had been arranged, but after mid-year, financial officials were frequently abroad, reportedly attempting to obtain the final amounts needed to balance international payments. During 1982 the government ceased releasing some financial statistics. Journalists pieced together apparent developments during the year from banking sources in Brazil and abroad. Reportedly, Brazilian officials had to increase the short-term debt and reduce foreign exchange reserves from US$7.5 billion to under US$3 billion in order to meet debt and other international payments during the year. Brazil negotiated a loan from the International Monetary Fund (IMF) and the United States government, steps the authorities had previously avoided because of the conditions that would be attached. In late 1982 international bankers were reporting that Brazilian authorities had agreed to severe austerity measures with unpleasant political effects in order to obtain the needed financial help. Some of the austerity measures probably would include a sharp reduction of government subsidies and a stop to the adjustment of wages for very low-income workers-a large proportion of the urban work force-above the rate of inflation. Imports would have to be cut back further. The balance of payments constraint was expected to persist for several years because of the hump in debt service into the mid-1980s. Experts predicted relatively low growth by Brazilian standards. The reaction of the population to austerity measures was expected to be negative. Fiscal Management The public sector plays an important role in the Brazilian economy. In 1979, for example, about one-quarter of GDP was collected through taxes by public sector organizations. Allocation of these funds was difficult to trace, however, in Brazil's unusual fiscal and financial structure. The public sector consists of the federal government, some 500 federal autonomous entities, over 200 special funds, governments of the 23 states and three territories, and about 4,000 municipalities (municipios-see Glossary). Until the 1980s attempts to gather and consolidate data from this multitude of organizations had proved less than successful. Even control or timely knowledge of the autonomous and decentralized federal agencies' activities had proved elusive. The federal budget was the only entity for which reasonably complete, consistent, and current data were available, but it accounted for only about 10 percent of public sector expenditures after budgetary transfers. The bulk of public sector investments was made by several hundred public enterprises, most of which reported little about their activities. A further complication to fiscal management arose from the preparation of a monetary budget as well as the government's regular budget. The monetary authorities prepared the monetary budget, which included many special funds and programs administered by federal agencies (see Banking and Monetary Policy, this ch.). Until the 1980s, for example, major subsidy programs and interest on the government's debts were included in the monetary budget and excluded from the federal budget. Through most of the 1970s the federal budget showed a modest surplus. Officials appeared to have discretionary authority where items were entered and chose those that presented the fiscal view desired. Another anomaly occurred during the 1970s when the federal government sold bonds, although the federal budget was in surplus. The proceeds from the sale of securities passed through the monetary budget to meet obligations on federal programs. While the federal budget showed modest surpluses through most of the 1970s, state budgets incurred increasing deficits, partly because of declining revenues resulting from federally decreed fiscal incentives, particularly for industrial investments and exports. The amount of revenues lost by these incentives was unknown. Public sector enterprises were also increasingly in debt. Although federal authorities began restraining expenditures and investments from the mid-1970s, public enterprises responded slowly. By 1976 many contractors and suppliers had to wait months for payment. In the early 1980s similar complaints continued on federal projects. Public enterprises also resorted to substantial borrowing, often abroad. Limited data indicated that the public sector deficit amounted to around 10 to 12 percent of GDP in 1979, the bulk of which arose from the subsidized credit programs. Another difficulty in the fiscal system was extensive use of taxes specifically earmarked for particular purposes. The use of earmarked taxes increased during the 1970s, peaking at a little below half of federal tax revenues in 1978. This practice considerably reduced flexibility in the use of fiscal resources and largely negated attempts to establish planning priorities. The earmarking of tax revenues consisted of both tax sharing with state and municipal entities and collecting funds for a specific use. Taxes on petroleum products, public utilities, and electric power, for example, were almost completely designated for use by federal, state, and municipal authorities in the activities from which they came regardless of need or more pressing priorities. In the late 1970s and early 1980s important reforms were instituted to increase federal knowledge and control over decentralized agencies and improve management of the economy. In 1979 an organization to control state enterprises was established within the presidency as part of the Planning Secretariat. It possessed wide authority to set ceilings on expenditures, borrowing, imports, and personnel levels. Timely reporting was also required of federal agencies. In 1979 a presidential decree required a phaseout of earmarked taxes, which started in 1981. Excluded were those taxes for revenue sharing with lower levels of government and those designated to help the Northeast and Amazon regions. The earmarked taxes not exempt would go to the National Development Fund until 1983, when the fund would cease to exist. From 1984 on, the federal treasury would receive the funds for discretionary and priority uses. This measure was expected to reduce earmarked revenues to only about one-quarter of treasury receipts. In 1980 several subsidy programs, the most important of which was the wheat subsidy, and debt service were transferred from the monetary budget to the federal budget. Additional measures intended to improve fiscal policies and management were taken. In 1979 indirect taxes on goods and services produced the most federal revenue (see table 5, Appendix). The industrial products tax, a value-added tax, was the major indirect tax. The share of indirect taxes tended to decline in the 1970s largely because of the incentives provided exports. In contrast, income taxes on businesses and individuals became more important after the tax reforms of the 1960s and improved administration. In the mid-1970s public enterprises became increasingly subject to income taxes, which boosted revenues. Taxes on foreign trade provided less than 10 percent of federal revenues in the late 1970s. A variety of other taxes, some newly added or with increased rates, added to total federal revenues, which declined slightly relative to GDP after the mid-1970s. Federal expenditures declined relative to GDP after the first oil crisis. The major federal current expenditures were personnel costs. The government limited these costs by placing temporary freezes on hiring and restraining wage and salary increases. The major portion of revenues passing through the federal budget was transferred to other agencies and programs outside of the immediate control of federal fiscal authorities. Earmarked taxes were the main funds transferred. Budget transfers increased in the 1970s as a share of GDP because of the expansion of earmarked taxes. Capital investments were the main expenditures in which federal authorities could make major cuts in the last half of the 1970s. Federal capital expenditures declined from 2.4 percent of GDP in 1976 to 0.8 percent in 1979. The structure of the government and the budgetary process before the 1980s severely limited the ability of federal authorities to manage cyclical adjustments or economic development. The reforms introduced by 1982 facilitated centralized control even though additional changes may prove necessary. The planning Secretariat finally had the necessary authority and data flow to weigh past and present commitments of resources against future availabilities and the needs of the economy. Federal economic policy makers should be in a better position in future years to evaluate the trade-offs in different courses of action and to establish rational priorities. Labor Force In 1978 the labor force numbered almost 45 million (see table 6, Appendix). Since 1950 it had grown by an average of 3.6 percent a year, slightly higher than population growth because of the youth of the population and greater participation by women. In 1978 women made up 32 percent of the economically active population, compared with 15 percent in 1950. Agricultural workers continued to increase absolutely but at a slow pace, averaging 1.4 percent a year. In 1978 agriculture employed 34 percent of the labor force compared with 60 percent in 1950. Industry and service employment about equally absorbed the rapid growth of the economically active and the marked shift from farm to nonfarm employment. The industrial labor force increased an average of 5.2 percent between 1950 and 1978, reaching 17 percent of the economically active population in the latter year. About half of industrial employment was in small plants and shops, which contributed substantially to the absorption of new workers. In 1978 employment in all service industries totaled 19 million, about 42 percent of the labor force. Growth of service employment averaged 5.3 percent a year between 1950 and 1978. Part of service employment, however, consisted of street vendors and peddlers, eking out a bare existence but hoping for real jobs. Most observers characterized the workers as industrious, productive, and accustomed to long hours. The work force contained highly trained and skilled people, but many had little education and few skills. Training programs were sometimes necessary. Extensive labor legislation set most conditions of work and established the rights of labor and management. Fringe benefits and other employer costs usually were in the neighborhood of 50 to 70 percent of payroll. Labor unions similar to those in the United States did not exist. There were labor organizations but almost no collective bargaining. The federal government strongly influenced wage rates in addition to working conditions. The constitution guaranteed the right to strike, but federal laws imposed narrow conditions under which a legal strike could be called. After the military takeover in 1964, labor relations tended to be tranquil, but by the late 1970s and early 1980s labor unrest and wildcat strikes mounted as economic growth slowed and inflation rose. An increased voice for labor and more autonomy for unions were issues that the government continued to suppress (see Liberal Groups, ch. 4). After the military takeover, labor organizations were largely disbanded and wage costs controlled. Some of the mechanisms used included a minimum wage set by federal authorities and a formula used to adjust monetary values for inflation. Some economists have argued that an important part of the economic miracle of 1968-74 resulted from the squeeze on real wages. In the mid-1970s wages were allowed to increase, and adjustments nearly compensated for inflation. Later in the 1970s as economic conditions began to deteriorate, the rise of wages was restrained. Changes in the formula to compensate for inflation caused a lag in the adjustment process. The 1981 recession raised unemployment to around 8 to 10 percent in some major urban centers where such statistics were recorded. The prospects for austerity and slow economic growth in the immediate years ahead posed questions about the reactions of labor, the unemployed, and the larger numbers of underemployed.