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$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.