The Brasilia Consensus: A New Model of Development?

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1 The Brasilia Consensus: A New Model of Development? by Roberto Fendt September 27, 2004 Analysts see Brazilian President Luiz Inácio Lula da Silva establishing a development model that combines the macroeconomic elements of the Washington Consensus with enhanced spending on social services. The new plan, dubbed the Brasilia Consensus, would elevate social welfare to the level of structural reforms within a larger economic reform process, providing a new model of development for the region. But notwithstanding some success, the reforms have hewn closely to macroeconomic elements and have not yet included the promised boost to social welfare programs that would have made the Brasilia approach unique. It remains to be seen if the current administration will end up implementing its new vision of economic reform that can serve as a model to other countries in the region. Is the Washington Consensus definitely dead? Some World Bank analysts see Brazilian President Luiz Inácio Lula da Silva establishing a new development model in the wake of the Washington Consensus, 1 a prescription for economic reform that urged countries to undertake economic austerity measures before social reforms. President da Silva s purported new plan, sometimes dubbed the Brasilia Consensus, after Brazil s capital city, is an updated approach to economic reform in which economic and social progress are inseparable, leaving behind the notion that attention to social welfare should be sidelined until economic reforms are well under way. The da Silva administration pledged, in accordance with what some now identify as this new development agenda, to restore public confidence by achieving macroeconomic stability a commitment which has induced a significant decline in the spread between Brazilian and U.S. Treasury debt instruments and stabilized both the exchange rate and the ratio of Brazilian public debt to GDP. On the social front, the administration has pledged a range of infrastructural and basic service improvements, including providing potable water to 3.7 million people in Brazil s poorest Northeast region, building 1.2 million housing units for the poor, forming 30,000 family health teams to deliver essential comprehensive care for those in need. 2 The President made an additional major commitment during his election campaign, to create ten million new jobs during his term. These are admirable goals, susceptible to testing against the hard facts of reality. Have these and other goals materialized, or are they in the process of materializing? Many analysts believe so, and will be watching the progress of this new agenda to apply its lessons to other countries in Latin America. The Center for International Private Enterprise is a non-profit affiliate of the U.S. Chamber of Commerce and one of the four core institutes of the National Endowment for Democracy. CIPE has supported more than 800 local initiatives in over 90 developing countries, involving the private sector in policy advocacy, institutional reform, improving governance, and building understanding of marketbased democratic systems. CIPE programs are also supported through the United States Agency for International Development. Center for International Private Enterprise th Street NW Suite 700 Washington, DC USA tel: (202) fax: (202) web: forum@cipe.org

2 The Washington Consensus As the argument goes, the Brasilia Consensus is a new model of development, quite different from the Washington Consensus. Is it so? Let us start by recalling what the Washington Consensus really meant. The expression was coined by John Williamson, a senior fellow at the Washington-based think tank Institute for International Economics. Originally it comprised a list of policy prescriptions already being pursued by several Latin American countries to reform their institutions with a view to create a solid basis from which sustainable development could arise. It also reflected what, in the words of Williamson, most people in Washington believed Latin America (not all countries) ought to be undertaking as of 1989 (not at all times). And the purpose of putting the list together was precisely to persuade Washington that Latin America was engaged in serious reform, not to furnish a policy agenda for Latin America. 3 The Consensus comprised ten reforms, which are listed below, with my own views on them which sometimes coincide with Williamson s, sometimes not. The first reform would be implementing fiscal discipline, meaning simply that governments should progressively live within their own means. If you prefer a more neutral definition, it implies reducing better still, eliminating the chronic public sector deficits observed over decades in most countries in the region. The obvious consequences of monetizing public sector deficits have been either recurrent balance of payments crises, or cycles of hyperinflation only temporarily halted, or both. The second reform would be the reordering of public expenditure priorities. The emphasis should be on reducing subsidies and eliminating tax loopholes for inefficient industries which are owned by the rich few and increasing expenditures in human capital formation (health and education, primarily). This change of priorities would mostly benefit the (many) poor, with the added advantage of reducing the extremes of income distribution concentration in many countries in the region. In the particular case of Brazil there was a noticeable increase in social expenditures (public health and education, in particular), although the quality of this expenditure is the subject of dispute. Third would be tax reform. This is aimed at broadening the ridiculously small tax base in most countries in Latin America. This, in turn, would eventually allow a decrease in general tax rates; these rates tend to be regressive, which means that the poor pay, relative to their income, more taxes than the rich. And perhaps, someday, this reform would lead to the reduction of the progressive rates of the direct taxes: where is it written that God wished a country s work ethic to be sabotaged by public finance professors and tax bureaucrats? Such a reduction of the tax rate would have obvious positive moral effects. It would also increase disposable income in the hands of the poor, enlarging the domestic market and increasing employment opportunities. Then, liberalizing interest rates, in the particular sense that there is no growth without investment, no investment without savings (domestic savings in most countries), and no savings without a minimally developed capital market. Therefore, liberalizing interest rates should be taken as shorthand for financial market liberalization. The fifth reform would be to allow a competitive exchange rate, for which I simply mean that the market should have a larger say in determining the rate of foreign exchange. By the way, what is so different about U.S. dollars and euros that requires their prices in domestic currency to be determined by a sacrosanct central bank? The experience of Argentina with its Currency Board is not enough to tell us there is something afoot when central banks in the periphery try to play the market with the foreign exchange? The sixth reform would deal with trade liberalization. This means simply that more trade is better than less trade and that since 1776, since Adam Smith, free trade as an engine of growth is one of the very few propositions to command some degree of unanimity (or should I say relative broad acceptance?) in the economics profession. Of course, there is a myriad of ways to liberalize trade, from the extreme of unilateralism à la Chile, to liberalization within the context of extensive traded concessions and economic blocs, either regional (e.g., Mercosur and NAFTA) or multilateral, under World Trade Organization rules. Then, the seventh reform would be liberalization of inward foreign direct investment, which does not apply to small economies with inconvertible currencies. Looking at the matter from a different angle and sticking again to matter-of-fact realities, how are we expected to grow if we save barely enough to replace depreciation on existing productive assets? If the rate of return is higher in the periphery than 2

3 at the center, and the rule of law prevails, why should investors repatriate their investment, creating a balance of payments problem in the future? Investors will not invest as much as they wish due to the imperfect protection of property rights and the absence, in many countries of the region, of the rule of law. Privatization is the eighth reform. There are very few examples of quality privatization in the region. Most were made, not out of deep-seated beliefs in the superiority of private over public ownership, but due to the more pedestrian and pressing need for funds to finance large current account deficits which in many cases originate in overvalued foreign exchange policies conducted by the region s central banks. Deregulation was not pursued enough, unfortunately, in most countries of the area. Latin Americans have a passion, a secret love, for regulation. This stems from the patrimonial tradition of Latin America something the Anglo-Saxons never had and I suspect they can barely understand. 4 Of course, deregulation does not mean a return to 19 th century capitalism; in many cases, privatization will turn state enterprise monopolies into private monopolies. There is a clear case for government regulation, in this and similar cases. Finally, the patrimonial tradition mentioned above precludes in many cases the clear definition of property rights. They are essential, not the least as Hernando de Soto correctly pointed out to allow idle capital, such as the houses of the poor, to be used as collateral for loans to the poor to finance productive investment and start a virtuous cycle of growth. 5 The Brasilia Distinction: Macro- and Microeconomic Reform Comparing the precepts of the Washington Consensus with those of its Brasilia counterpart, the two programs look about the same. The similarities are strong among the macroeconomic adjustment instruments. This is the case especially of the first item, fiscal discipline. Brazil now has been running primary fiscal surpluses for five years in a row, and the new economic team has raised it to 4.25 percent of GDP not only in 2004, but also until Brazil s new administration has also sent to Congress a bill aimed at a new tax reform law. Tax collections at all levels federal, state, and county now amount to more than 37 percent of GDP, higher than the corresponding U.S. figure and much higher than the average 20 percent for most Latin American countries. It also maintained a floating exchange rate regime and the inherited trade regime, which began to be liberalized slowly from 1984 and more vigorously into the early 1990s. Also kept as received, liberalization of inward foreign direct investment. Today s interest rates are as flexible as during President Fernando Henrique Cardoso s administration and much more flexible than in the early 1980s. Therefore, items one through six of the Washington Consensus were inherited from the previous and kept by the current administration. So far, six out of ten of the items are similar in the two Consensuses. Fiscal discipline receives deeper emphasis in the Brasilia Consensus. What about the microeconomics part of the list? The right macroeconomic policy is necessary to assure the background for sustainable development, but it is not in itself sufficient. What really explains the wealth of nations is the existence of an institutional environment conducive to investment and growth reflected, to a significant extent, in the micro-instruments. These instruments are the remaining four items on the list: a reordering of public expenditure priorities away from subsidies and toward the creation of incentives to human capital accumulation, is the subject of the next section. Privatization is definitely not part of the Brasilia Consensus, since privatization has been virtually halted although Mr. Antônio Palocci, Minister of Finance, was the first mayor in Brazil to privatize municipal services, a fact for which the city s voters rewarded him with a second term. Neither is the deregulation aspect of the Washington Consensus a part of the Brasilia Consensus. Regulatory agencies are being dismantled, and a new wave of regulation is introducing uncertainty into many markets. Finally, the enforcement of property rights, is undergoing benign neglect by the new administration. Therefore, it is legitimate to say that the Brasilia and Washington development models differ with respect to most of their microeconomic foundations. But not to all. President da Silva s administration is, in practice, placing the same priority on social expenditures as did the Cardoso administration. 3

4 The Record of the First Year of the Current Administration In order to restore investor confidence, both domestic and foreign, the new administration prioritized fiscal discipline over social expenditures. One wonders whether other options were available. Some of the more high-profile assessments of Brazil s prospects under the new administration emerged when figures on federal public expenditures for the whole of 2003 were not yet available. The record is clear by now, and the facts speak for themselves. The schedule and amounts of disbursement of the funds available in the budget law for 2003 were changed twice, in February (Decree 4591, February 10, 2003) and September (Decree 4708, September 25, 2003), when cuts were announced. All in all, taking into account the budget cuts, social expenditures were reduced by 14 percent. Overall expenditures on education ended the year 27 percent below the ceiling authorized by Congress. But only 23 percent of the allocated funds were spent for a program aimed at improving the quality of elementary education. Health expenditures fared better, drawing on 86 percent of the total federal expenditures authorized by the budget law. But, again, programs aimed at improving quality were neglected most: only 13 percent of the funds allocated for these types of programs were used. Even worse, public sanitation, essential to prevent disease, totaled only 5 percent of the available resources in the budget. Cuts were deeper in the case of social assistance, where 62 percent of the original funds allocated in the budget were excised. Particular programs, such as Pronager devised to promote labor training in poor communities used only 1.5 percent of the budget funds allocated. Despite all the emphasis on land reform during the elections, the new administration used only 45 percent of the funds allocated for this purpose. The list goes on. Expenditures on federal government housing programs used only 1.8 percent of the budget allocation; energy, where the state still owns all the hydroelectric capacity, used only 37 percent; transportation, 30 percent. Finally, unemployment and the prevalence of informal jobs continue to plague the labor market in Brazil. Together, they comprise 72 percent of the Brazilian labor force 12 percent unemployed and 60 percent in the informal market. President da Silva promised to create 10 million jobs during his term; in 2003, his first year in office, unemployment figures grew another million. Overall, the unemployment rate rose from 10.5 percent at the end of Cardoso s second term to 12.3 percent in the first year of President da Silva s term. As a consequence, the average per capita real income fell 12.9 percent in Is this really a consensus that emphasizes social priorities? According to rhetoric, this is the case. Hard figures tell a different story. If the lessons of the Brasilia Consensus are to be applied elsewhere, this new consensus cannot be limited to the macroeconomic adjustment part of the original agenda. At the very least, it should incorporate the remaining original microeconomic aspects of the agenda as well. To summarize the evidence, it pays to compare the neoliberal Cardoso Administration with the first year of President da Silva s term, on the basis of the hard facts of the figures on social expenditures. What Remains to be Done In order to understand what remains to be done, one must understand where and why the Washington Consensus worked and did not work, with reflection on some serious attempts to implement the agenda in several other Latin American countries. The agenda did work in Chile, although not from the beginning. The Chilean government implemented fiscal austerity; did not allow the exchange rate to appreciate in real terms; undertook privatization correctly and reduced public debt by selling public assets to private interests; progressively, and, eventually, fully liberalized foreign trade; and did not liberalize the capital account of balance of payments. In addition, while rule of law prevailed, the government deregulated most markets, with an 4

5 emphasis on introducing flexibility in the labor market. The agenda worked. Yes, a resounding yes, it worked. The agenda could not and did not work, for sure, in Argentina. Argentina hardly even attempted to implement the agenda. The real exchange rate appreciated to record levels under the currency board regime, meant to be the anchor for controlling inflation; public sector deficit remained untouched, especially in the provinces; and so on and so forth. With the exception of trade liberalization which was, unfortunately, accompanied by liberalization of the capital account. To sum up, everything went wrong because everything started wrong and continued to go wrong until Argentina s economy collapsed. I am using these two extreme cases simply to argue that versions of the original agenda call it Washington Consensus if you wish were implemented, and that the outcome of either case was determined in large part by the great difference in the external environment in the two cases. Chile benefited from behaving like Moliere s Monsieur Jourdan in a very favorable external environment: it applied the agenda call it common sense economic policy before the agenda even existed. The Case of Brazil Argentina and the other Latin American countries, including Brazil, reverted to the Washington Consensus amid several external shocks; these plagued Brazil s President Cardoso two terms in a row. There is nothing in the agenda warning against the vagaries of the international market in general and the U.S. economy in particular. Brazil s Finance Minister Palocci s policy takes this into account, by quickly reducing Brazilian indebtedness denominated in foreign exchange and, in the process, improving the original agenda. By the same token, Mr. Palocci has maintained the inflation target regime. Flexibility of the domestic interest rate is the essence of this regime; Mr. Palocci, and central bank governor Henrique Meirelles, have been resisting all the ferocious criticisms of Brasilia Consensus supporters in favor of a drastic reduction in the basic interest rate. Indeed, there is very little room to reduce further real interest rates without risking the gains made on the stabilization and confidence fronts. But, as mentioned previously, the microeconomic items of the agenda are still to be pursued; Brazil has kept its eyes on the rear view mirror on these items. Despite rhetoric, a bill has not yet been sent to Congress on the reform of articles of the Constitution dealing with labor union organization the easiest part of the overall labor market reform. We still have in place the Brazilian version of the fascist Italian Codigo del Lavoro [Labor Code] of the 1940s. This body of legislation keeps the Brazilian labor market completely inflexible and enlarges its duality, as mentioned before. The rule of law is being solemnly ignored, particularly with respect to property rights. Tax rates went far beyond the point in the Lafer curve which induces people to pay taxes; as a result, we are becoming also a dual society, divided between those few who pay taxes (multinationals, state enterprises) and the majority, which evades them. Isn t it time to reconsider these microelements and really create a new agenda, a real Brasilia Consensus, which would put an end to 20 years of stagnation and respond to the expectations of the Brazilian people and developing world as well? Conclusion President da Silva s stated plan for economic reform what is being referred to as the Brasilia Consensus was meant to be an enlightened version of earlier reform efforts, one that improved upon and expanded the recommendations of the Washington Consensus. But notwithstanding recent successes, the da Silva reforms are very familiar. As of mid-2004, they closely resemble the Washington Consensus and virtually ignore the promised social reforms that would have made Brazil s approach unique. It remains to be seen not just whether a more comprehensive approach to reform including both macroeconomic and microeconomic elements would break Brazil s development deadlock and provide a model for the region, but also whether the current administration will end up implementing a plan that is substantively different from the Washington Consensus. 5

6 Notes 1. De Ferranti, David and Vinod Thomas, Why Eyes Are on Brazil: A New Model of Growth, International Herald Tribune, December 23, Ibid 3. See John Williamson, Did the Washington Consensus Fail? Outline of remarks at the Center for Strategic and International Studies. Washington, D.C.: Institute for International Economics, November 6, The concept was introduced by Max Weber. Gesammelte Aufsätze zur Religiossoziologie. Tübingen: J. C. Mohr, For an interesting use of the concept to understand contemporary Brazil, see: Raymundo Faoro. Os Donos do Poder: Formação do Patronato Político Brasileiro. São Paulo: Globo, See Hernando de Soto. The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else. Basic Books: New York, Roberto Fendt is a consultant on international business and serves as a board member of several firms and organizations. The views expressed by the author are his own and do not necessarily represent the views of the Center for International Private Enterprise. The Center for International Private Enterprise grants permission to reprint, translate, and/or publish original articles from its Economic Reform Feature Service provided that (1) proper attribution is given to the original author and to CIPE and (2) CIPE is notified where the article is placed and a copy is provided to CIPE s Washington office via mail, e- mail, or fax. 6