Lula, magician?

All this is rather impressive when compared to Brazil’s economic track record of the previous two decades, but hardly the stuff of magic by global standards. Brazil’s economic growth under Lula’s administration has averaged a relatively modest 3.5 per cent, far below the average 8 per cent expansion over the past four years in Russia, India and China — the other three rapidly expanding emerging markets referred to together as the BRIC. However, Brazil had to sacrifice some growth over the past few years to tame the inflation beast.

Still, Brazilian policymakers must seriously consider how to take the country to 4 or 5 per cent growth, which would put it on track to becoming a major economic power. To achieve this end, Brazil needs to look no further than a country with strong Latin connections — Spain. Twenty years ago, Spain was in exactly the same position as Brazil. It had a similar per capita income and had recently fought a victorious war with inflation. It was ready for initiatives to spur growth.

To unleash the entrepreneurial energy in the economy, the Spanish government cut back government’s role by reforming the social-security system, shutting down unprofitable state enterprises and making the labour market flexible — just the type of reforms Brazil needs to enact now. The economic boom that followed took Spain to a developed market status by the mid-’90s. Per capita income in Spain currently stands at a remarkably high $27,000. Brazil’s population is four times greater than Spain; if Brazil can achieve a similar growth profile, the impact will be enormous.

The current risk is that Brazilian policymakers are content with just achieving stability. It’s important to realise that very favourable global economic conditions have facilitated, in no small measure, the current growth. The boom in commodity prices has particularly helped Brazil, as commodities comprise 50 per cent of the country’s exports. More importantly, it will be hard for Brazil to achieve globally competitive interest rates as long as the government occupies such a large share of the economic sphere. At 35 per cent, Brazil has one of the highest ratios of government spending to GDP in the developing world. To fund that spending, it naturally has a prohibitive tax structure. As a result, Brazil’s productivity growth over the past two decades has averaged an abysmal 1 per cent.

This is not how Brazil used to be. In the 1950s and ‘60s, it was the China of the world, with the economy galloping at double-digit growth and professors heralding it as the paragon of economic virtue. But the first oil shock in 1973 made Brazil lose its way. What happened since should serve as an important lesson to the emerging economic stars of today. Brazil succumbed to the populist appeal of creating a welfare state with policies directed more toward redistributing the pie, such as an overly generous social-security system and extensive retirement benefits for government employees. Government spending exploded and private investment got crowded out. Today, Brazil has one of the lowest investment-to-GDP ratios in the developing world — just 16 per cent. Infrastructure bottlenecks are rife and the cost of doing business is among the highest anywhere. Brazil’s economic experience shows how countries can lose their will to grow once they reach a certain per capita income level, and why so many nations aren’t able to break out of their middle-class existence.

With a popularity rating of 70 per cent, Lula has the political capital to implement serious reforms that will take the country to a higher growth path. Lula has already tasted political and economic success by sticking to economic orthodoxy that has brought the country its much-needed stability. But to go down in history as a leader who truly changed the course of a nation, he needs to get more ambitious. Simply maintaining stability won’t make for economic magic.

The writer is head of emerging markets at Morgan Stanley Investment Management Newsweek