Growing Pains

Economic growth, in general, and industrialization, in particular, were the main goals of Brazilian policymakers until the 1980s. Thereafter, all efforts were concentrated on attacking the balance of payments crisis and inflation.

Werner Baer and Claudio Paiva

In the mid-1990s Brazil had a population of 156 million and a gross domestic product (GDP) estimated at US$676 billion in 1995, placing its economy among the nine largest economies in the world. The per capita GDP was estimated at a little over US$3,000. Within the Third World Brazil is among the most industrialized countries, with industry's share having fluctuated between the low and high thirties, as against only about 10% for agriculture. Although it is a market economy, the state has played an unusually large role, as both a policymaker and a direct participant in economic activities. In 1985, a survey of the 8,094 largest firms revealed that the share of net assets of state enterprises was 48%, while the share of private Brazilian firms stood at 43% and of multinationals at 9%. And in 1990, just prior to the introduction of the privatization process, another survey examined the 20 largest firms by sectors and found that state firms had the following percentage of total sales: public utilities, 100%; steel, 67%; chemicals and petrochemicals, 67%; mining, 60%; transport services, 35%; gasoline distribution, 32% (Melhores e Maiores, Exame, August 1991).

Despite the rapid growth of nontraditional exports and recent effort toward internationalization, Brazil's economy remains relatively closed, with external trade (exports plus imports) amounting to less than 14% of GDP in the early 1990s.

Growth Record

Brazil has experienced one of the highest growth rates among capitalist economies in the twentieth century. This observation is particularly true for the period ranging from the early 1950s to the mid-1990s, despite the crisis that lasted throughout most of the 1980s (the so-called lost decade) and into the early 1990s. A first assessment of the country's economic performance in the period can be made by noting that the yearly GDP growth rates averaged 7.15% in the fifties, 6.12% in the sixties, 8.84% in the seventies, 2.93% in the eighties, and 1.60% in the years 1990-95. For a comparative vision, one should note that the United States economy grew at a yearly average rate of 3% in the period 1960-92.

It will be noted that the high yearly growth rates of the 1950s and 1960s took place with relatively low investment/GDP ratios, when compared with the 1970s and 1980s. This may have been due to the lower capital intensity of the prevailing technology and also due to the great emphasis on the promotion of industrial sectors with low capital/output ratios. In the 1970s and 1980s, the higher investment/GDP ratios reflect an emphasis on industries with greater capital-intensive technologies (such as capital goods production) and a large amount of investment in infrastructure projects (such as the world's largest hydroelectric dam at Itaipu), which use up a huge amount of capital relative to short-term output. Also to be noted is the decline of investments in the 1980s and early 1990s, which is even clearer when measured in constant 1980 prices. This reflects the crisis of the 1980s and early 1990s. (…)

Besides the rapid increase in the national product, one should also note the structural changes that occurred in the economy during the growth process. Industry was the motor of growth and the centerpiece of all development strategies implemented throughout the period. Industrial production grew at a yearly average rate of 6.89% during the four decades but 8.5% if the lost decade is excluded. For the period as a whole, the yearly average growth rates of agriculture and services were 4.27% and 6.83%, respectively. As a result, the share of industry in GDP rose from about 24.14% in 1950 to 34.2% in 1990, after having reached 40.58% in 1980. Agriculture's share dropped from 24.28% to 9.26% in forty years, while the service sector's share rose from 51.58% to 56.54% . It should be emphasized that besides showing the fastest growth rates, the industrial sector became the main determinant of the economy's dynamism, triggering both the upturns and the downturns of the growth cycles.

Structural changes also took place within Brazil's industry. The ISI (import substitution industrialization) process led to a greater diversification of the sector, both horizontally (industries in different sectors) and vertically (industries related to each other as suppliers or customers), producing not only various types of consumption goods, but capital goods and basic industrial inputs as well. For instance, machinery production increased 205% in the seventies, electrical equipment, 223%, and chemicals, 163%. The share of the machinery subsector in industrial production rose from 2.2% in 1949 to 12.5% in 1992; the share of electrical equipment went from 1.7% to 6.8% in the same period. Some of the early dominant industries of the first half of the twentieth century had their relative importance decreased. For example, the textile industry's share of industrial output declined from 20.1% in 1949 to 4.6% in 1992, and the food and beverage products' share declined from 24% to 15.7% in the same period.

Another characteristic of Brazil's industry that has emerged over the decades is its high degree of concentration. In the 1980s the share of the eight largest firms in total sales was 62% in transport equipment, 64% in pharmaceuticals, 100% in tobacco, 60% in printing and publishing, 72% in chemicals, 54% in beverages, and 81% in rubber. The average for industry as a whole was 52%.

There were also notable changes in Brazil's employment structure. The share of agriculture in total employment declined from 62% in 1950 to a little less than 23% in 1990, and that of services increased from 25% to 54% in the same period. Industry's share in total employment rose to a much smaller extent than its share in GDP; in 1950 it amounted to 13%, rising to 23% in 1990.

Accompanying the changes in the production structure of the country was the diversification of the commodity composition of exports. This was especially the case after the first intensive import substitution industrialization, from the late sixties on. The basic idea of ISI was to produce domestically goods that were being imported, thus stimulating the economy. In 1950 the share of traditional export products (coffee, sugar, cotton, cocoa) was about 80%, while the share of manufactured products was about 13%; by 1992 the share of industrial products had risen to 66.7%, while the traditional exports' share had fallen to 5.2%. In addition, it should be noted that Brazil also diversified its agricultural exports. For instance, soybean and orange juice, which were almost nonexistent in Brazil's exports in the early 1970s, accounted for 7.3% of total exports each (totaling 14.6%) in the 1990s.

Background

Prior to the 1930s, Brazil was a primary exporting economy. Its major export products were coffee, sugar, cocoa, cotton, and, for a short period, rubber. Although some manufacturing industries made their appearance from the 1890s on, industry was not a leading sector. Coffee exports were the engine of growth throughout most of the nineteenth century. Also, as in the latter part of the nineteenth century the coffee economy had shifted from the state of Rio de Janeiro to the state of São Paulo, so the economic center of the country gradually shifted to that region, where it has remained until the present day. The secondary effects of the São Paulo coffee economy—employment of free immigrant labor, foreign investment in infrastructure, capital accumulation of coffee growers, and some derived growth of industry—were to deepen regional dualism between the dynamic Center-South and the rest of Brazil (especially taking into account the Northeast).

The Great Depression of the 1930s had a severely negative effect on Brazil's exports, whose value fell from US$445.9 million in 1929 to US$180.6 million in 1932. The price of coffee in 1931 was at one third of the average price in the years 1925-29. In addition to the decline of export receipts, the entrance of foreign capital had come to almost a complete halt by 1932. The decline of export earnings and the large amounts of foreign exchange needed to finance the country's external debt, not counting the remittances of the profits of private entities, forced the government to take some drastic actions. In August 1931, it suspended part of the foreign debt payments and introduced foreign exchange and other direct controls of imports. Combined with a devaluation of the currency, which increased the price of imports, these controls caused a decline of imports from US$416.6 million in 1929 to US$108.1 million in 1932.

Since at the beginning of the depression coffee accounted for 71% of total exports, and exports, in turn, stood at about 10% of GDP, the government's main concern was to support the coffee sector. The steep decline of world demand for coffee brought along by the depression also coincided with a huge coffee output, which was the result of plantings that had taken place in the 1920s. In order to protect the coffee sector, and thus the economy, from the full impact of the decline of world coffee markets and prices, the federal government, through the National Coffee Council, bought all coffee, destroying large quantities that could not be stored. Government protection of the coffee sector also included measures to help debt-plagued agricultural producers by having the government pay off the debt, thus creating new money and enabling the debtor to postpone payments.

The curtailment of imports and the continued domestic demand resulting from the income generated by the coffee support program caused shortages of manufactured goods and a consequent rise in their relative prices. This acted as a catalyst for a spurt of industrial production. In fact, the growth was so pronounced that industry for the first time became the economy's leading sector, responsible for an early general recovery from the impact of the World Depression. By 1931 industrial production had fully recovered from a decline that started in 1928, and in the following years it more than doubled. Especially noteworthy by 1939 was the rapid growth of production of such sectors as textiles (147% larger than in 1929), metal products (almost three times larger than in 1929), and paper products (almost seven times larger than in 1929).

World War II caused shortages of imported manufactured goods, which acted again as a stimulant to more intensive domestic production. But the war prevented a concerted development effort, as there was little investment in new productive capacity. Output increased mainly through a more intensive utilization of existing capacity. Thus, at the end of the war, Brazil's industrial capacity was obsolete, and transportation infrastructure was inadequate and badly deteriorated.

Since the wartime years made it possible for Brazil to earn a substantial amount of foreign exchange, the country found itself with a substantial amount of reserves at the end of the war. This made it possible in the early years after World War II for policymakers to decrease barriers to imports. However, trade liberalization was short-lived. The overvalued exchange rate established in 1945 and maintained fixed until 1953, a persistent inflation, and a repressed demand meant sharp increases in imports and a sluggish performance of exports, which soon led again to a balance of payments crisis.

Fearing a negative impact on inflation and having a pessimistic outlook on the future of Brazil's exports, the government, instead of devaluing the cruzeiro, decided to deal with the crisis with exchange controls. In 1950 a system of licensing was established, giving priority to the importation of essential goods and inputs, fuels, and machinery and discouraging that of consumer goods. These policies had the effect—initially unanticipated—of providing protection to the existing consumer goods industry.

Starting in the early 1950s, Brazil's policymakers adopted import substitution industrialization as the country's main development strategy. In the initial stages of ISI, exports were almost totally neglected, while from the mid-1960s on it was accompanied by simultaneous efforts to diversify exports.

Industrialization Policies

Two distinctive phases can be observed when analyzing Brazil's economic policies between 1950 and 1994. Economic growth, in general, and industrialization, in particular, were the main goals of policymakers until the 1980s. Thereafter, all efforts were concentrated on attacking the balance of payments crisis (early 1980s) and the inflationary process. In this section we focus on the growth strategies implemented in the period, leaving the stabilization policies to be discussed separately.

As already mentioned, from the early 1950s on Brazil's policymakers adopted import substitution industrialization (ISI) as the country's main development strategy. They had come to the conclusion that the only hope for rapid growth was to change the structure of the economy through ISI. This was achieved through (1) protection of the domestic market through tariffs, exchange controls, and import licensing; (2) the attraction of foreign direct investment through various incentives; (3) the creation of state enterprises in basic industries and public utilities; (4) the creation of a development bank (Banco Nacional de Desenvolvimento Econômico, BNDE) that, in the absence of an adequate capital market, provided long-term investment capital to both state and domestic private enterprises, often at subsidized interest rates; (5) the direct promotion of specific sectors.

The 1950s began with a more relaxed fiscal and monetary policy, compared to the austerity years of the late 1940s. The exchange rate appreciated in real terms (i.e., the exchange rate remained fixed, while the domestic price level increased, thus making imported goods increasingly cheaper in cruzeiros), while import controls on consumption goods (especially consumer durables) were instituted. The combination of these measures with easy credit policies reduced investment costs and improved the prospective returns, stimulating investment and the importation of capital goods. The latter was further facilitated by increased revenues from coffee exports at the time. As a result of these policies, the rate of investment increased substantially, rising from 12% of GDP in 1950 to an average of 15.2% in the following four years, and the economy expanded by 47% in the first half of the 1950s.

In the second half of the 1950s a number of specific programs were introduced in order to better control the direction of the industrialization process, to remove bottlenecks, and to promote the vertical integration of a number of industries. Special attention was given to industries considered basic for growth, such as the automotive, cement, steel , aluminum, cellulose, heavy machinery, and chemicals industries. The administration of the exchange rate, tariffs, and other import controls was used to stimulate these industries. For instance, foreign companies in such sectors as those mentioned above were given the privilege of importing machinery without foreign exchange cover. Without this privilege, foreign investors would have had to send dollars to Brazil at the free market rate and with the cruzeiros bought they would have had to repurchase dollars in the auction market at a higher price. Also, the special Tariff Law of 1957 expanded protection of favored industries with tariffs as high as 60, 80, and 150%.

The government announced a very ambitious program of public investments in infrastructure, especially electricity generation and transportation. Illustrating the increasing participation of the public sector of the economy, the share of government expenditures in the national product went up from 19% in 1952 to 23.7% in 1956. Private investments were favored by facilitated access to internal and external credit, and expansionary monetary and fiscal policies completed the stimulation of the economy. Among the most impressive results of this phase were industry's growth rate of 16.8% in 1958 and the 10.8% GDP growth for the same year. Investment went up for four consecutive years, from 15.2% of GDP in the first half of the decade to 18% in 1959.

The ISI strategy also left and even created a number of problems. The type of growth that occurred resulted in a substantial increase of imports, notably of industrial inputs and capital goods, and the foreign exchange policies of the period resulted in an inadequate growth of exports (no efforts were made to diversify them). The balance of trade deficits in the second half of the 1950s were financed by a substantial influx of foreign capital, both in the form of direct investments and in the form of loans. By the beginning of the 1960s Brazil's foreign debt amounted to more than 2 billion dollars. A large proportion of the latter was short term, and both the interest and, amortization payments, combined with profit remittances of foreign firms, produced increasing balance of payments difficulties.

Stagnation and Rapid Growth, 1960-74

The first half of this period was characterized by economic stagnation while in the second half Brazil experienced the highest yearly growth rates ever achieved. The stagnation has been attributed to the end of the initial ISI cycle, to the imbalances it had created, to inflationary distortions, and to political instability. The subsequent boom was the result of structural changes brought about by military governments within a favorable international setting.

The above-mentioned period of stagnation occurred after a decade of prosperity. The GDP growth rate in 1963 was below 1%, and the inflationary impact of the policies adopted in the previous years started to be felt. The main explanations for the crisis were the completion of another stage of the ISI process and the resultant higher level of capital intensity of the domestic industry, which would inhibit new investments; low incentives to invest as a consequence of existing excess capacity and political instability; and insufficient domestic demand resulting from a highly concentrated income distribution.

In 1964 military forces took over Brazil's administration. Its first economic team believed that the main elements impeding growth were high inflation and an unfavorable balance of payments. Inflation, in turn, was considered to be caused by the public deficit, which was around 4% of GDP, the expansionary credit policies implemented in the late fifties, and the wage increases above productivity gains. In accordance with this diagnosis, economic policy until 1967 concentrated on reducing the deficit (which declined to 1.1% in 1966); controlling monetary expansion; and implementing a new formula to determine wage adjustments. The balance of payments problems were tackled by a reform and simplification of the foreign exchange system, with the introduction of a mechanism of periodic devaluations of the cruzeiro, taking into account inflation, and by stimulating a greater internationalizing of the economy by increasing exports and attracting foreign capital. Public investments were also expanded to improve the country's basic infrastructure and modernize and expand state-owned basic industries.

These policies succeeded in reducing inflation and attracting foreign capital, predominantly in the form of foreign loans. The adjustment was considered completed for the most part, and the economic team that took over in 1967 initiated a new development strategy. The remaining inflation was considered to be of a cost-push type, and the austerity policies were replaced by price controls. Interest rates were reduced, various forms of subsidies and tax incentives to encourage diverse types of investments (in backward regions, in sectors whose development was considered essential) were implemented, and measures to modernize capital markets were introduced. The resulting recovery of private investment was accompanied by an increase in public investments, especially in infrastructure (road building, power generation, telecommunications, etc.). Quite notable during this period was the expansion of such state enterprises as Petrobrás and Companhia Vale do Rio Doce. The former, founded in 1952, began with a monopoly in oil exploration. It expanded its activities into refining and various types of petrochemicals through the foundation of a number of subsidiaries. Vale do Rio Doce, which was founded in the 1940s to export iron ore, expanded into other types of mining activities, steel mills, and various types of forest products. Foreign investment also increased significantly, responding to a more favorable legislation on dividend repatriation, the existence of a well-defined growth strategy, and the country's political stability.

These measures, together with the rapid expansion of the world economy, helped to bring about a time of very rapid growth between 1968 and 1974, during which the yearly growth rate of GDP was 11.1%, with industry expanding at over 13% a year. Its leading sectors consisted of consumer durables, transportation equipment, steel, cement, and electricity generation. The period also witnessed a rapid increase in demand for automobiles, luxury goods, and upscale housing, which was brought about by a rapid growth of upper-strata income and by credit schemes created by the capital market reform.

As a result of the post-1964 policies, external trade expanded substantially faster than the economy as a whole. There was a significant growth of exports, especially of manufactured products, but imports grew considerably faster, rapidly increasing the trade deficit. This did not present a problem, however, since there were massive inflows of capital, and the balance of payments showed surpluses.

In the 1968-74 period the concentration of personal income worsened and the regional disparities became larger. Industrial expansion took place more vigorously in Brazil's Center-South, the region that has benefited most from the ISI strategy. Its per capita income considerably exceeded the national average, its infrastructure was more developed, and it had an adequate supply of skilled workers and professionals. This enabled the region to take advantage of the opportunities and incentives offered by the military regime. Although there was a special regional development strategy for the poor Northeast of the country, it promoted a distorted industrialization that benefited only a few of that region's large cities; its linkages with the Center-South were stronger than those within the region.

Debt-Led Growth, 1974-80

The late-1973 oil shock (which quadrupled the price of oil) hit Brazil very hard as the country was importing more than 80% of its oil needs at the time. Contrary to most countries, Brazil did not accept the conventional thought that it would have to face a slowdown of economic activity as a response to the oil shock. In fact, Brazil's response to the international crisis was to implement an ambitious program of investments and to reinforce the economic policy instruments used to stimulate ISI.

Import substitution was promoted in basic industrial sectors like steel, aluminum, fertilizers, and petrochemicals. More intensive efforts were made in oil exploration both by Petrobrás and through risk contracts with foreign oil multinationals. In addition, Brazil engaged in a vast program to substitute alcohol for gasoline. Large public investments were also made to expand the country's economic infrastructure and to promote and further diversify exports. Besides the usual fiscal incentives and market protection through import controls, private investments were stimulated by subsidized credit and faster capital depreciation rates. Due to these policies, Brazil was able to maintain a high growth rate, the annual real GDP and industrial growth rates in the 1974-80 period being 6.9% and 7.2%, respectively.

Although the goal of these investments was to reduce imports, their immediate growth impact resulted in a higher quantum of imports (especially of capital goods). In addition, the rising value of imports was also attributable to the higher prices of imported oil. The resulting large deficit in the current account balance, which rose from US$1.7 billion in 1973 to US$12.8 billion in 1980, forced the country to borrow heavily in the international financial market. This borrowing was facilitated by the glut of petrodollars, which international banks were eager to lend. Policymakers expected that the combined effect of import substitution and export expansion would eventually bring about trade surpluses needed to service and repay the debt. By the end of the decade, however, interest rates rose dramatically (most of Brazil's external debt was on a flexible interest rate basis), forcing the country to borrow more just to meet its debt service obligations. As a consequence, the foreign debt rose from US$6.4 billion in 1973 to US$54 billion in 1980. The situation was worsened by the Mexican foreign debt moratorium of August 1982, which resulted in the closure of the international credit market to most Latin American countries, including Brazil, and the debt crisis became the major concern of Brazil's government.

In the same period Brazil experienced an acceleration of inflation and a steady worsening of its public finances. Not only were revenues decreasing because of the many tax incentives, but government expenditures were also rising rapidly due to many subsidies (especially to public service state firms whose prices were not allowed to rise with increased costs and whose resulting deficits had to be covered by government subsidies), the high level of public investments, and the rising domestic and foreign debt servicing obligations. While between 1968 and 1973 the rate of inflation had steadily declined, the trend was reversed from 1974 on. Yearly price increases rose from 16.2% in 1973 to 110.2% in 1980.

Stagnation, inflation, and Crisis, 1981-92

Throughout the 1980s and early 1990s Brazil suffered from both inflation and economic stagnation. This contrasts with most advanced industrial economies, where long periods of stagnation have usually been accompanied by either no or very low rates of price increases. Brazil's stagflation comes as no surprise to the observer since both inflation and stagnation can be interpreted as different manifestations of the same imbalance.

The Fiscal and Monetary Crisis

Over many years Brazil's public sector experienced chronic budget deficits that were financed by increases in the indexed domestic debt. The problem in the 1980s was the gradual decline of the government's credibility with the public: there was increasing doubt about the government's capacity to service the debt and eventually to repay the principal. This gradual loss of credibility required the shortening of the terms of financing, reaching a point at which most of the debt had to be refinanced daily through the overnight market. Extremely high real interest rates were also required to roll over the debt, which substantially increased the government's financial expenditures. This created a vicious cycle of rising debt leading to rising deficit leading to further increases in the debt.

Besides the negative impact on the budget, the debt had an additional perverse effect on monetary control due to the characteristics of its financing. On top of the short terms and high rates, the government was forced to offer an extra attraction to financial institutions that acted as intermediaries in the sale of public bonds. The Central Bank was committed to repurchase from these institutions those bonds that did not find buyers in the market. This hindered the control over monetary policy, as net withdrawals of funds from the overnight market implied automatic increases in the money supply.

The large fiscal deficit, debt, and high interest rates also had a profound impact on resource allocation and economic growth. There was an increasing allocation of credit to the government, as the financial system became less and less an intermediator of resources to the private sector and increasingly a facilitator of the transfer of savings to the public sector. For instance, in 1980 the private sector received 74% of total credit, the rest going to the public sector. In 1990 this composition had changed significantly, as the private sector received only 47% and the public sector, 53%. The rising amount of funds placed in the financial rather than in the productive sector implied a decline in economic activity. In the years 1981-90 the average growth rate of the financial sector was 5% per year, which was double the growth rate of the GDP. As a result, the share of the financial sector in the GDP rose from 8.56% in 1980 to more than 19% in 1989.

Excerpted from The Political Economy of Latin America in the Postwar Period, edited by Laura Randall, University of Texas Press, Austin, 1997, 329 pp

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The Political Economy
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edited by Laura Randall
329 pp

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