Download Case Study – Brazil

Case Study – Brazil
Economic Performance
Brazil is the largest economy in Latin America.
Population (millions, 2004)
Human Development Index (Rank)
Adult Literacy (%, 2002)
Life Expectancy at Birth (2004)
GNI per capita (US$, PPP, 2004)(Rank)
184
0.792 (63)
86.4
71
7940 (86)
Brazils annual average economic growth was just 2.6% over the period from 1990-2003,
down from 2.7% in the 1980s
Brazil’s strategy has focused on shielding its domestic industries from overseas
competition to promote domestic industrialization. This strategy has boosted domestic
firms and protected domestic employment; it has also contributed to the lack of
international competitiveness among Brazils exporting firms.
Brazil has still achieved a substantial level of economic development. There has been an
increase in life expectancy from 63 in 1980 to 71 in 2004, an increase in adult literacy
rate, up from 82% in 1990 to over 88% in 2004. Human development index has also
increased form 0.680 in 1980 to 0.792 in 2003.
There is a high level of income inequality in Brazil with 7.5% of the population on less
than US$1 per day and 25% of the population on less than US$2 per day. On a global
rank, Brazil is the 10 most inequitable countries in the world with 74% of the population
being the lower classes and 5% of the population owning 80% of the income.
The natural environment is an ongoing feature of Brazil’s economy and is faced with
the difficult task of managing it. The natural environment is under strain as a result of
Brazil’s population, poorly developed infrastructure, the effects of industrialization and
deforestation of the Amazon and Brazil’s Atlantic coast rainforests. Deforestation
remains a highly controversial issue for Brazil. In 2003 26,000 square kilometers of land
was cleared, the second highest rate of land clearing on record.
Brazil also suffers from a high level of water and environmental pollution. Less than 10%
of waste water is treated, and almost half of the countries garbage and other solid wastes
are not collected. Only 58% of the population lives in housing that is not connected to a
sewerage system. Poor sanitation is a major contributor to public health problems.
Brazil’s Response to Globalisation
Brazil has been open to financial flows. Brazil relied largely on foreign borrowing to
fund its industrialization and import substitution program. The import substitution
program is focuses on developing domestic industries that could substitute imports for
locally made goods rather than focusing on overseas markets. This strategy was
implemented through tariffs and subsidies which helped to keep import levels down
however it made the Brazilian industry less competitive internationally and therefore less
successful at developing export markets which lead to Brazil not being able to generate
the required export funds to service debt.
They have however been slow to embrace world trade. Brazil first began opening up its
economy to global forces by encouraging foreign investment inflows from the US and
Europe. Greater access to foreign capital allowed Brazil to create a large industrial base
and reduce its dependency on imported manufactured goods in the hope of developing
greater self-sufficiency. While Brazil pursued increased economic integration through
finance and investment its purpose was in fact to reduce its reliance on the global
economy by substituting imports with domestically produced goods and services. The
result of financial inflow is a major foreign debt problem which left Brazil vulnerable to
external shocks. The first shock came in the early 1980s when Brazil was unable to
service its foreign debt as interest rates in the US rose and its currency depreciated
sharply. Brazil has experienced a succession of exchange rate crises. To counteract this
they have implemented an Economic Stabilisation Process whereby the new currency,
the real, which was created after an exchange rate crisis, was pegged to the US dollar.
This brought inflation under control and increased purchasing power of incomes. By the
real was hit by another crisis so Brazil adopted a floating exchange rate which was
successful. Adopting a floating exchange rate has forced Brazil to accept greater day-today volatility in the value of the real.
Impacts of Globalisation
The major threat facing the Brazilian economy in recent years has been its ongoing
exposure to external shocks. Adverse economic conditions in other countries can have
an impact on Brazil’s exports, access to foreign capital and the currency. As the Asian
financial crisis showed in the late 1990’s, sudden currency depreciations can cause an
explosion of foreign debt and inflation, economic recession, and falling living standards.
The economic crisis in Argentina in 2002 had particularly severe consequences for
Brazil’s economy. The impacts of the crisis included:
 In US$ terms, the value of GDP shrank from US$765 billion in 2001 to US$459
billion in 2002.
 Inflation jumped 4.5% to 12.5% within one year.
 Interest rates averaged 23.4% in 2003.
 High unemployment and excessive inflation had severe effects on low income
earners, increasing the incidence of poverty and worsening the degree of income
inequality.
The most significant problem underlying Brazil has been the high level of foreign debt.
 The cost of servicing Brazil’s enormous foreign debt reach 92% of export revenue
in 2005, but with recent trend surpluses it declined to 46% in 2005. Nevertheless,
Brazil still has one of the highest debt servicing ratio amongst middle income
countries.
 Around 80% of Brazil’s total debt is owed to foreigners and is dominated in
foreign currency. As a result, any depreciation of the real immediately increases
debt servicing costs.
The economic crises in 2002 prompted intervention by the IMF. The IMF intervention
was successful in restoring investor confidence in the Brazilian economy.
Ethanol: In response to the world oil price shocks of the mid 70’s, the Brazilian
government established a national program to promote the use of a domestically
produced alternative fuel source called ethanol, which is made from agricultural products
such as corn, grain and sugar-cane. By encouraging ethanol production from Brazil’s
large sugar plantations, the Brazilian government hoped to make the country less
vulnerable and volatile to world oil prices. Since 1976, all petrol sold in Brazil has
contained at least 25% ethanol. The ethanol program has encouraged the development of
Brazil’s sugar industry and as ordinary motor vehicles must be modified to run on pure
ethanol, the program has also promoted Brazil’s domestic motor vehicle industry.
Brazil’s Recent Policy Development
A range of short term macroeconomic stability measures and longer term micro
reforms have been implemented in Brazil. It consisted of fiscal discipline, inflation
targeting and a floating exchange rate. The Fiscal Responsibility Law ensures that fiscal
policy is being used to reduce the level of public debt, which makes up around 55% of
foreign debt. This means that fiscal policy is not being used as an instrument to influence
the level of economic growth. There have also been reforms of the state pension system
for public servants. The pension system, which is similar to Australia’s superannuation
system, was introduced as part of the Constitution at the time when democracy replaced
military government in 1988. It guaranteed public servants an annual salary equivalent to
their final year’s salary before retirement. They also simplified the tax system. The aim
of these reforms is to replace 27 state taxes that currently apply throughout the production
process with five levies. President da Silva has introduced a number of policies to reduce
inequality in Brazil. In 2004, the government merged four of its income transfer
programs. By merging income distribution payments, the government hopes to cut down
duplication and resource wastage, and target inequality more effectively.
Key Terms
Regional Economic Integration: Closer economic relations between Brazil and its
neighbouring regional economies.
External Shocks: The effects from adverse economic conditions in other countries that
impact on Brazil.
‘Contagion’ process: In which a crisis in one region spreads elsewhere as investors
become increasingly risk-adverse.
Servicing the Debt: Funds required to repay foreign liabilities on an annual basis.
Import Substitution: Replacing imported good and services from other countries by
encouraging domestic producers to produce the good for the country to become self
sufficient.
Foreign Liabilities: Brazil’s total financial obligation (foreign debt plus foreign liability)
to the rest of the world.
Fixed Exchange Rate: When the value of an economies currency is officially set by the
government or central bank.
Floating Exchange Rate: When the value of an economies currency is determined by
the forces of demand and supply in FOREX markets.