Brazil's Economic And Political Future

Julian M. Chacel

• Publisher: Taylor & Francis
• Year: 2019
• Print ISBN: 9780367006334
• eBook ISBN: 9780429718021
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: Business General
• Index: Politics & International Relations

The 1985 elections in Brazil returned South America's largest country to democratic rule after two decades of military government. But the Sarney administration faces substantial economic and political challenges: over a 250 percent annual inflation rate, a foreign debt of more than $115 billion, and over a 20 percent unemployment rate. This collec

PART ONE
The Brazilian ''Miracle'' and Brazil's Foreign Debt

1
Brazil's Economic Stabilization Plan: An Analysis

João Sayad

On February 28, 1986, the Brazilian government implemented a far-reaching program of economic stabilization with the objective of eliminating one of the oldest and most perverse elements of the Brazilian economy: inflation. The cruzeiro (Cr$), a weak currency that was declining in value at the rate of almost 0.5 percent per day, was replaced by the cruzado (Crz), a strong currency with fixed parity in relation to the U.S. dollar. The new currency was a clear signal to Brazilian society that a complete transformation has been wrought in the economic life of the nation.

After decades of living with consistently two-digit annual inflation—three digits in recent years—the Brazilian people have been introduced to a situation absolutely unprecedented for an entire generation. In a single concentrated action, those mechanisms that had been created by different economic agents—including the government—as means of defense and protection against the distortions provoked by the steady rise in prices and that, with time, had become the primary causes of inflation were stricken from the nation's economic life. Paradoxically, the majority of Brazilians were beset with a sense of permanent loss—caused by continuous price increases—and with an illusion of extraordinary gains, at the moment in which their incomes were readjusted. Actually, the situation resulted in permanent loss for most people—and even greater losses for those in the nation's low-income worker class.

Thus it was not by chance that the people immediately rose in support of the program. Popular mobilization took place with the aim of supervising prices, which are now temporarily frozen, and many independent public opinion polls gave the government a rate of approval of 80 percent or more.

The fundamental guideline of the entire program is a commitment to sustained economic growth and social justice. Politically, it is a commitment to democracy. What we are dealing with here is, therefore, a program that rejects the idea that inflation must be combatted through recession. Recent Brazilian history clearly demonstrates that policies of this type provoked recession, generated unemployment, and gave rise to authoritarian regimes but had little practical effect in curtailing inflation.

The path chosen by the Brazilian government is politically opposed to this alternative: It rejects recession while opting for growth. It is also ethically opposed, for it rejects unemployment and protects the income of workers. It is opposed on the basis of economic theory because it recognizes that the process of inflation feeding upon itself and creating ever higher inflation is at the core of the Brazilian problem.

In the first place, the government guaranteed control or the primary sources of inflation: The public deficit was reduced, interest rates dropped, farm price stability was achieved, and the external accounts were brought into a state of balance. Despite all these measures, inflation moved along inexorably at rates of almost 0.5 percent per day. The only conclusion to be drawn from this process was that to snap the price spiral the institutional practices and mechanisms that produced the spiral would have to be eliminated.

Wages were converted from cruzeiros to cruzados on the basis of real average wages of the last six months plus a bonus of 8 percent, raised to 16 percent in the case of the minimum wage. Unemployment compensation and an automatic wage scale were also created. Therefore, the program is balanced and protects the nation's workers, especially those in low-income brackets.

The stabilization program has introduced profound modifications into the functioning of the Brazilian economy. Financial speculation—a highly developed activity in recent years—has been practically eliminated. The resources previously channeled into financial assets are now available for investment in productive sectors of the economy. The government certainly recognizes that the price freeze will have to be ended, however only after the country has learned to live and work in an environment of monetary stability.

Finally, the objectives of the stabilization program must be clearly understood. Though it represents an all-out attack on inflation, the program does not solve other crucial economic and social problems, such as uneven income distribution and inadmissible levels of poverty to which a great number of people are subjected. Once inflation has been eliminated and monetary illusions removed, the real problems and needs of the nation will come to the fore. At that point, Brazilian democracy will have to come up with the answers.

The Economic Stabilization Program

The objective of the measures implemented is to stabilize the general price levels and then reestablish the relative price system, restoring the allocatory function of prices, which is seriously hampered in an environment of high inflation rates. Based on the premise that aggregate supply and demand are basically balanced—thus eliminating the dangers of cost shocks and sharpened demand—the program acts directly against the core of the inflationary process. From the distributive point of view, the program is essentially neutral; it is based on a complex of conversion rules applicable to the different types of prices, incomes, and liabilities extant in the Brazilian economy. The central elements of the program are creation of a new currency, temporary freezing of prices, elimination of most indexing mechanisms, and conversion of wages and other incomes based on past averages.

Prices were temporarily frozen at the levels prevailing on February 27, 1986. To facilitate supervision of these prices, the government published lists of maximum prices and applied the necessary legal instruments to ensure the normalcy of supply. These measures are radically different from those expressed in the orthodox therapy, in which the quantities often perform the role of adjustment variables. In economies marked by high rates of inflation and generalized indexing, a temporary price freeze is essential; only in this way can inflationary expectations be reduced drastically while preserving the purchasing power of wages.

The elimination of indexing mechanisms is another essential element or the program. The rate of exchange—previously subjected to daily deval-uations—was fixed at 13.84 cruzados per dollar for an indefinite period. The value of National Treasury bonds was fixed and readjusted after twelve months rather than changed monthly. It was also determined that financial assets with maturities of less than one year cannot be indexed. The only exceptions to this rule are savings accounts, the Time of Service Compensation Fund, and other funds in which employees are the beneficiaries.

Depending on the type of contract, the conversion of financial liabilities into cruzados obeyed several criteria. In the Brazilian economy, there were two types of liabilities: those with preset monetary indexing and those with postset monetary indexing clauses. The liabilities with preset monetary indexing clauses were to be settled with the equivalent of a 14.4 percent monthly devaluation rate. The purpose of this measure was to discount the inflationary expectations implicit in preset contracts. Although certainly arbitrary, the rate of daily devaluation of the cruzeiro was based on the hypothesis that, normally, the inflationary expectations built into preset financial liabilities approximately reflect average inflation in the three-month period immediately prior to implementation of the stabilization program. Liabilities with postset monetary indexing clauses would be indexed according to the terms of the contract on a pro rata basis up to February 28. From that date onward, they would be converted into cruzados and would be entitled only to interest rates.

The government recognizes that the interest rates in force in the Brazilian economy are still excessively high. However, during the initial phase of program implementation, it was decided that these rates should remain at the levels prevailing immediately before February 28; in that way it would be possible to avoid speculative movements against the program in the form of accumulation of stocks, goods, or foreign currency. Because it is impossible to anticipate the behavior of real money demand, interest rates will be used as the principal monetary policy indicator and thus will be the variable utilized to regulate demand for consumer goods and stocks.

The conversion of wages at their average values corresponds to the adoption of substantially equivalent criteria in the area of prices. It should be noted that, in an environment marked by high levels of inflation, most prices—and particularly those determined by the interaction of supply and demand—undergo more frequent markups and, therefore, fluctuate relatively little in the range of the real average. In other words, for these products, freezing prices at the levels in effect on February 27, 1986, is equivalent to fixing them at a level quite close to the average of the recent past. In the case of prices subjected to government control, increases are normally introduced over greater periods of time, and the government had already been regulating these prices on the basis of averages.

Consequently, it was not by chance that the new anti-inflationary policy obtained widespread public support. Such support was engendered both by the price freeze and by the fact that the program not only preserved the purchasing power of workers but also introduced specific benefits. First, it granted an 8 percent bonus applicable to all wages, with the exception of the minimum wage, which was increased by 16 percent. Second, wages would be automatically increased if the accumulated change in the value of the Consumer Price Index reached a level of 20 percent during any given period. This type of increase would be classified as an anticipation of wage adjustments and would be equivalent to the rate of inflation over the specific period in question. Third, at the time of annual employer/ employee negotiations workers would be entitled to increases equivalent to 60 percent of inflation during the period of the respective contract, whereas the other 40 percent would be subject to bargaining. In this context, it should be noted that the government is free to decide whether it will or will not permit the transfer of these increases to prices. Fourth, negotiations between employees and employers would be free, with no predetermined limits on wage increases. Finally, a system of unemployment compensation was introduced for those workers dismissed from their jobs without justified cause or when a company suspended its operations.

Inertial Inflation

An understanding of the reasons that led the government to opt for this stabilization program requires an explanation of the Brazilian inflationary process. Inflation in Brazil has been an age-old problem that seriously worsened in the postwar period. From 1974 onward, the occurrence of two successive oil shocks in 1973-1974 and 1979-1980 pushed inflation to increasingly higher levels. This situation was further aggravated by the sharp rise in international interest rates that began in 1980, caused by a lack of coordination between the monetary and fiscal policies of the United States. Because Brazil carries a very large external debt—further magnified by the successive energy shocks—which has floating rate interest, the sudden rise in those rates had an extraordinary expansionary impact on the nation's interest expenditures and, therefore, led to even further growth in the debt.

Finally, in 1982, the violent cutback in international credit operations forced the government to apply an aggressive exchange rate policy together with other economic policy measures to generate the enormous trade balance surpluses needed to honor its international payments commitments. The cost pressures provoked by this policy rapidly spread to the other areas of the economy.

The recession and the accelerated process of inflation that, to a great extent, resulted from the external sector crisis, led to sharp decreases in public sector revenues, thus worsening the imbalances in government budgets. Aside from this, with the shutdown of access to the international financial market, the government began financing its own operations on the internal credit market, and this in turn led to growth in the public debt as the only means by which the economic system was accessible to absorb the monetary pressures produced by the trade surplus generated by the private sector. The results of this process were dizzying growth in the public deficit and an explosion in the levels of internal interest. To finance the deficit, the government increased interest rates, which, in turn, raised the public deficit and further strengthened inflationary pressures. The correction of external imbalances, therefore, provoked accentuated internal financial imbalances.

Until February 28, 1986, the peculiarity of the approach taken to the inflation issue in Brazil was that the government, recognizing the impossibility of eliminating the problem, decided to take measures to attenuate the corrosive effects of inflation on savings, income distribution, the allocation of resources, and the balance of payments. To a certain extent, this objective was achieved through the increasing indexing of the economy.

It must be emphasized, however, that indexing is not capable of completely protecting economic agents from the distortions provoked by inflation. In a context of high interest rates, there is a significant increase in the possible range of price movements and, therefore, even greater uncertainty about future growth in prices. In practical terms, when prices are adjusted on the basis of an average inflation index, there is the constant possibility that indexation will subject specific sectors of the economy to heavy burdens or extraordinary gains, depending on whether their prices are above or below the specified average.

A number of studies have demonstrated that the dispersion of price changes around an average inflation index is directly dependent on the level of inflation itself. Situations frequently exist in which prices increase at rates below the level of inflation whereas others expand at levels far above the average. In this context, the definition of monetary indexing strictly on the basis of the average rate of inflation represents a real financial cost to most sectors of the economy, to which one must add interest rates already at very high levels.

Since 1974, the system of monetary correction or generalized indexing— once considered an important pillar of support of the Brazilian economic miracle (1968-1973)—has come under an increasingly severe barrage of criticism. The system of monetary indexation gradually became an important cause of inflation, in the sense that the omnipresent formal or informal systems of indexation guaranteed continuous transmission of past inflation into the future.

Despite the absence of significant cost or demand pressures, inflation remained at high levels as a result of self-sustaining mechanisms associated with monetary indexing. The primary factors of inflation—such as the operational deficit of the public sector and monetary policy—were basically under control. There was no truly inevitable need for significant readjustments in relative prices, such as real exchange devaluations or elimination of the subsidies provided to the prices of basic products or to public service rates. Aside from this, the inflationary pressures provoked in terms of agricultural supply and the external accounts had essentially been overcome. The economic conditions had made it possible to maintain prices very close to a level of stability, provided the inertial component of inflation could be removed. And this component is precisely what cannot be explained by the primary factors of pressure on prices.

It must be emphasized that there is a fundamental difference between this interpretation of Brazilian inflation and conventional diagnoses, which attempt to create a frequently simplistic bond between the rate of inflation and monetary and/or fiscal imbalances. In light of the reality that inflation feeds upon itself producing ever greater inflation, policies of this type would provoke recession and would have little practical impact on inflation. For this reason, the Brazilian stabilization program was founded on the principle that it was necessary to direct an assault against the inertial component of inflation for only in this way could the vicious circle of inflation be broken.

Preconditions

To understand the meaning and implications of the measures announced on February 28, 1986, one must consider them in the wider context of Brazilian economic policy and establish their connections with a series of recent decisions. In the last few months, a series of economic policy initiatives was undertaken in preparation for the announcement of the new measures.

The first of these occurred in December 1985 when the National Congress approved substantial changes in the tax system. One of the central objectives of this tax reform was the recomposition of the gross tax burden. As is clearly demonstrated in the First National Development Plan of the New Republic, the tax burden declined in the last decade from a level of 25.9 percent of the gross domestic product (GDP) in 1970-1974 to 23.6 percent in 1980-1984. With the measures taken in...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Contents
• Foreword
• Acknowledgments
• Introduction: Brazil's Economic and Political Future
• PART ONE THE BRAZILIAN "MIRACLE" AND BRAZIL'S FOREIGN DEBT
• PART TWO THE POLITICAL STRUCTURE IN THE NEW BRAZIL
• PART THREE ELECTIONS AND REDEMOCRATIZATION IN BRAZIL DURING THE 1980s
• PART FOUR BRAZIL'S FOREIGN POLICY AND FOREIGN RELATIONS
• Selected Bibliography
• About the Editors
• About the Contributors
• Index