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Journal Author: John O. Ward, University of Missouri at Kansas City
Ward's article details the story of the Brazilian economic "miracle," a short-lived victory in its fight to maintain rapid growth, a bloated government, and full employment, simultaneously.
In leading up to this second "Brazilian Miracle," Ward explains the first miracle, which led to the conditions of the second miracle. Prior to 1962, Brazil's economy relied on a policy of important substitution, relatively stable prices, and adequate exports to finance its development. By 1964, however, the economy had stagnated, and inflation had run out of control, reaching the 100% level. The military government, throwing out President Goulart, undertook a program to try to resolve this crisis.
As might be expected from a military government, the "First Miracle" did not center on the efforts of the market but on government controls. The cruzeiro, the Brazilian currency was devalued, and would continue to be devalued, in order to encourage exports. A program of export diversification was undertaken, and wages and interest rates were fixed to prices. An acceptable rate of inflation, coupled with read GDP growth of over 10% a year, attracted foreign investment, which peaked in 1981 with a net influx of $17.2 dollars. The Brazilian government used these funds to build its industrial base, primarily in state enterprises, as well as finance infrastructure building.
This large foreign debt, however, proved the country's undoing. A rapid rise in interest rates forced Brazil to spend increasing amounts of its funds financing a debt that had ballooned by 1984. The government tightened its belt, but world doubts about Brazil's ability to pay its debt halted the flow of funds. The government devalued its currency in 1979 and 1983, but this rapidly increased the domestic cost of financing the existing debt. It took more cruzeiros to buy the dollars to pay off the debt, and the government resorted to selling more securities, increasing the monetary base and fueling inflation. The government system of fixing wages to prices, moreover, became a self-motivating source of inflation. By June of 1986, the cruzeiro had fallen to 12000 to the dollar and inflation hit the 400% mark, the hyperinflation level. The IMF continued to give "advice," which Brazilians government officials chose to ignore.
The "Second Miracle," the "Plan Cruzado" aimed to solve this crisis, again, through governmental fiat, not market forces. President Sarney, near a re-election bid, introduced the plan. First, the government latched more tariffs on imports in an attempt to encourage the position of Brazilian producers. Second, Brazil struck a deal directly with its creditors, avoiding the IMF completely, to ease some of its payments. Third, Brazil introduced a new currency, the cruzado, worth 1000 of the old cruzeiros. Most interestingly, Sarney tried to "shock" Brazil out of inflation by simply ordering inflation to stop with price freezes, rent freezes, and wage freezes. To kind of ease the blow, wages were given a 8% increase before the freeze.
At first, the "Plan Cruzado" seemed to be working. Brazil's GDP was expected to reach 12% for 1986. Inflation had nearly disappeared-as ordered. Finally, Brazil achieved a re-negotiation of another $31 billion of external debt. It appeared that Brazil had its cake and could eat it too: it had eliminated inflation but continued to have rapid GDP growth. President Sarney won his re-election bid.
Unfortunately, the Brazilian economy's problems couldn't be solved quite so easily. In the face of fixed prices and ample consumer demand, goods quickly disappeared from shelves and consumers ended up facing long lines. Instead of too many cruzeiros chasing too few goods; Brazilians now had too many cruzados chasing too few goods. Retailers got around price controls by introducing "new improved versions" of the same products at significantly higher prices. Meanwhile, the Black Market became a more significant source of trouble. Offering much better than government rates of exchange, it became a source of capital flight. The growth rate halved.
The government attempted to respond to these problems with yet another government incentive, the Pacote Plan which created a national holding company for state-owned enterprises. Continued funding for this company came from mandatory taxes tacked onto the price of gasoline and alcohol (which is used for fuel in many Brazilian cars) and automobiles. This was an attempt to hold down consumption. The government would then take this money and invest it in improving industrial expansion, hopefully to meet booming demand and, eventually, fighting inflation. It didn't help.
The government finally allowed prices to increase. By mid 1987, inflation had reached 1000% a year, and external debt had risen to $125 billion. In the face of overwhelming demand, the Brazilian economy was working at full capacity; unfortunately there was no funding to increase that capacity. Foreign banks felt no incentive to invest in Brazil, and Brazilian funds went into consumption or fled the country. The government resorted to some desperation moves, such as swapping actual state assets for debt. The miracle was over.
Ward blames the failure of the miracle on three basic factors. First, that final wage 8% increase by the government before the price ceilings automatically created inflation, which manifested itself in black market activity, "new improved models," and long lines (the Russian version of inflation). Second, Sarney didn't dismantle government industries or do anything to control government spending. Third, Brazil refused to deal with the IMF and its suggestions, choosing to "go it alone," making final negotiations more painful.
Finally, Ward blames the basic problem on Brazilian society itself. Brazil's economy has always been controlled by a military-social elite, as is the case in most Latin American countries. In Brazil, this elite fastened itself to the state enterprises and felt reluctance to let go of its power or influence, at the cost of preserving inefficient, bloated state industries. In fact, when the crisis came, the government actually increased the power of these industrial warlords by hoisting the tariff barriers. Ward did not feel that Brazil's miracle offered a good example for other investing countries.
Ward's analysis of the second Brazilian debt crises reveals two important points beyond its historical significance. First, a developing nation, such as Brazil has to be willing to deal with an economic reality: rapid growth, left uncontrolled, leads to inflation. Second, cultural factors greatly effect a nation's economic history and may make that nation unwilling to deal with these realities.
First, Brazil, like China today, has enormous resources which, in turn, naturally attract foreign investment. That foreign investment, whether directly invested in industry, or indirectly invested in the government, as in Brazil, result in more money available in the economy, leading to inflationary pressures. Quite correctly, Brazil spent some of its funds on infrastructure and developing its own industries. Its state industries, however, were left protected too long; lowering its trade barriers might've eaten some of those cruzeiros on foreign goods, but Brazilian need the foreign exchange credits to finance its debt. Another important step Brazil didn't take would've been to cut government spending. Selling of state enterprises, would've lowered consumption by diverted some money into investment, leaned out industries, and decreased the government budget's simultaneously. The government might've even limited foreign investment. The basic fact remains: had Brazil been willing to curb its rate of growth, or at least control it, the inflationary crises might've been avoided.
This leads to the more significant conclusion that development must considered in the light of the country being developed. Brazil possesses a Latin American government with a cultural tradition of crooked governments, bloated bureaucracies, and a boom and bust, primary resource-based economy. Given those realities, the primary concern of the government consists in avoiding military coups, not growing broke when the price of sugar or bananas falls, and in keeping the people "happy," not in sound financial planning.
One aspect of this Brazilian situation, moreover, is an intense nationalism. Brazilians take great pride in being Brazilians and being accounted a "South American powerhouse." Accordingly, they see massive government enterprises as a show of strength. The incredibly expensive capital of Brasilia is only one example of this attitude. Development (or misdevelopment) of the Amazon is another example. In this context the IMF advisors, no matter what their intentions, sound to Brazilians like "meddling foreigners" and not working with them would seem a kind of victory.
Brazilian governments, further, feel the pressure of overpopulation. While Brazil is a massive country, 90% of the population lives with 15 miles of the coast, a potentially explosive situation when the lack of wealth of most of the population in considered. If the standard of living of the population can somehow be improved, kept at acceptable levels, or dispersed into the Amazonian hinterland, the pending population crisis can continue to be deferred. Rapid growth, especially interior growth, therefore, will proceed as long as money is available from any source.
Finally, there are political realities to consider. As Ward rightly notes, Sarney did win his re-election as president, but more was at stack than one party or another. Brazil's military has left the barracks several times since World War II, and had one political party or another not done something, quickly, to solve the crises, the military might've felt obligated to take another try at governing Brazil. To Ward, there is no distinction between the military and civilian government, he considers them in terms of economic performance, but, in fact, the period of military rule resulted in numerous human rights violations. To rate Sarney's performance in simply economic terms, then, is to miss something important. Somehow or another, the political parties, corrupt or not, managed to keep democracy going, and that's something of a victory.
In my opinion, then, the bankers and investors in this crises were as much to blame for their ignorance of Brazil as were the Brazilians for their failures as economists. Any real study of Brazil would've encouraged a cautious investment strategy, even when lending to the government itself. This shows, again, that understanding international development requires an understanding of international relations. Further, a proper study of an economic action must always consider the situation of the society in which it occurs.
Ward does conclude with this, but I'm amplifying his conclusion.
As printed in A.J. Kondonassis, et. el. Major Issues in Global Development. Norman Oklahoma: University of Oklahoma Press, 1991, pp. 201-216.