News 1

Brazil’s economic overview

Items	Figures (2014)
Nominal GDP (S)	2.246 trillion USD
GDP rank	7/191
Population rank	5/228
Geographical Area Rank	5/252
Global Competitiveness Rank	57/144
Economic Freedom Index Rank	114/178
Human Development Index Rank	79/187
Major Industries	Services, industrials, agriculture, iron ore mining, oil exploration

Figure1: Brazil’s overall economic picture

Brazil’s comparative advantages:

Figure2: Pie chart of Brazil’s GDP component

Industry	Percentage in GDP	Percentage in Labor Force
Agriculture	5.71	62.70
Service	69.32	21.90
Manufacturing	24.98	15.30

Figure 3: Brazil’s major industries contribution to economy

Brazil is the biggest economy in Latin America, and is one of the BRIC economies. In terms of Brazil’s production, it is observed that its comparative advantage is in service, industrial and agricultural sector. Service sector, which includes banking and retail, is the most significant contributor to Brazil’s GDP. Industrial industry is the second most important contributor to the country’s GDP, this involves iron ore, machinery and transport equipment. Agricultural industry follows by it. It specializes in producing agricultural produce like sugar, coffee, beef, soybeans, and so on.

(A)Analysis on Brazil’s consumption:

During 1970-2013, Brazil’s household consumption per capita has increased by 27.5 times, to 6995.4 US dollars. The reasons of rising consumption are due to rise in disposable income, household wealth, and lower interest rate. Consumer- oriented sectors such as retail, automobile manufacturing, and financial services have been much benefited.

Figure4: Brazil’s rate of change in extreme poverty and income inequality

Firstly, it is noticed that Brazilian’s wealth has increased in recent years since Lula da Silva took office in 2002 and rolled out policies that redistribute income. Both extreme poverty and income inequality have decreased sharply throughout the years. Nowadays, more than half of the 200 m population Brazilians belongs to the lower middle class. Brazilians that belong to extreme poverty is lowered from 25% in 2001 to 7% in 2012. In comparison, the world extreme poverty hovered around 20%.

For instance the Bolsa- Familia scheme transferred money to poor families provided that children in the families are immunized and sent to school.

The above government policies increase people’s transfer payments, and thus disposable income, people then have extra money available to spend, and consumption expenditure increases. Initially, the transfer payment does not associate with GDP as there is no production of goods and services in return, but as the transfer payment are spent on goods and services by households, it benefits the consumption spending sector.

Figure 5: Rate of change of middle- class in Brazil

Besides, the growing middle class in Brazil also hints an expanded consumer class, which is significant in sustaining the country’s economy during the global crisis. In terms of changes in middle class, Brazil has 30% population as middle class in 2008/2009, compared to 15% that of China. Within Brazil, the C income group has increased from 37.6% in 2003 to 55.1% in 2011, and is projected to be 60.2% in 2014. A growing middle class means wealth of Brazilians increase, hence their purchasing power and consumption spending.

Besides, interest rate in Brazil has been decreasing since 2003, meanwhile Co- branded credit cards issued by banks and prominent retailers has become popular. The decrease in cost to borrow funds to finance consumption on durable goods encourages consumption spending.

(B)Analysis on Brazil’s planned investment changes

From the figure, it is noticed that investment of Brazil has hovered below 20% from 2001 to 2011, while that of China has increased from 36% in 2001 to almost 50% in 2011. The lack of momentum of growth in planned investment in Brazil is due to a large informal sector, and high interest rate.

Figure 6: Rate of change of interest rate in Brazil

First of all, it is worth noticed that a very significant factor that affects planned investment is interest rate. After the global crisis in 2009, in order to boost the economy, alternation was made in bankruptcy regulations. Subsidized loans from the state development bank were made available; this caused an almost double increase in availability of private credit since 2007. As risk of lending loans decreases, supply of loans (money) increase, and interest rate decreases. According to the World Bank, Real interest rate of Brazil, which is the interest rate corrected for the effect of inflation, has decreased from 47.7% in 2000 to 18.4% in 2014. Though Brazil’s real interest rate has decreased, it still belongs to a high level. In contrast, China’s real interest rate is 4.2% in 2014. A high real interest rate implies a high cost in borrowing loans. Hence, fewer loans are borrowed to finance investment spending.

Secondly, It is believed that the major reason that leads to unsatisfactory investment spending in Brazil is due to high business tax, which leads to prevailing informal sector. This encourage informal sector. Business tax in Brazil is as high as 36%. For comparison, business tax in China is much lower, at 25%. The rigid labor law in the country, which ensures minimum wage, and high cost in dismissing labors together makes investors unwilling to engage in formal sector. Inefficient tax system means mid- sized Brazilian firms have to spent 2600 hours a year to file their annual tax returns, this further drives away investors of formal sector. The entrepreneurs who work in these informal sectors are worried that their firms may be closed or confiscated by the government someday. Hence, investment is limited in these firms to minimize the potential loss. As a result, there is little investment spending on machinery and equipment. According to the World Bank, it is estimated that the size of informal sector in Brazil is 45%.

(C ) Analysis on change of government purchases

From the graph, it is noticed that since Lula took office in 2002, the gap between government spending and government revenue has increased. This indicates a more severe budget deficit. Primary balance in Brazil decreases from 3.4% in 2008 to 2.4% in 2012. In 2014, Brazil has had its biggest annual budget deficit. The country’s overall budget gap, including account debt servicing costs, doubled to 6.7% of GDP. In comparison, China had budget deficit in 2009, 2010, 2013, with a budget deficit of 0.1% of GDP in 2014.

This is due to Brazil’s quest to build a welfare state. Public spending has shot up from 22% of GDP to 36% of GDP in the last 25 years. And 50% of public spending is on pension. The country’s Constitution also guarantees free health care and a university education to its people.

However, is the lavish public spending on pensions a wise choice? As shown from the demographic graph of Brazil, Brazilian population is highly concentrated within the economically active population range. The dependency rate is low; the government shall encourage working- age adults in the labor force to financially support elderly at home, instead of splashing large public fund on pension.

Other problems surface with budget deficit in the country. The country’s net public debt has been wandered above 35%. As the country is having primary budget deficit, this harms the economy in servicing its sizable debt, on which it pays double- digit interest rates. It also posts a gloomier outlook on Brazil’s investment- grade credit rating. Investors are pessimistic about future profitability, thus reduce investment spending and aggregate demand. This causes multiplier effect and harms consumption sector. Sales and profits of firms decline as a result, less tax revenue is received by the government while more transfer payment in the form of unemployment benefit is paid by the government, this leads to a vicious cycle.

In response to widening budget deficit, since the Rousseff’s government took office in December 2014, it has decreased government expenditure by reducing pension and unemployment benefits.

When the government reduces unemployment benefit, it increases the opportunity cost of searching job, this increases the incentive for people to search for jobs. Frictional unemployment and duration of unemployment decrease. Unemployment rate decreases. Plus, the deduction on pension increases incentive for people to work harder when they are still in the labor force so they that can be self- sufficient when they retire. This increases productivity of the labor force.

Meanwhile the government plans to increase tax revenue by raising tax on cosmetics, personal loans, fuels and imports. However, tax on imports and fuels may impose a more severe inflation. Fuel is significant input of natural resources. Imposition of tax on imports increases production cost and leads to a negative supply shock. This increases producer price index and consequently consumer price index. In addition, when tax imposed on tax increases, domestically produced goods which use imports raw raw materials would bear a higher production cost. Producers then share the costs with buyers by raising prices. This cause imported inflation.

(D) Analysis of change in Brazil’s net exports

From 2001 to 2012, trade surplus was recorded in Brazil. However, in 2014, the country recorded a 12- month current account deficit, or 3.2% of GDP. Decrease in exports was greater than that of imports. In contrast, China, Brazil’s biggest trading partners, had record high trade surplus in 2014. In the past, trade surplus in Brazil is attributed to Brazil’s exports of commodities goods, namely raw goods. However, Brazil’s major exports like iron ore and soybean decline in global price, and demand is inelastic, hence export value decreases.

The Sino- Brazil trading relationship is worth to note.China is the biggest trading partner of Brazil. Brazil has enjoyed trade surplus with the Chinese counterpart. However, it is exports of raw goods like iron ore and soybean that contribute to trade surplus, meanwhile Brazil has a trade deficit of manufactured goods. The top three imports manufactured goods from China are high-end products like television, LCD screens, and telephones. In 2010, Brazil had a trade deficit of manufactured goods with China at US$23.5 billion. As the Brazilian market is increasingly dependent on manufactured goods from China, it triggers the deindustrialization in the country. Investment spending on factories, equipment and machinery decrease. Investment spending decrease. Aggregate demand and real GDP decreases.

Compared with raw goods, Brazil does not have comparative advantage in producing manufactured goods due to rise in its rising exchange rate in the past years and low productivity.

Firstly, The exchange rate of Brazil has been increasing since 2011. Each Brazilian dollar is exchanged for more foreign currency. Brazilian goods and services in foreign dollars sold in other countries are more expensive. Exports decrease.

Secondly, Brazil’s productivity is low due to poor infrastructure and its large size of informal sector. As mention, size of firms in Brazil is usually smaller with less capital investment as many of them engage in informal sector; this makes manufacturing firms in Brazil less productive. Beside, poor infrastructure also hints less productive manufacturing sectors. only 2% of GDP in Brazil is spent on infrastructure, compared to 5% by India and 13% by China. Poor infrastructures, like rigid roads an d patchy rail network increases freight costs for producers. This raised productive cost. This causes Brazil difficult to gain comparative advantage (lower opportunity cost in production than other countries) in its manufactured goods.

It is worth noticed that Brazil adopts protectionism, which lower imports value. The country taxes everything imported from cars to computers. The tax imposed on imported motor vehicles is as high as 30%. Import tax decreases supply of imports and leads to a higher import price, hence decrease value of imports if demand is elastic.

A more positive light is the weakened local currency. As net export decreases, it has a significant impact on the foreign- currency exchange market. Demand for dollars decreases. Foreigners need less domestic currency to buy domestic net exports. exchange rate decreases. This is expected to improve trade balance in the future.

Other economic problems:

(1) Inflation

In the mid- 1990s Brazil had a hyperinflation that hit a whopping 2100%. It was resulted from overprinting of money. Currency has to be changed for several times to bring price stability. The problem of inflation still hovers Brazil, and is increased from as low as 3% in 2007 to 7.4% in February 2015. In contrast, the price level of China is relatively stable. The inflation rate is 5.63% in 1986 to 2014.

The major reasons of fleeting inflation rates in Brazil are as follow:

Firstly, the recent cause of high inflation can be accounted with its physical factor, Brazil is experiencing severe drought which increases its cost of production. More than 60% of electricity in Brazil is generated by hydroelectric power. However, Brazil has been experiencing the most severe drought in 80 years since February of 2014, Mass black has occurred in the industrial south- eats, electricity rationing is to be practiced. This increases electricity fee. After all, electricity and other regulated prices are in input cost in the production, distribution and sale of almost every good and service. The supply shock increases cost of significant natural resources input, increase in production cost decreases short run aggregate supply, pushes up general price level.

Secondly, political factor is also accounted for fleeting inflation rate. As the government raised fuel taxes to narrow down its budget deficit, tax increase on fuel increases transport costs, and increases production costs. This supply shock decreases short run aggregate supply, thus increases general price level.

Last but not least, foreign trade factor is to be considered too. Brazil’s currency is rapidly depreciating, trading at its weakest level against foreign dollar since 2004. As Brazilian currency depreciates, there is imported inflation. Domestically produced goods whose inputs are imported are more costly to produce. Producer share the increased costs with consumers. This leads to imported inflation.

(2) Unemployment

Unemployment figure though seems optimistic, hints otherwise. From the figure , unemployment rate has decreased rapidly from 7.9% in 2008 to 4.3% in December 2014(actual). In comparison, China’s unemployment rate is 4.2% in 2014, and that of India is 4.9%. Unemployment rate is calculated as percentage of total unemployed people, divided by total labor force. The unemployment figure, though low, is distorted. The labor force participation in Brazil is low. A Reuters analysis of unemployment data found that the share of working- age people ‘not willing to work’ in Brazil’s six major cities have increased to 39% since 2002. In another word, about 2.5 million people have opted out of the labor force. This is roughly equivalent with number of unemployed.

The low labor force participation rate is caused by a longer time for adult- age population to stay at schools and receive better education, rather than finding jobs to support families. In the long run, this can increase pool of skilled labors. However, in the short run, this hints that the remains of labor force in the market may not be mostly high skilled ones. Producers have to pay a higher cost (wages) in recruiting and retaining qualified workers. This increase production cost and decreases short run aggregate supply curve, general price level increases and real GDP decreases.

Economic growths have lifted millions of Brazilians out of extreme poverty and have led many families into the middle class over the past decade. However, sustainable social gains in Brazil seem doubtful as for almost 3 years Brazil has grown very little or nothing at all. It is potentially headed for recession. Brazilian families who usually bought on credit will be no longer doing so. People are afraid to spend. Decline in consumption leads to less jobs created or available in the market, which creates a vicious cycle. I doubt if the middle class families can maintain their living standard or if some of them will be kicked out from the middle class, pitifully. Also, Bolsa Familia, the direct government payments to the poorest of the poor, may not help these people anymore as the government is planning big spending cuts. The disastrous economic performance hit the middle class and the extreme poor.

http://www.bbc.com/news/business-31658750

News 1

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Brazil Worst Budget Deficit Shows ‘Tougher Measures’ Needed

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