Brazil: Economic Downturn an Opportunity for Improvement

The Brazilian economy, which has expanded greatly since the mid-1990s, is slowing down. In fact, Brasilia estimates that the economy will grow by only 1.85 percent in 2012, compared to the 8 percent growth it saw in 2010. Growth in the country's real estate sector is also slowing, and there are signs of stress in Brazilian credit markets. Foreign direct investment has dropped from $12.4 billion in the first half of 2011 to $7.5 billion in the first half of 2012. Domestically, Brazilian companies are delaying an estimated $95 billion in investments. Brazil initially emerged from the international financial crisis unscathed, but South America's largest economy now faces serious economic challenges.

In response to these challenges, the government will implement several reforms to stimulate growth and curb spending. The reforms will address key areas such as infrastructure construction, labor relations, the pension system and the cost of electricity. A major goal for the government is to make Brazilian producers more competitive in domestic and international markets.

Reforms and Challenges

Brazil desperately needs to improve its outdated and insufficient infrastructure. As a part of the infrastructure reforms, the Rousseff administration will lead the effort to privatize Brazilian ports in much the same way it has led the effort to privatize the country's airports. Currently, Brazil's ports are operated by state or municipal governments, which struggle to maintain — let alone upgrade — the ports' dilapidated facilities. Privatization measures led by the Rousseff government will require congressional approval at the federal level.

The reforms will also address land transportation infrastructure. Media reports suggest that the Rousseff administration is planning to solicit bids from private companies to build 5,700 kilometers (roughly 3,500 miles) of highway and 5,000 kilometers of railway.

Brazil Locator Map

The government also plans to address Brazil's high electricity costs. Taxes constitute 45 percent of the end cost of electricity in Brazil. Of those taxes, 50 percent are federal, 47 percent are state, 2.5 percent are labor and 0.5 percent are municipal. A measure to reduce federal taxes on electricity has already been sent to the Brazilian legislature, and the Rousseff government has plans to work with state governments to reduce their share of taxes.

Labor reform also will be included in Rousseff's proposals. Although details are not yet available, the government is planning to reduce the cost of hiring Brazilians and to streamline the hiring process. Moreover, after the October elections the government will send to the legislature a proposal intended to give employers and employees more flexibility in labor contracts. The proposal would set a minimum retirement age of 65 years for men and 60 years for women (currently, men may retire after 35 years of service and women after 30 years of service). Any new changes will come alongside a measure that has already been approved by the legislature to eliminate a mandatory 30 percent pension contribution by employers. With this cost removed, additional reforms would significantly reduce the employee burden on employers.

The details of these measures will emerge this week and most will likely change over the coming months as the reforms work their way through the Brazilian legislative process. There will be little political opposition to liberalizing reforms for transportation infrastructure — highway and rail projects do not require legislative approval — but the sheer scope of the projects will create obstacles in financing and overcoming bureaucratic barriers.

Labor reform will pose the biggest challenge for the Rousseff government. Labor laws have hurt foreign investment for many years, and Brazil's powerful unions will likely resist changes to labor laws. Persuading state and municipal governments to reduce taxes on electricity will likewise encouter opposition. Despite potential gains to businesses, states may be unwilling to give up revenue generated by high state taxes.

A Decisive Moment

In the wake of the international financial crisis, increased commodities exports — mostly to China — buoyed Brazil's economy. But now Brazil is feeling the effects of its weakening manufacturing sector and strong currency that, along with higher consumer confidence, have spurred a consumer boom in Brazil. Brazil's challenges in infrastructure and labor historically have significantly contributed to limiting Brazil's growth potential. Rousseff's proposed reforms, in addition to several other changes that have been initiated in recent months, will face enormous hurdles before they are implemented.

These challenges notwithstanding, Brazilian development has come to a decisive moment. The 1990s were a decade of chaotic reform that set the stage for a decade of stability. Stability allowed Brazil to take advantage of high commodity prices while building up a manufacturing sector that was protected from outside competition and designed to service the domestic market. However, the global downturn hit Brazil's manufacturers hard, forcing Brazil to face the limitations of its uncompetitive producers. Reducing taxes, improving infrastructure and lowering bureaucratic barriers are necessary steps in Brazil's ascendance as an international economic power. With a government willing to make politically difficult decisions and confront major power brokers, including unions, this downturn may end up being a boon for Brazil in its quest for global economic status.