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Dreaming of glory

A special report on Brazil l April 14th 2007

Brazil is big, democratic, stable and rich in resources, says BrookeUnger. So why is it not doing a lot better?

(over six feet) shallower than it should be.The state environment regulator is with-holding permission to deepen it. Transportcosts consume nearly 13% of Brazil’s GDP,�ve percentage points more than in theUnited States, according to Paulo Fleury ofCOPPEAD, a business school in Rio de Ja-neiro. And that is only a small part of theburden that businessmen refer to despair-ingly as custo Brasil (the cost of Brazil).

Fecundity and frustration sum up thestate of Brazil these days. It is bursting withthe commodities coveted by the risingeconomies of Asia, from soya to iron ore.No other country is better placed to cash inon the global craze for biofuels. Yet Brazilrefuses to grow in line with the expecta-tions of its 188m people. Since the end ofthe �miracle years� of the 1960s and 70s,when it was the world’s second-fastest-growing large economy, Brazil has lagged(see chart 1, next page). In the past fouryears, whereas developing countries as awhole have grown at an average of 7.3%,Brazil has loped along at 3.3%.

In 2003 Goldman Sachs, an investmentbank, selected Brazil, along with Russia, In-dia and China, as one of the four �BRICs��the developing countries that would sharedominance of the world economy by2050. It has been the slowest-growing by

Heavy goingThe biggest enemy of Brazil’s promise is anoverbearing state. Page 3

The blessings of stabilityLower in�ation has done wonders for �nanceand industry. Page 5

The economy of heatNature has been almost too kind to Brazil.Page 6

The �nal frontierFor Brazilians, land still has a mythical quality. Page 8

Rich man, poor manE�orts to reduce poverty and inequality arebearing some fruit. Page 9

Low marksEducation is still letting the country down.Page 11

The slow road to paradiseWhy Brazil is taking so much time to reach itspotential. Page 12

No end of violenceLaw enforcement remains a weak spot. Page 13

The Economist April 14th 2007 A special report on Brazil 1

1

Land of promise

ON THE right bank of the wide channelthat constitutes the port of Santos,

Brazil’s biggest, the Orange Wave awaits acharge of orange juice for delivery to NewJersey. The North King, of Panamanian reg-istry, is taking on soya grown somewherebetween Brazil’s temperate south and thesavannahs of the centre-west. Further ongleaming ranks of cars await their vessel.Portside terminals, once owned by thestate, now display corporate heraldry: thelogos of Cosan, a sugar and ethanol pro-ducer; Bunge, a global food trader; andAmerica’s Dow Chemical. Last year San-tos broke its 1909 record for exporting cof-fee, the commodity that midwifed the portin the 19th century.

The Victorian majesty of berthed shipsgives no hint of the di�culties the cargomust overcome on its way to and fromSantos, which handles 27% of Brazil’s inter-national trade. For soya these can start inthe �eld, where scarce storage sometimesforces growers to dispatch it to port regard-less of price. Then it faces a bumpy journeyon potholed roads (80% of the cargo ar-rives in Santos by lorry rather than by rail).Privatisation of the terminals and bettertra�c management have boosted theport’s e�ciency, but ships must still awaithigh tide to clear the channel, which is 2m

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Exchange ratesBrazilian real, March 30th 2007

$1= 2.05 ¤1= 2.72

¥100= 1.73 £1= 4.01

2 A special report on Brazil The Economist April 14th 2007

2 far, leading some Brazilians to wonderwhether the �B� would be dropped. SouthKorea’s income per person overtook Bra-zil’s in the 1980s; it may not be so long be-fore China’s and India’s do the same.

Brazilians have non-economic groundsto fret, too. In its �rst crack at nationalpower the Workers’ Party (PT) of PresidentLuiz Inácio Lula da Silva�which used tocrusade against corruption�orchestrated abaroque scheme involving bribes to Con-gressmen in exchange for votes, known asthe mensalão (monthly allowance). TheCongress that ended its four-year mandatein December is widely reviled as �theworst in history�. Within the past year Bra-zil’s two biggest cities, São Paulo and Riode Janeiro, have been terrorised by gangsoperating from inside the prison system.Education, perhaps Brazil’s biggest failing,seems to be getting worse rather than bet-ter. Air travel has been crippled followingthe mid-air collision last year between apassenger plane and an executive jet. Bra-zil is �falling to pieces�, lamented Lya Luft, acolumnist for Veja, the biggest news maga-zine, last year.

What’s the problem?If so, many Brazilians appear not to havenoticed. President Lula resoundingly wonre-election last October, largely on thestrength of support from the poor. Theirliving standards have been soaring, thanksin part to handouts from the federal gov-ernment. Income inequality, from whichBrazil su�ers more than most other coun-tries, has at last begun to shrink.

The same is true of in�ation and its lin-gering symptom, high real interest rates.The introduction of the real as Brazil’s cur-rency in 1994 ended decades of high in�a-tion. Many observers feared that Lulawould rekindle it when he was �rst electedpresident in 2002. His PT had opposed theReal Plan. The risk premium on Brazil’sbonds soared. But Lula realised that in�a-tion hit the poor most. Defying his com-panheiros, he has entrenched stability,faithfully sticking to the policy �tripod�put in place by his predecessor and politi-cal foe, Fernando Henrique Cardoso: aprimary surplus (ie, before interest pay-ments) high enough to reduce debt as ashare of GDP, a �oating exchange rate andin�ation targets.

Helped by global enthusiasm for Bra-zil’s goods and �nancial securities, the Car-doso-Lula tandem has wrought an econ-omic miracle of a di�erent sort. In�ationlast year was only 3%, below the target of4.5% set by the central bank. The markets

expect it to remain below target this year.Real interest rates are at their lowest levelsince 2001. The risk of a panic abroad trig-gering a crisis at home, which often hap-pened during the 1990s, has diminished.Exports and the trade surplus have soared(see chart 2), pushing foreign-exchange re-serves above $100 billion. When Brazil be-came independent in 1822 Britain insistedthat it assume the debts of the Portuguesecrown. Now Brazil’s government is an in-ternational creditor. An investment-gradecredit rating is probably only a matter oftime. When Lula �nishes his second termin 2010 Brazil will have enjoyed �16 yearsof stability and predictability�, says Mail-son da Nóbrega, a former �nance ministerwho now heads Tendências, a consul-tancy. That is an important and sometimesunderrated discount on custo Brasil.

In some ways Brazil is the steadiest ofthe BRICs. Unlike China and Russia it is afull-blooded democracy; unlike India ithas no serious disputes with its neigh-bours. It is the only BRIC without a nuclearbomb. The Heritage Foundation’s �Econ-omic Freedom Index�, which measuressuch factors as protection of propertyrights and free trade, ranks Brazil (�moder-ately free�) above the other BRICs (�mostlyunfree�). One of the main reasons whyBrazil’s growth has been slower thanChina’s and India’s is that Brazil is richerand more urbanised.

This special report will argue that dis-gruntlement persists because Brazil is abattleground between progress and iner-tia. Since independence was proclaimedby the son of the Portuguese king, Brazilhas been adding layer upon layer ofchange rather than sweeping away the oldand starting afresh. The 1988 constitution,which restored democracy after 20 yearsof military dictatorship, did not abolishthe culture of cordialidade, which in poli-

tics means the primacy of personal bondsover rules. Liberties and electoral rights areentrenched, says the former president, MrCardoso, �but there’s a lack of citizenship,of respect for the law. Democracy meansthat, too.�

Too much, too soonThe constitution too readily createdrights�of bureaucrats to job protection, ofsub-national governments to tax reve-nues, of ordinary citizens to governmenttransfers�that Brazil can ill a�ord. Theyhelp explain why real interest rates remainamong the highest in the world, why pub-lic investment in roads, ports and other in-frastructure is stunted and why the taxburden be�ts a rich European welfare staterather than a young developing economy.

Brazil is thus in the midst of a slow me-tamorphosis in its economy, society andpolity. �Contemporary Brazil is a hybridbetween two moralities: one unequal andhierarchical, the other universal and egali-tarian,� argues Jacqueline Muniz, an an-thropologist in Rio de Janeiro. Rigid legal-ism sits alongside rampant illegality, and avibrant private sector coexists with a scle-rotic state. President Lula, who presentedhimself as the scourge of old-style oli-garchs, now governs with their help. Fewmodernisers are untainted by the past.

Although progress is slow, Brazil’s insti-tutions are now strong enough to make itreasonably sure. Goldman Sachs recentlyrea�rmed the country’s BRIC status. Econ-omic growth may top 4% this year. WhenGDP �gures were revised in March, Brazildiscovered that it was richer and less in-debted than it had thought. It could do bet-ter still. But that would require another in-sight from Lula, as important as hisconversion to low in�ation: that the mainobstacle to progress is the state itself. 7

1Plodding

Sources: Penn World Table;

Economist Intelligence Unit

*At purchasing-power

parity in 1996 $

GDP* per person, $’000

1950 60 70 80 90 2000 05

0

5

10

15

20

RussiaSouth Korea

BrazilChinaIndia

2Going global

Sources: Ministry of Development, Industry and Trade;

Economist Intelligence Unit

External trade

2000 01 02 03 04 05 06

0

30

60

90

120

150

6

4

2

0

2

4

+

–

Exports, $bnImports, $bn

Current-accountbalance as % of GDP

1

The Economist April 14th 2007 A special report on Brazil 3

IN 2002 Caio Mesquita and Marcelo Fer-raz quit jobs in �nance and publishing re-

spectively to start Wraps, purveyors of�healthy and tasty� meals at seven restau-rants across São Paulo. Sometimes theywonder why. Their competitors evadetaxes (one trick is to put individual eateriesin the names of friends and relatives toqualify for small-business tax breaks). Thelabour laws, they say, �are almost impossi-ble to comply with� (although they do):people who wash dishes are not allowedto clean tables, and vice versa. Of theseven sta� in Wraps’ corporate headquar-ters, two do nothing but ward o� lawsuitsfrom former employees. The readers ofwater and electricity meters sought bribesto cut their bills. A policeman who came toinvestigate a robbery was more interestedin selling his private security service. �I feltlike I was in Baghdad,� says Mr Ferraz.

To experience the state as meddlesome,covetous, ine�cient and corrupt is no rar-ity in Brazil, and no novelty either. MarcosFernandes of the Fundação Getulio Var-gas, a business school, traces the origin of a�rent-seeking state� to 1808, when Napo-leon chased Portugal’s royal family to Bra-zil. Mussolini helped inspire the EstadoNovo of President Getúlio Vargas in 1937,whose system of labour and industrialsyndicates is the basis of today’s labour re-lations. The 1988 constitution was politi-cally liberating but economically sti�ing.Indeed, Brazil’s modest growth is a tri-umph over state-sponsored adversity.

The Brazilian formula is to crowd outenterprise or drive it underground with ex-cessive spending and taxation, then to ha-rass it further with capricious, nonsensicalregulation. Last year the state’s tax take setanother in a series of records, at 35% ofGDP, much higher than the average of itsdeveloping-country peers (see chart 3). Nosurprise, then, that the grey market ac-counts for a much higher proportion of theeconomy than in Mexico, China or India,according to the International FinanceCorporation (IFC), part of the World Bank.Informal �rms underinvest and weakentheir formal-sector competitors. McKin-sey, a consultancy, thinks this is the biggestdrag on productivity. Infrastructure invest-ment, now shy of 2% of GDP, should be at

least 3%. To match South Korea’s infrastruc-ture Brazil would have to treble that, ac-cording to the World Bank. Despite its free-spending ways, the state cannot a�ord todo that, yet it has discouraged the privatesector from �lling the gap. Overall invest-ment, though growing, is an underpo-wered 16.7% of GDP.

The political left blames the centralbank for keeping interest rates high. Butmost of the responsibility lies with thestate’s excesses, which have built up a netpublic debt running at 45% of GDP and arenow stoking demand while restrainingsupply. The solutions lie in a long to-do listof reforms which has been around foryears without making much headway.The tax system, pensions and labour lawsare all in need of redesign; trade needs tobe liberalised further; spending should bemore �exible; and the central bank shouldbe given formal autonomy (in practice itgets a free hand to hit in�ation targets).

All this is part of a more ambitious pro-ject that is not on the political agenda: athorough review of the role of the state,

which would reconsider how it taxes andspends, how it makes and enforces rulesand to what extent it should be directly in-volved in �nance and infrastructure.

Spend it wiselyApart from debt service, the federal gov-ernment spends its money mainly onthree things: pensions, transfers to lowerlevels of government and its own bureauc-racy. In none of these areas is spending ef-�cient or equitable. Take pensions. Brazil isa young country with the pension costs ofan old one. With 6% of its population overthe age of 65, Brazil spends 11% of its GDP

on publicly �nanced pensions. A bigchunk of this goes to workers in the formalsector, who can retire after contributing tothe system for 35 years (30 for women) re-gardless of their age. More than 60% ofworkers who bene�t from this scheme re-tire by the age of 54. Besides Brazil, only afew big oil-exporting countries have suchan indulgent system, says Fabio Giambiagiof IPEA, a think-tank with links to the gov-ernment. In his second term as presidentMr Cardoso tweaked the rules to discour-age early retirement, but that provoked anexplosion of claims for disability bene�ts,which trebled between 2001 and 2005.

Two-thirds of all pensions pay out theequivalent of the minimum salary (now380 reais a month), which has doubled inreal value since 1994. Many of these go tobene�ciaries who have not paid into thesystem. This encourages people to work inthe informal sector, because if they will getthat pension anyway they have no incen-tive to contribute. Demographers have no-ticed an unusual upsurge in marriages be-tween pensioners and much youngerpartners in the countryside, probably pro-voked by this bene�t. Spending on pen-sions in the private sector has risen frombelow 6% of GDP in 1996 to 8% now.

On top of that comes the cost of publicservants’ pensions, which is about halfthat of the private-sector scheme but bene-�ts a group of people only one-eighth thesize. One of the Lula government’s �rst�and bravest�acts was to raise the mini-mum retirement age for public servantsand to tax people on high earnings whohad previously retired with a pay rise.

Heavy going

The biggest enemy of Brazil’s promise is an overbearing state

3A greedy state

Source: Brazilian Institute of Tax Planning

Government tax revenues as % of GDP

2004

Federal State Municipal

0 10 20 30 40

OECD average

Brazil

South Korea

Argentina

Mexico

Russia

China

1988 90 92 94 96 98 2000 02 04 060

10

20

30

40

1

4 A special report on Brazil The Economist April 14th 2007

2 The federal government’s second bigtask is to transfer revenue raised primarilyin the rich states of the south-east to stateand municipal governments mainly inpoorer states. These transfers more thandoubled in real terms between 1995 and2004. Such redistribution is justi�ed byBrazil’s regional inequalities, which persistdespite the spread of industry beyond itsSão Paulo heartland. Average income inthe north-east is only two-�fths that in thesouth-east.

Transfers play an important part inholding the country together; they are�why we don’t have separatism�, says JoséRoberto Afonso, a specialist in public �-nance. But the money, spent mainly onhealth, education and administration,rains down on 27 states and 5,564 districtsthat di�er vastly in their capacity to spendit well. Despite the redistributive intent,some of the criteria applied militateagainst justice and e�ciency. Brazil’s fed-eral system makes no distinction betweenforested provinces and the metropolis ofSão Paulo with its population of 10.8m.�Every municipality has competence to doeverything, which is absurd,� says RaquelRolnik, the national urban secretary.�Most don’t have capacity.� More thanhalf rely for most of their revenue on trans-fers from federal and state government.

Revenue without responsibility is abad idea. The more that municipalities de-pend on transfers, the more they spend onadministration and the less they invest ininfrastucture and social programmes.States that get a lot of their revenue fromthe central government pay bureaucratsmore relative to private-sector workers. Aminimum grant for municipalities wassupposed to help the poorer ones, but alsoencouraged hundreds of them to breakthemselves up into smaller and less e�-cient units. It also disproportionately ben-e�ted the rich south and south-east, whichhas most of the smaller districts. The con-stitution stipulates that health spendingmust rise with GDP, guaranteeing thatmuch of it will be wasted.

Fat and �abbyThe bureaucracy, the third big spendingcategory, is neither lean nor agile. On aver-age, public servants earn more than twiceas much as workers in the private sectorand have an easier life. The constitutionprotects them from dismissal. Merit tendsto be measured by the number of trainingcourses they have attended rather than bytheir competence. Some 20,000 federaljobs are �lled by political appointees. Nel-

son Marconi, of the Fundação Getulio Var-gas, believes that public employmentcould �easily� be slashed by 30% withoutmaking services worse.

Successive governments have, in e�ect,built a �scal escalator that mainly goes up.Presidents can, and often do, speed its as-cent, for example by raising the minimumwage, but have enormous trouble slowingit down. Financial catastrophe has beenavoided by raising taxes and squeezing in-vestment. But, says Raul Velloso, an experton public �nance, investment has a �oorand taxation a ceiling. The government’s�growth acceleration package�, an-nounced in January, tries harder to lift in-vestment than to lower taxes, and allowsfor the possibility of a lower primary sur-plus to pay for it. That can work as long asinterest rates are falling. But if the balmy �-nancial weather changes, the governmentwill face hard choices.

What Brazil loses in e�ciency it doesnot gain in poverty alleviation. Becausemost revenue comes from consumptiontaxes, a Brazilian earning less than twicethe minimum wage pays out nearly halfhis income in tax, whereas someone on 30times the minimum wage pays only abouta quarter in tax. Such bene�ts as pensionsand free tuition at public universities �owdisproportionately to the well-o�. In a re-cent study comparing the redistributive ef-fects of taxation and spending in 16 coun-tries, most of them rich, Brazil came last bya long way.

Government bureaucracy can be da-maging too. In a league table of the ease ofdoing business in 175 countries, the IFC

ranked Brazil 121st. The average �rm takes2,600 hours to process its taxes, a world re-cord. Opening a business, on average, re-quires 17 procedures and 152 days, putting

Brazil in 115th place. Hiring people is ex-pensive because taxes add 60% to salariesand workplace rules are an invitation tocon�ict. At Unibanco, a big private-sectorbank, the turnstiles are programmed tokeep workers out of the building until aminute after their allotted lunch hour; aminute too soon and they could demandextra pay. Despite such precautions, thebanking sector alone is embroiled in160,000 cases in the labour courts, whichare faced with a total of 2m new cases ayear. The solution? �Try to have as fewpeople as you can,� says Pedro MoreiraSalles, the bank’s boss.

Investing in infrastructure is a legal andregulatory adventure. Investors do nottrust the supposedly independent regula-tory agencies. Brazil’s �nance minister,Guido Mantega, insists that �it’s not truethat the government is hostile to regula-tory agencies.� But the World Bank main-tains that �the majority of the agencies donot have full autonomy and are subject tointerference from other [government] or-gans.� Courts can delay projects for yearsat the behest of angry environmentalistsor disappointed bidders. �It always takestwice as long as you estimate to imple-ment an infrastructure project in Brazil,�says one �nancier.

At your serviceBrazilians yearn for a state that behaveslike the servant of its citizens. RaymundoMagliano, the president of the São Paulostock exchange, ended a recent interviewby recalling a trip to the Antipodes, wherebureaucrats in New Zealand have no jobsecurity and the tour guide at the parlia-ment in Canberra knows exactly howmuch the institution costs each Australiancitizen. Brazil is not ready for that. Toomany lobbies have an interest in keepingthe system as it is.

Despite the grumbling, there have beensome successes. Judicial reform was �oneof the few that advanced�, says JoaquimFalcão, a member of a council newlycreated to oversee the judiciary. It crackeddown on nepotism, resulting in �thou-sands� of dismissals over the past twoyears. The súmula vinculante, a new mech-anism under which lower courts have tofollow the Supreme Court’s decisions, willstrip �millions of cases� out of the cloggedcourt system, Mr Falcão predicts. State gov-ernments are speeding up procedures foropening businesses. The federal govern-ment recently ended the monopoly of thestate-owned reinsurance underwriter. Anew regulatory framework for sanitation

4Growing largesse

Source: Raul Velloso

*Excludes debt service and transfers †Includes

pensions for public-sector workers

Federal government spending*As % of GDP

1995 97 99 2001 03 05 060

5

10

15

20

Pensions

Personnel†

Health

Other

1

The Economist April 14th 2007 A special report on Brazil 5

2 should encourage private investment. Lula’s critics indict him as a lucky bum-

bler who may have kept Brazil out of trou-ble but has done nothing to improve itsprospects. That is not entirely true. But hissecond term may be less productive thanhis �rst. His main economic initiative aimsto simplify an incredibly cumbersome sys-tem of state-based sales taxes, laying thegroundwork for a national value-addedtax. That would be wonderful, but it de-

pends on the government buying o� thepotential losers. The government hasstarted to tackle fraud in the pension sys-tem and has created a forum with businessand labour representatives to deal withknottier pension problems, but this looksmore like a device for avoiding the issue.Other high-pro�le plans, such as labour-market reform and central-bank auton-omy, seem to be o� the agenda. DilmaRousse�, Lula’s chief of sta�, describes the

growth acceleration package as �publicmoney direct to the vein.� That, not re-form, is the government’s passion.

In spite of everything, Wraps is pros-pering. It is talking to a German entrepre-neur about opening a branch in Frankfurt.Its habit of paying taxes and obeying therules is making Wraps attractive to private-equity funds. Last year the chain’s pro�tsexceeded the return on investing in gov-ernment bonds. That is big news. 7

BRAZIL is the country of the future andalways will be, goes a sour old joke. In

fact, the opposite is true. Brazil has neverput much stock in the future, and that hasheld it back. Brazil’s three founding cul-tures lived for the present, argues EduardoGiannetti, a philosopher and economist atIBMEC, a private university. IndigenousBrazilians had no need to plan; the Portu-guese came for quick enrichment; andslaves, who did not even own their ownbodies, had no reason to invest in any-thing. After a dozen years of economic sta-bility, �Brazil is beginning to take a longerperspective,� says Mr Giannetti.

The e�ect has been subtle but far-reach-ing. Corner shops are gaining market shareat the expense of supermarkets, againstthe global trend, because housewives nolonger spend money as quickly as they getit to beat in�ation, says Fábio Prado of Uni-lever, a consumer-goods giant. There is nolonger a need for court-clogging lawsuitsto challenge the way that savings and pen-sions are adjusted for in�ation. Invest-ment in innovation seems more worth-while. Enterprises are planning for thelong term and investors are beginning toback them.

Brazil’s receding riskiness and a globalabundance of liquidity have narrowed thedi�erence in yields between Brazilian andAmerican bonds to less than two percent-age points, down from 24 points just be-fore Lula was elected (see chart 5, nextpage). The drop in domestic interest rates ispushing investors to look for alternativesto short-term government bonds. Theeconomy may be trotting, but credit, prop-erty and the stockmarket are o� at a gallop.

In the hyperin�ationary 1980s, 70% ofUnibanco’s pro�ts came from ��oat reve-

nue�, placing free deposits in high-yieldgovernment paper. That �nancial child’splay now accounts for only 1% of its in-come. As late as 2002, eight years into thereal era, bank credit to the private sectoramounted to less than a quarter of GDP.That has now leapt to 34%. Only in the pastfew years have banks launched them-selves into large-scale lending, startingwith credit cards and hire-purchase �-nance for consumers (still at absurdly highinterest rates). More recently lower-rateloans secured on the borrower’s paycheque or pension have taken o�. Big com-panies can raise money on the capital mar-kets, but banks are still wary of lending tosmall business.

Enterprises raised a record 70 billionreais through debentures last year, 60%more than in 2005 and �ve times the levelin 2002. The stockmarket last year set a 20-year record for the number of new listings.It used to be dominated by state-ownedcompanies and enterprises that issuemainly non-voting shares, which enablescliques of shareholders to control themwith relatively small �nancial stakes. Thenewcomers are a di�erent breed. Almostall list on the Novo Mercado (new market),which mandates full voting rights for allshares and high standards of corporategovernance. They leaven the stockmark-et’s menu of infrastructure companies andheavy industry with retailers, technology�rms and airlines. Their managers are will-ing to risk control for growth.

Some are poised to change their indus-tries. Totvs, a supplier of managementsoftware, used nearly half of the 460mreais it raised to buy a rival. DASA, a chainof medical laboratories, is absorbing com-petitors as it expands from its home mar-

ket in São Paulo to the rest of Brazil andeventually to Latin America. Cosan plansto consolidate the ultra-fashionable sugarand ethanol industries. Last year set a re-cord for mergers and acquisitions, fuelledin part by the capital raised through initialpublic o�erings, says Cláudio de Leoni Ra-mos of KPMG, a consultancy. Many of thedebutantes were ushered to the market byprivate-equity investors, who after a longdelay can now take their pro�t and chasenew opportunities.

Safe as housesOne of the biggest pay-o�s from �nancialnormality will come in property and con-struction. Property �nance, throttled by in-�ation, low incomes and a legal system

The blessings of stability

Lower in�ation has done wonders for �nance and industry

A property boom on the horizon

1

6 A special report on Brazil The Economist April 14th 2007

2 that failed to protect lenders, amounts to anegligible 3-4% of GDP. This leaves Brazilwith a shortage of 8m houses and hugepent-up demand, especially from thepoor, who tend to build their own dwell-ings one room at a time. Mexico has 60% ofBrazil’s population but builds four timesthe number of houses, says Sérgio Rossi ofRossi Residencial, a builder. Now builderslick their lips at the prospect of �Mexicani-sation�, thanks to stability and better loanguarantees. Property and constructioncompanies are prominent among thoseheading for the Novo Mercado.

Property lending doubled in 2006,partly because of lower interest rates andpartly because arcane rule changes madeit safer. Foreclosure can take up to 12 yearswith a traditional mortgage, but a newishtype of loan, which withholds full controlof the property until it is paid o�, cuts thetime of repossession to 12-18 months. Thisis part of a broader credit reform which iscoaxing banks to take more risk. Under alaw passed in 2005, lenders with collateralhave moved ahead of the government inthe creditors’ queue for debtors’ assets. Thenew law �has given con�dence to lendersto approach companies which they wouldnot have done under previous regula-tions�, says Unibanco’s Mr Moreira Salles.

Normalisation has further to go. De-posits are still too short-term to allowbanks to �nance many property loans of

15 years or more, and �nance is still too ex-pensive for the mass of poor Brazilianswho need it most. Builders are beginningto move down the economic pyramid, butslowly. Ga�sa, a publicly quoted construc-tion company, is starting a separate enter-prise to build houses at prices up to150,000 reais, but that is still out of mostpeople’s reach. The main bene�t to thepoor of a construction boom, at least at�rst, is likely to be the jobs it will create.

Another mouthwatering prospect isthat of private investors underwriting theports, power plants, roads, sewage andother infrastructure projects that Brazil sopatently needs. There is plenty of moneyaround. �Today, �nancing is not a serious

problem,� says Martus Tavares of BRVias, anew infrastructure-investment �rm. Whatis a problem is the state’s obstructionismdescribed in the previous article. In Janu-ary the government suspended a long-awaited concession of 2,600 km of federalroads on the ground that returns to inves-tors of nearly 13%, the ceiling set by the gov-ernment’s audit court, would be too gener-ous. At that rate, says Mr Tavares, morethan 30 enterprises would have bid, possi-bly driving the yield lower. Below 12%there is �not much interest�.

The government is convinced that Bra-zil is on the verge of an investment-gradecredit rating and economic growth of 5%.That is why investors are crowding aroundBrazilian infrastructure projects like thirstysheep. If it comes to pass, any concessionpaying 13% (or more) will deliver a wind-fall. The government has shrewdly gaugedinvestors’ greed but overlooked their fear:that the projects will be mired in expensivedelays, that the government will changethe rules, or that an investment-grade rat-ing will remain beyond reach.

But it would take a disaster to bringback the days when the only sensiblething to do with one’s money was to spendit immediately, or else invest it in govern-ment paper. As Álvaro Gonçalves of Stra-tus, a private-equity �rm, puts it, �the Bra-zilian economy is now turning toward thereal sector.� 7

5Calm after the storm

Source: Thomson Datastream

Government-bond spreads and inflation

2002 03 04 05 06 070

5

10

15

20

25Spread over US Treasuries,% points

Consumer-price inflation,%

APINE tree in a Finnish forest takes 50years before it can be pulped and

milled into paper. A eucalyptus tree in Es-pírito Santo, on Brazil’s coast, is ready inseven. Growers in Petrolina, in Brazil’snorth-east, harvest grapes twice a year,twice as often as their competitors inFrance. Sadia, a meat producer, needs noelectricity to heat its chicken houses, un-like its competitors in colder climates. Bra-zil has more than its fair share of theworld’s sun, soil and water, and in manyof the products based on those ingredi-ents, including soya, sugar and beef, it maybecome pre-eminent.

This natural advantage revives an oldanxiety. For much of the 20th centurycountries at the periphery of the richworld lamented their dependence on

commodities (for Brazil it was sugar, co�eeand rubber) and yearned to become mod-ern industrial economies. Beginning withGetúlio Vargas, a succession of strong pres-idents frogmarched Brazil into the indus-trial age, often with little regard for cost orcompetitive advantage. The partial open-ing of the economy in 1990 by the debon-air Fernando Collor, who was later im-peached for corruption, shocked industryinto modernisation.

Now Brazilians worry about slippingback into their commodity-dependentrole. Brazil’s success in selling raw materi-als and other basic products pushes up thereal, which makes other Brazilian exportsless competitive and exposes industry tocheap imports, especially from China. Thisis leading to talk of �deindustrialisation�

and �Dutch disease�. �We’re competitivewhere nature has helped,� says EugênioStaub, head of Gradiente. He does notcount his company’s televisions and mo-bile phones among the bene�ciaries.

So far there is little evidence of whole-sale deindustrialisation. The share of ex-ports based on natural resources did risesharply between 1989 and 2005, but halfthe gain came from petroleum, and manu-facturers of medium- and high-technologygoods also increased their shares slightly.A study by BNDES, the national develop-ment bank, concluded that there was nogeneral shift in production to natural-re-source-based industries.

But the real has stayed strong, and wor-ries have grown. Last year the trade sur-plus in manufactures fell for the �rst time

The economy of heat

Nature has been almost too kind to Brazil

1

The Economist April 14th 2007 A special report on Brazil 7

2 since 2000, notes Edgard Pereira, chiefeconomist of IEDI, an industry associa-tion. The March revision of GDP �guresshowed that services had a bigger shareand industry a smaller one than previ-ously thought. Domestic consumptionand investment are growing at a healthypace but manufacturing is not keeping up,in part because demand is being �lled byimports. Labour-intensive products suchas shoes and clothing are under the mostpressure. The (protected) car industry isbooming, thanks to easier credit. But thisyear the strong real forced Volkswagen toscrap its plan to use Brazil as the exportbase for Europe of its compact Fox model.The country is in little danger of becomingan open-air greenhouse. But its economymay be starting to specialise, which is bothpainful and exhilarating.

Sweet smell of successLuckily, the economy of heat is diverse.The showcase is ethanol. Brazil’s variety,based on sugar cane, is cheaper than any-one else’s and has encouraged a lot of in-novation beyond the basic commodity.�With biofuels we’re suddenly at the fore-front,� says Fernando Reinach of Votoran-tim Novos Negócios, which runs a ven-ture-capital fund that invests in ethanoltechnology.

This is a turnaround for the sugar busi-ness, previously notorious for exploited la-bour, insolvency and pollution. Ethanolgot started after the oil-price shocks of the1970s, when dictators induced the car in-dustry to convert from petrol that Brazilcould no longer a�ord. The Proálcool pro-gramme ended with a hangover around1990 as oil prices fell and cane growersswitched back from ethanol to sugar, in-furiating drivers of ethanol-only cars.

But it left behind a system for distribut-ing ethanol to petrol stations which sud-denly looks like a national treasure, thanksto two recent developments. One is theBrazilian invention of �ex-fuel cars whichcan run happily on any combination ofethanol and gasoline. Introduced in 2003,these cars, which enjoy a small govern-ment subsidy, cost no more than single-

fuel models and now account for 83% of allnew cars sold in Brazil.

The second is the belated realisationthe world over that fossil fuels overheatthe planet, are controlled by dodgy re-gimes and cost too much. In January Presi-dent George Bush announced an Ameri-can version of Proálcool�he wants to cutpetrol consumption by one-�fth�and hassince signed an agreement with PresidentLula to spread production and consump-tion of ethanol worldwide.

It will take a while for any other coun-try to copy Brazil, where ethanol alreadyaccounts for 40% of the fuel used by cars.The United States insists on producingmost of its ethanol from home-grownmaize, which is more expensive than Bra-zil’s cane-based version and burns upabout seven times more fossil fuel per unitof energy produced. No other country canmatch Brazil’s distribution network, so inthe short term ethanol will be mostly anadditive to fuel, not the main ingredient.

Even that is enough to cause a fever.Brazil currently produces 18 billion litres ofethanol a year of which it exports 4 billionlitres, just over half of worldwide exports.By 2013 consumption in Brazil is expectedto double. Global ethanol trade could rise25-fold by 2020.

If these calculations are correct, Brazilwill need $90 billion of investment in newmills, plus $2 billion for pipelines, railwaysand storage. It already has 357 mills and isplanning another 136 at a cost of $14.5 bil-lion, according to Datagro, an industryconsultancy. The investors are mostly Bra-zilian, but also include Louis Dreyfus andTereos of France and Cargill of the UnitedStates. If anything there is an excess of en-thusiasm. �A lot of money is chasing toofew opportunities,� worries David Bunceof KPMG.

To become a staple in the world’s en-ergy diet ethanol needs to be commodi-tised, with global standards of purity and avibrant futures market. But the industry re-jects the stigma of commodity status.Workers in the new mills wear white coats,and laboratories are springing up besidethem. Biocell is one of several biotech com-panies looking for a way to convert the cur-rently unused two-thirds of the cane plantinto ethanol. Alellyx, which Mr Reinachclaims is the only company tweakingsugar-cane DNA, has started �eld trials of avariety with 80% more sucrose�the rawmaterial for sugar or fuel�than the stan-dard sort. Researchers are also working ondrought-resistant varieties that will growfar beyond the São Paulo heartland.

Coming of ageCorporate Brazil is coming of age in otherways too. A new personage, the Brazilianmultinational, has appeared. CompanhiaVale do Rio Doce (CVRD), privatised in1997, last year became the world’s second-largest mining company when it acquiredInco, a Canadian nickel producer. Gerdauhas become the biggest producer of longsteel products in the Americas (and hasvaulted trade barriers) by buying opera-tions in nine countries, including the Un-ited States. Embraer is the Boeing of the re-gional-jet market. Last year, boosted by theCVRD acquisition, Brazil for the �rst timeinvested more abroad than foreign compa-nies did in Brazil.

Brazilian bosses reckon they have out-smarted a di�cult economy by cuttingcosts, consolidating their business and

6Too commodity-dependent?

Source: Ministry of Development, Industry and Trade

Brazil’s top export products, 2006

Product Value, $bn % of exports

Transport equipment 20.4 14.9

Metallurgical products 14.7 10.7

Oil and fuel 13.0 9.5

Mineral ores 9.8 7.1

Soyabeans & derivatives 9.3 6.8

Chemicals 9.1 6.6

Meats 8.5 6.2

Sugar and ethanol 7.8 5.7

Machinery & equipment 7.7 5.6

Electrical equipment 5.8 4.2

Paper and pulp 4.0 2.9

Footwear and leather 4.0 2.9

Brazil’s new driving force

1

8 A special report on Brazil The Economist April 14th 2007

2 professionalising their management. If arecent book, �Sucesso Made in Brasil�, byDonald Sull and Martin Escobari, is to bebelieved, they have evolved special skillsfor surviving chaos and seizing opportuni-ties. Between 2003 and 2005 sales of pub-licly quoted companies grew three timesfaster than the economy as a whole. Manyof these companies are a long way frommining or farming. Last year’s merger ofSubmarino and Americanas created oneof the world’s biggest e-commerce opera-tion. Some businesses can be found nest-ling close to Brazilian multinationals, inthe way that growing companies cosy upto American universities. Cordoaria SãoLeopoldo started out making shoelacesand now produces cables to anchor Petro-bras’s deep-water drilling platforms.Graúna makes aircraft parts for Embraerand is beginning to export.

Sometimes outsmarting Brazil meansgetting away from it altogether. Part of

what drove Gerdau abroad was Brazil’slow growth and its high cost of capital.Manufacturers now realise that the cheapdollar is here to stay and that the exchangerate is less volatile than it used to be, saysJosé Roberto Mendonça de Barros of MB

Associados, a consultancy. So they are out-sourcing production, especially to China.Gradiente, which produced almost its en-tire output in Brazil three years ago, nowoutsources 40% of it, mainly to China. In2005 Brazil’s largest shoe manufacturer,Azaléia, shut a factory employing 800 peo-ple in the southern state of Rio Grande doSul and started producing in China.

But for most companies there is no es-cape. Of the 72,000 industrial enterpriseswith more than ten employees, only 1,200compete by di�erentiating their products,according to IPEA. They account for a quar-ter of turnover in the corporate sector butjust 13% of jobs. A middle group of 15,000�rms making standardised products that

compete mainly on price accounts for 63%of sales and nearly half of employment.The remaining �rms have �serious pro-blems of productivity and invest very lit-tle�, says João Alberto De Negri of IPEA.

In addition to economic growth, Bra-zil’s industrial health depends on threethings. The �rst is whether innovation willspread beyond a tiny minority of �rms.Spending on research and developmentamounts to only 1% of GDP, of which wellover half is done by universities. TheOECD average is more like 2% of GDP, andtwo-thirds of that is done by industry.

The second is the outcome of the Doharound of multilateral trade talks. Brazil’sagriculture would be the biggest gainerfrom an ambitious settlement, but itsmanufacturing would be less protected.

The third and most important is whathappens to custo Brasil. As technologychanges, even Brazilian ethanol may startto be weighed down by it. 7

IF BRAZIL disappeared from the face ofthe earth, the rest of humanity would

probably miss the Amazon rainforestmost. It is one of the world’s biggest reser-voirs of carbon dioxide, the principalgreenhouse gas, as well as a rain factory forall of South America and, possibly, a vitalregulator of the world’s weather. If Brazil’scontribution to global warming came onlyfrom its �eet of vehicles and power plants,it would be a model environmental citi-zen, thanks to its use of renewable re-sources. But three-quarters of its carbonemissions come from the destruction ofthe Amazon, turning the country into oneof the top ten polluters. Will Brazil save theworld or destroy it?

That depends on how Brazil managesits 8.5m sq km (3.3m square miles) of terri-tory. �Brazil is a sea of empty unoccupiedland without need for irrigation,� says Pli-nio Nastari of Datagro. There should beplenty of room for all the beef, sugar cane,soya, eucalyptus trees and other commod-ities that Brazil wants to produce. But Brazilsometimes feels like a continent-sizedplanning dispute. Every commodityseems to provoke a purpose-built protestmovement. During President Bush’s recentvisit to Brazil he was treated to slogans

against the sugar-cane �monoculture�.Corporate landowners often �nd them-selves embroiled in disputes with indige-nous peoples or landless movements. InBrazil �everyone loves the land,� says Car-los Aguiar, chief executive of Aracruz, apulp and paper manufacturer that hasbeen repeatedly invaded by both groups.

Brazil is still in the process of discover-ing itself. Agriculture, having conqueredmuch of the savannah of the centre-west,is opening new fronts in the north-east.The old mining centre of Minas Geraisnow has a rival in Carajás, in the Amazo-nian state of Pará. Industry, having con-verged on the city of São Paulo for much ofthe 20th century, has been dispersing fordecades. Oil has come to the rescue inparts of declining Rio de Janeiro. Braziliansassociate space with opportunity, whichlures them to their frontiers.

This restlessness has devastated theAmazon. Since the 1960s, when militaryrulers promoted settlement to rid them-selves of troublesome social groups andlay claim to a vulnerable part of the coun-try, about 18% of the forest has disap-peared. Sometimes the cycle of destruc-tion starts with illegal logging, whichetches the �rst trails into the forest. Land

grabbers often follow, or stake their claimto virgin forest by razing and burning thetrees and turning the land into pasture.Then come the planters, who replace pas-ture with more pro�table soya, driving theranchers deeper into the forest. The pio-neers outrace the state’s capacity to en-force the law and to exercise its own prop-erty rights.

This may be changing. Deforestationhas fallen by more than half over the pasttwo years, to its lowest level since 1991 (seechart 7). Part of the explanation is the

The �nal frontier

For Brazilians, land still has a mythical quality

7Down in the forest something stirs

Source: INPE *Average 1977-88 †Estimate

Brazilian Amazon’s deforestation rate’000 sq km per year

* † †

1988 90 92 94 96 98 2000 02 04 060

5

10

15

20

25

30

1

The Economist April 14th 2007 A special report on Brazil 9

2 appreciation of the real, which has put o�ranchers from opening new tracts of forest.But it helps that the state is beginning tomake its presence felt. The government hascreated 40m hectares of conservation ar-eas in the past four years, many of themacross the arc of deforestation, a bandalong the southern and eastern fringes ofthe forest. A new law declares that no pub-lic forest can be privatised, which shoulddiscourage land-grabbers, and providesfor concessions for �sustainable� loggingand other tree-friendly uses. Federal policehave arrested dozens of o�cials for traf-�cking in fraudulent logging licences. Con-sumer pressure, transmitted from richcountries to the Amazon via green NGOs,is beginning to have an e�ect. Last July pro-cessors announced a two-year morato-rium on buying soya from deforested land.

Putting a price on a priceless assetThe government’s goal, says the federalsecretary of biodiversity, João Paulo Capo-bianco, is �zero illegal deforestation� (prac-tically the only kind these days). Amazo-nian governors are more committed to thisthan ever before, he reckons, and now Bra-zil wants the rest of the world’s help.

This is new. Brazil has always resistedthe idea of allowing outsiders any say inthe fate of the Amazon. But last year it for-mally proposed an international fund topay Brazil for the forest’s environmentalservices to the planet. Under the scheme,Brazil would be compensated for reducingdeforestation below a certain baseline ac-cording to the market value of the carbonsequestered in the intact forest. This wouldgive it a value to compete with the pro�tsto be gained from its destruction and �-nance the cost of proper policing. There are

other possible methods, for example theuse of carbon-credit markets. But Brazil’snew willingness to put forest preservationon the market is �an extremely importantstep�, says Paulo Moutinho of IPAM, a re-search institute.

With the revival of soya and the gov-ernment’s new �growth acceleration pack-age�, which proposes to pepper the Ama-zon with infrastructure, Brazil is about toput its new model to the test. More thantwo-thirds of Brazil’s unexploited hydro-power potential is in the Amazon. The gov-ernment is warring with environmental-ists over proposed dams on the Madeiraand Xingu rivers. The package calls forpaving several Amazonian roads,traditionally the main vectors of destruc-tion. If the state does not use them to police

crime better, they will be a blessing toenvironmental criminals.

Brazil need not chop down the Amazonor destroy the remaining savannahs to ex-pand its agriculture. Most of Brazil’s farm-land is pasture, running to some 175m hect-ares and occupied by around half a cowper hectare. Crops take up just 63m hect-ares. If ranching were made more inten-sive, crops could expand into empty pas-ture. Embrapa, the government’sagricultural-research arm, is promotingintegration of crops and cattle, whichcould multiply the density of the cattlepopulation by �ve. �The big problem is tochange the mentality of the rancher,� saysEmbrapa’s Eduardo Assad. Brazil may behuge, but it is not as inexhaustible as Bra-zilians think. 7

BACABEIRA�a low-slung settlementwhere the main street is a federal high-

way and most of the rest are dirt tracks�isnot a rich place. More than half its popula-tion lives below the o�cial poverty line of120 reais a month per person. The mainsource of jobs is local government. Butlately this district with 12,000 inhabitants,about 50km from the port city of São Luís,the capital of Maranhão, has been experi-encing a boom of sorts. Four furniture

stores and a DVD shop have opened, andwomen no longer have to go to neighbour-ing Rosário for beauty treatments. School-children now carry backpacks.

Bacabeira owes much of its newfoundprosperity to infusions of federal cash. Thereal value of pensions, which is linked tothe o�cial minimum wage, has doubledover the past 13 years. Well over half thefamilies receive Bolsa Família, a bene�t ofup to 95 reais a month that requires parents

to keep their children in school and takethem to clinics for health check-ups. A ver-sion of Bolsa Família existed before Lulatook o�ce, but he greatly expanded its cov-erage and increased the value of the bene-�t. It now reaches 46m people, a quarter ofBrazil’s population, making it the world’slargest �conditional cash transfer� pro-gramme (ie, bene�ts are linked to the re-cipients’ behaviour). �It helps a lot,� saysRosângela Quindere, a mother of �ve. Out-

Rich man, poor man

E�orts to reduce poverty and inequality are bearing some fruit

1

10 A special report on Brazil The Economist April 14th 2007

2 side her house sits the barber’s chairwhere her husband o�ers alfresco hair-cuts. As usual, it is empty.

Poverty and inequality are to Brazilwhat wars of independence are to othercountries. Brazil is not unique in its historyof slavery and the obliteration of its indig-enous peoples. But there is no Brazilian Bo-lívar to distract attention from these injus-tices, and no founding ideology ofequality to set against them.

Brazil’s bloodiest con�icts, with the ex-ception of the ruinous Paraguayan war of1865-1870, have been internal a�airs, pit-ting classes, regions and races against eachother. The country’s thinkers have dwelton the paradox of a nation where power isa rich man’s luxury and vitality �ows frombelow. Its politics are a quest to narrow theawkward gap between the Brazil of closedcondominiums and the other Brazil of un-treated sewage.

Income distribution in Brazil is moreskewed than in any other big country. Vio-lence and pollution are spread even moreunequally. The road that separates Gávea,a rich neighbourhood of Rio de Janeiro,from Rocinha, a favela (slum) dominatedby gangs of drug dealers, marks a ninefolddi�erence in unemployment, a 17-fold dif-ference in income and a 13-year variationin life expectancy, says André Urani ofIETS, a think-tank. Such indicators are cor-related with race, but Brazilians argue overwhether racial inequality is a cause or aconsequence of economic inequality.

Narrowing these gulfs has become themain business of government since therestoration of democracy. Lula, who revelsin his image as �the father of the poor�, an-noyingly claims copyright on the idea, butthe recent progress builds on initiativestaken by his predecessor, Mr Cardoso,himself a scholar of Brazil’s race relations.Between them they have produced a start-ling reduction in poverty and inequality.

The poor are getting richerThe Real Plan prompted a sharp drop inpoverty by slashing the in�ation that taxesthe poor. The �rst three years of the Lulagovernment have seen an equally dra-matic decline. Even more strikingly, in-equality has at last begun to yield. TheGini coe�cient, which measures con-centration of income, fell by 4.7%, from0.596 to 0.568 between 2001 and 2005. Be-tween March 2002 and June 2006 theshare of national income going to thepoorer half of society increased from 9.8%to 11.9%; the share going to the richest tenthfell from 49.5% to 47.1%. The economy may

be sluggish, but �the very poor are livingChinese growth rates,� says Marcelo Neriof the Fundação Getulio Vargas.

This looks like the combined e�ect ofearlier reforms and the ramping up of so-cial spending. One of the main levellershas been the labour market. Despite theslow pace of economic growth the num-ber of new formal jobs doubled betweenthe start and the middle of the current de-cade. Mr Neri reckons that greater econ-omic stability gave employers the con�-dence to resume hiring. The wage gapbetween large and small cities fell as theexport boom created rural jobs and indus-try �ed from urban complications such ascrime and trade unions.

Another reason for less unequal wagesis less unequal access to education. Prim-ary education did not become available toeveryone until the 1990s. That allowed thepoor to compete for jobs previously occu-pied by the lower middle classes. It is alsopossible that real incomes increased morethan the o�cial statistics suggest. Twoeconomists from the IMF have argued in arecent paper that the consumer-price in-dex exaggerated in�ation after the openingof Brazil’s economy.

The second principal boost to equalityhas come from federal income transferssuch as Bolsa Família, which have themost impact outside the metropolises ofthe south-east. According to IPEA these in-come transfers account for a third of the re-duction in inequality.

Flies in the ointmentLula’s poverty-alleviation programme hasbeen an undoubted success, but many Bra-zilians also see downsides to it. One is po-litical. With Bolsa Família and other fed-eral programmes, Lula has found a way toreach deep into the interior districts of the

poor north-east, where local �colonels�traditionally call the shots and the PT hadnever made much impression. Lula wonan unprecedented 77% of the vote in thenorth-east in the last election. �Incometransfers mean you won’t have competi-tive elections,� frets Bolívar Lamounier, apolitical scientist. A graver problem is �s-cal. Pensions and Bolsa Família contrib-uted equally to the decline in inequality,but the higher pensions cost four to �vetimes more.

There is also concern that income trans-fers will mark the end of developmentrather than its beginning. In theory, BolsaFamília breaks the cycle of poverty by en-suring that children are healthier and bet-ter educated than their parents. In practice,poor schooling means that the next gen-eration’s earning power will not improveas much as it should (see next article). Gov-ernment cash may also breed depen-dency. �Here 95 reais is a lot of money.Many families get used to it,� says SérgioMoraes, who runs Bolsa Família in Baca-beira. But systematic studies do not con-�rm that suspicion. Instead, having a guar-

Too many Rocinhas

8That’s better

Source: Fundação Getulio Vargas

Proportion of Brazilians below the poverty line, %

1992 94 96 98 2000 02 0504

20

24

28

32

36

1

The Economist April 14th 2007 A special report on Brazil 11

2

FROM the inside the Unidade de Educa-ção Básica Cidade Olímpica feels more

like a dungeon than a school. Slits wideenough to admit trays of food pierce thewalls between the classrooms and a cav-ernous hallway. The pre-class clamour ofchildren does not stop with the bell be-cause some teachers have not turned upyet. Paula Souza, the school’s director, saysthat 40% of the teachers are absent at leastone day a week. Some resent being as-signed to this primary school on the poorperiphery of São Luís. Its performanceshows it: in a national exam administeredin 2005 Cidade Olímpica’s scores in Portu-guese and maths were below average forcity, state and country.

The real problem is those averages forthe country as a whole. Brazil came deadlast in maths and fourth from the bottomin reading in tests administered in 40 coun-tries by the OECD. Half of ten-year-oldsare functionally illiterate and there is littlesign of improvement. Working-age Brazil-ians have an average of 4.1 years of school-ing, compared with six in China. This is thebiggest obstacle to Brazil’s ambitions. Ifeducational standards were as good asthose in the United States, the di�erence inincome per head would fall by 30-40%, cal-culates Samuel Pessôa, an economist at theFundação Getulio Vargas. To diminish thatgap, all three levels of government, whichshare responsibility for education, mustraise their game.

To be fair, Herculean progress has al-

ready been made. Little more than a de-cade ago some 17% of children aged 7-14did not go to school. That changed in the1990s when the federal governmentstarted distributing money to states andmunicipalities on the basis of enrolmentin primary school. The extra pupils thenthronged the high schools, which tripledtheir output of graduates during the 1990s,according to Claudio de Moura Castro ofPitágoras, a chain of private schools. Qual-ity deteriorated in part because quantityexpanded so fast.

Upgrading is harder than expanding.Brazil spends 4.3% of GDP on public educa-tion, less than it should, given the relativeyouth of its population. Much of thatmoney is wasted. Brazil is among theworld champions in grade repetition, with

30% more children in primary school thanthe total in the 7-14 age group. Under-trained, overstretched teachers know noother way of controlling their classrooms.The practice costs 13 billion reais a year,nearly a �fth of basic-education spending.�It’s a vicious circle. You can’t invest inquality because of repetition,� says Al-berto Rodríguez of the World Bank.

Starting salaries for teachers are low,which deters good candidates, but then in-crease steeply, encouraging incumbents tostay until they retire, �ve years earlier thanother workers. In that brief career, encour-agement and incentives are both in shortsupply. Training is long on theory andshort on practical experience. Many teach-ers work at two or even three schools, oneof them private. In Maranhão experiencedteachers refuse to teach in remote districts,which are served by students who takeclasses during the week and pursue theirstudies at the weekend. The São Luísschool system is plagued by absences formedical reasons, which can last up to 15days without a doctor’s certi�cate. Mayorsreward political supporters with schooldirectorships and sometimes teachingjobs. �Many states have tried to limit politi-cal intervention but these e�orts havebeen short-lived,� says Mr Rodríguez. Andstudents spend an average of only threehours a day in class.

Worry about Brazil’s lagging educationsystem is becoming more widespread. Agaggle of enterprises and NGOs banded to-

Low marks

Education is still letting the country down

9No lessons learnt

Source: Ministry of Education

Average proficiency by school levelMaximum=500

1995 97 99 2001 03 05

150

200

250

300

Portuguese:Mathematics:

Secondary school

Primary school

Secondary school

Primary school

anteed income gives parents the securityto look for better work opportunities, saysKathy Lindert of the World Bank, whichhelps �nance Bolsa Família.

The programme could be upgraded, forexample by extending the bene�t from theperiod of primary schooling to cover highschool too. With virtually all of Brazil’spoor families in its database, Bolsa Famíliacould be used to give them priority accessto 150 social programmes, such as trainingand sanitation, says Ricardo Paes de Barrosof IPEA. He thinks it is �surprisingly iso-lated from other programmes.�

If the poor are racing ahead when aver-age income is plodding along, somebodymust be losing out. That somebody is what

is loosely described as the middle class,which includes many people close to thetop of the pyramid. The reforms of the1990s reduced the government’s share ofsalaried employment and forced busi-nesses to shed high-paying jobs. In2002-04, 86% of new formal jobs paid atmost double the minimum salary; thenumber of jobs paying at least ten timesthe minimum salary fell by 11%. In metro-politan areas informality rose sharply be-tween 1992 and 2005 even as it fell nation-ally. The minimum wage increase ispushing up salaries at the bottom, andhighly quali�ed people at the top are stillmaking a good living. But �the middle ispurgatory,� says José Pastore, a sociologist

at the University of São Paulo. Employ-ment has been expanding only justenough to absorb the 2m people who en-ter the labour force annually. Unemploy-ment is stuck at about 10%.

In this respect, Bacabeira may be lucky.Gerdau, a steel company, recently boughta pig-iron plant in the district, which is aprime candidate to receive the spilloverwhen industry runs out of space in SãoLuís. But the locals complain that suchcompanies bring in most of their employ-ees from outside. �I can’t a�ord a trainingcourse for my son,� says one woman. Bra-zil is still a long way from creating all thejobs it needs�and providing people withthe quali�cations to �ll them. 7

1

12 A special report on Brazil The Economist April 14th 2007

2

ON A balmy Saturday night in Februarythe hilltop favela of Cavalão (�Big

Horse�, because that was what wasneeded to reach it) warms up for Carnival.In the asphalted clearing that serves as themain square men cluster in plastic chairsto drink beer. The entertainment is pro-vided by musicians drawn partly from Ca-valão’s police station.

Yet only three years ago Cavalão was an�inferno�, says Valmir Mariano, whoworks in a luxury hotel in Niterói, the citynear Rio de Janeiro of which the commu-nity forms part. Police and drug tra�ckersexchanged gun�re �almost every day�. Ona Saturday evening such as this everyoneelse would have been cowering indoors.That changed when police installed them-selves inside the favela, earned the trust ofresidents and began playing the occa-sional samba. Cavalão, formerly one ofthe most violent neighbourhoods in Riostate, has seen no murders since 2003.

The question Brazilians should be ask-ing is why their country does not alwayswork as well as this. Why does it smotherenterprise, abandon schoolchildren to ig-

norance and squander money? Why is Ca-valão’s community policing unit one ofonly �ve in the state of Rio? Brazil is teem-ing with promising experiments andhopeful initiatives. Why does it not putthem into mass production?

One answer may be that a mass markethas made itself felt only recently. The Bra-zilian state was not born answerable to thebulk of its citizens. Until 1985 those whocould not read and write were not allowedto vote. The constitution was an act of pen-ance that cast the state in the role of sav-iour. It would dispense benevolence, butwould require the developing world’smost elaborate apparatus of regulations,taxes and bene�ts to do so. It is not surpris-ing that this contraption serves itself morereliably than it does ordinary Brazilians.

But democracy and economic progressare beginning to change that. The constitu-tion has been amended 58 times to permitreforms and to remove aberrations. Lula,who once shined shoes in São Paulo andlost a �nger in a factory accident, is the �rstBrazilian president to be drawn from themass of ordinary voters who elected him.

Those who expected cleaner governmentalong with the common touch were disap-pointed, but that has only made the clam-our for accountability louder.

Part of the problem lies with the work-ings of the world’s second-largest propor-tional-representation system. Parties areweak, alliances struck before election dayare broken and recon�gured the day after

The slow road to paradise

Why Brazil is taking so much time to reach its potential

10A footloose parliament

Sources: Chamber of Deputies; Federal Senate

Chamber of Deputies

Federal Senate

National Congress, seats

Totalseats: 513

Independents16

PT 83

Coalition allies 284

Opposition130

Totalseats: 81

PT 11

Coalition allies 39

Opposition30

Independents1

gether last year to form �Everyone for Edu-cation�, a movement to push for better re-sults. Global competition is obligingenterprises to adopt international qualitystandards such as ISO 9000, which in turndemand a workforce educated to high-school level. Fernando Haddad, the educa-tion minister, says Brazil aims to match theOECD’s average performance by 2022, thebicentenary of independence.

Paying attentionHaving ignored basic education for muchof his �rst term, Lula now acknowledgesthat Brazil’s educational plight is �theworst of all worlds�. Fundef, the federalfund that �nanced the expansion of prim-ary education in poorer states, has beenturned into Fundeb, which covers pre-school and high school as well. Childrenwho go to pre-school are more likely to �n-ish high school and, the governmenthopes, less likely to have to repeat grades.A new �education development package�is to set performance targets for each stateand municipality and to reward those that

achieve them, with around 8 billion reaisearmarked as education aid over the nextfour years. This �new culture� of o�eringcarrots for results will require restructuringin the states, the cities and the ministry it-self, says Mr Haddad.

State and local initiatives also seem tobe making a di�erence. Seven of the tenhighest-scoring school districts in the stateof São Paulo had a private education com-pany, COC, to manage their classrooms. InCOC-run schools teachers attend monthlytraining sessions, are constantly evaluatedand learn how to deal with problem chil-dren. São Luís has hugely increased itsshare of teachers with a college degree,from less than 20% to more than 90%, andnow does much better in national tests.

As so often in Brazil, the question iswhether the bright ideas and promisingexperiments can work their way into its in-stitutions. Teachers want better educationas well, but they are more interested inspending, training and working condi-tions than in the nitty-gritty of managingschools and classrooms. Juçara Vieira,

president of the National Confederationof Education Workers, thinks that schoolsshould be evaluated but individual teach-ers should not, because that �would leadto competition�.

Nor is there much pressure from strug-gling, often single parents, who are in-clined to treat school as a form of day care.Ms Souza of Cídade Olímpica con�rmsthat �they [just] want us to take care oftheir kids.� Real change may not come un-til parents start demanding more fromtheir schools. The same might be said ofvoters and politicians. 7

Don’t repeat after me

1

The Economist April 14th 2007 A special report on Brazil 13

2

IN MAY 2006 a gang of jailbirds declaredwar on South America’s biggest city. For

the better part of a week shock troops ofthe Primeiro Comando da Capital (PCC),a prison-based criminal organisation,wrought havoc on São Paulo, killing po-licemen, �rebombing buses and banksand bringing the city to a virtual stand-still. The police struck back with evengreater ferocity. By the time the violencesubsided 150 people had died. In Decem-ber Rio de Janeiro’s locked-up criminalsorchestrated similar attacks in that city.They were less lethal but introduced ahorri�c novelty: one of the burnt-outbuses was full of passengers.

Brazilians are obsessed with crime.Prosperous paulistanos (residents of SãoPaulo) live behind high walls, drive ar-moured cars and send their children toschool in the company of bodyguards.Last month violence displaced unem-ployment as Brazilians’ top worry for the�rst time in years, according to a poll. Yetthe trend in violent crime in Brazil isdownwards, particularly in big cities suchas São Paulo, where the murder rate hasdropped by more than half since 2000.

No one is sure why. Among the rea-sons put forward are the peaking of crackaddiction, lower immigration and a

tougher policy on guns. All of these mayhave played a part. What is known is thatmore than half of all the murders in SãoPaulo are provoked by personal disputes;murder for pro�t has not fallen, says Gua-racy Mingardi of the São Paulo publicprosecutor’s o�ce.

But violence is moving out of the maincities, along with jobs and industry.�Crime follows the path of wealth, notpoverty,� says Sérgio Adorno, head of theNucleus for the Study of Violence at theUniversity of São Paulo. In a recent leaguetable in which cities were ranked by theirmurder rates, none of the state capitalsmade it into the top ten.

The murder rate for Brazil as a whole isstill an intolerable 23.8 per 100,000 peo-ple and, as the handling of last year’s pri-son-based terrorism showed, itslaw-enforcement institutions are still in-adequate. The terrorism in Rio de Janeiromay have been a message to the �BlueCommand�, police organised into protec-tion gangs that force their services on ter-ri�ed neighbourhoods. In December, 82of the state’s civil and military police o�-cers were arrested on suspicion of drugtra�cking and illegal gambling.

The PCC’s surprising ability to causemayhem from inside the prison system

stems from São Paulo’s policy of lockingup as many criminals as possible withoutcreating the infrastructure to managethem properly. But what was the point ofthe attacks? Ms Muniz, the anthropolo-gist, sees them as �marketing tools�. ThePCC is a collection of loose alliances witha weak chain of command that needs�symbolic acts� to enforce contracts andhold on to allies. There is a chance that itmay strike again.

Law enforcement remainsa weak spot No end of violence

A marketing campaign with a di�erence

and voters have little connection to theirCongressmen. Ideas, let alone ideology,barely enter the discussion. Between thevote-buying mensalão and the subsequent�bloodsucker� scandal (which involvedselling overpriced ambulances to munici-palities), 91 deputies and senators in theCongress whose term ended in Decemberwere accused of corruption. Congress saw�t to expel just four. It also set a record forparty-hopping: 195 of the 513 deputiesswitched parties, some several times, tomake a total of 345 moves. One of Con-gress’s �nal acts of sheer chutzpah was tovote itself a 91% pay rise, which the Su-preme Court promptly overturned.

Perhaps Congressmen behave this waybecause their links to voters are tenuous.Candidates for �proportional� o�ces�thelower house of Congress and the state as-semblies�compete in statewide races.

Seats are distributed to each party (or elec-toral coalition) in proportion to the num-ber of votes received by all its candidates.Within that quota, the winning candidatesare the individuals with the most votes.

This looks fair: both parties and person-alities are ranked according to their popu-larity. But the results can be perverse. Sinceevery vote contributes to a party’s quota, itmakes sense to �eld as many candidates aspossible, even though voters barely knowthem. For example, 541 candidates ran inMinas Gerais, the state with the country’ssecond-largest electorate, and the top vote-getter won a share of only 3%. Candidatesfrom the same party compete against eachother as well as against the opposition. Ifone gets more votes than he needs to beelected, his surplus votes go to lesser lightsfrom the same party or coalition. Thesenonentities often beat more popular can-

didates from less favoured groupings.Most of the 21 parties elected to Congressunder this system are little more thannameplates. Few of them practice democ-racy internally. And by party-hopping,deputies sever their last tie with the voter.

The connection that survives is the onewith the network that secured their elec-tion, which consists of mayors, special-in-terest groups and enterprises (which often�nance campaigns o� the books). Be-tween elections these machines continueto function, producing patronage, con-tracts and donations that bene�t all con-cerned. In the bloodsucker scheme, Con-gressmen, mayors and the ambulancevendor all shared in the bounty. �Congressis composed of representatives not of thepeople but of vested interests,� says MrCardoso, the former president.

These a�ronts have caused a backlash.

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14 A special report on Brazil The Economist April 14th 2007

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The abortive pay rise was denounced fromchurch pulpits and in e-mails that jammeddeputies’ in-boxes. In the new Congress re-formist deputies challenged two establish-ment candidates for the presidency of thelower house. They failed but were widelyapplauded. Indignation has gelled into aconsensus, shared by the government andmost political parties, that Brazil’s electoralsystem needs reform.

At least a score of reform proposals arecirculating in Congress, and more areemerging all the time. Among the mosttalked-about are outlawing private elec-tion �nance; penalising deputies whoswitch parties; requiring parties to poll aminimum number of votes to reduce theirnumber; and making voters pick a partyrather than an individual. The most radicalproposal under discussion is to create con-gressional districts, which would help vot-ers to keep an eye on their representatives.This could be combined with proportionalrepresentation, as is done in Germany.

Many of these ideas have drawbacks.Getting voters to pick parties rather thanindividuals, for example, might simplystrengthen the bosses, unless the partiesthemselves become more democratic.And no thought is being given to correct-ing the worst imbalance, created by therule that each state gets a minimum ofeight seats and a maximum of 70 in thelower house. This ensures that more thanhalf the seats go to the north, north-eastand centre-west, which between themhave only 41% of the electorate.

A nation of statistsNo political reform will resolve Brazilians’disagreement over what constitutes goodgovernance. Everyone wants honest politi-cians, but few Brazilians complain aboutthe size of government, despite the large

electronic impostômetro in the centre ofSão Paulo that tots up the government’stax take in real time.

Having failed to win re-election in the�rst round of voting last October, Lula re-gained the initiative by accusing his oppo-nent, Geraldo Alckmin, of plotting to pri-vatise the jewels of state-owned industry.He polled the most votes in regions wheregovernment transfers were highest. �Brazilis divided between those who depend onthe government and those who pay thebills,� says Guilherme A�f Domingos, ananti-tax campaigner who is now SãoPaulo’s labour secretary.

Lula emerged from the contest withpopular backing and an overwhelmingcongressional majority but no mandatefor state-slimming reforms. His 14-partybase extends from the conservative Pro-gress Party to the Socialist Party of Braziland incorporates almost all of the centristParty of the Brazilian Democracy Move-ment, a confederation of political �efs thatuntil now has resisted unity. Althoughabout 70% of all deputies are in the co-alition, Lula can probably count on onlyjust over 60%, reckons Christopher Gar-man of Eurasia Group, a consultancy. Thatis enough to change the constitution, butapart from simplifying taxes the govern-ment seems content to let public opiniondictate the pace of reform. Mr Mantega, the�nance minister, says it �wants to do along-term �scal programme where spend-ing is under control�. But it is relying oneconomic growth and a proposed cap onpublic salaries to reduce state spending asa share of GDP.

A stronger reforming impulse maycome from regional government. Aécio

Neves, governor of Minas Gerais, elimi-nated his state’s budget de�cit and shookup the bureaucracy. He was re-electedwith 77% of the vote. Rio de Janeiro’s newgovernor, Sérgio Cabral, has installed acabinet of technocrats. His new chief ofmilitary police helped pioneer the sort ofpolicing that paci�ed Cavalão. In SãoPaulo José Serra has promised to cut thetime required to open a business from 152days to 15. In 2010, when Lula’s second and�nal term runs out, Brazil may elect aspresident the �rst state governor since Fer-nando Collor. Mr Serra and Mr Neves,both of the opposition Party of BrazilianSocial Democracy (PSDB), will be amongthe strongest contenders. They will put ef-�ciency on the national agenda.

The problem is that few Brazilian politi-cians can conceive of benevolence with-out power, when it is often by surrender-ing power�either to the markets or toinstitutions within the state�that they cando the most good. Police in Rio require thesame esprit de corps as regulatory agenciesin Brasília, but no party has dedicated it-self to providing it. Lula’s PT and the PSDB,the likeliest source of an alternative presi-dential candidate, are political rivals butphilosophical kin. The two �liberal� par-ties excised that word from their namesthis year, in e�ect disavowing the creedthat challenges the size of the state. Eventhe reformist Mr Neves has trouble tolerat-ing an unfettered press in his home state.

It is this political lacuna that makes op-timists about Brazil so impatient. Democ-racy and economic change are pulling itforward, but at a halting pace. If only Brazilcould sort out the way it governs itself, itcould be racing for glory. 7

Lula has no mandate to slim the state

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