Published by EH.Net (January 2017)

Lee J. Alston, Marcus Andre Melo, Bernardo Mueller and Carlos Pereira, Brazil in Transition: Beliefs, Leadership, and Institutional Change. Princeton: Princeton University Press, 2016. xviii + 259 pp. $39.50 (hardcover), ISBN: 978-0-691-16291-1.

Reviewed for EH.Net by Leonardo Weller, São Paulo School of Economics, FGV.

Brazil in Transition is an intriguing book that holds the reader’s attention throughout. Alston, Melo, Mueller and Pereira make a rather provocative claim: that Brazil is likely to grow into a developed economy because it is in the process of becoming an open, inclusive and fiscally sound society. This inevitably comes as a surprise because Brazil is in its worst economic crisis since the 1930s: GDP fell by 3.8% in 2015 and is expected to fall again by 3.2% in 2016; the government is running a fiscal deficit of 10% of GDP; inflation is way above the 4.5% target; unemployment is at two digits; and poverty has been rising quickly. If one reads the Brazilian press, the book seems out of place, to say the least. Yet this is precisely the reason why it is interesting, whether it is right or wrong. The authors refer to history to contradict the current hysteria. They claim that Brazil is likely to follow a development path that started in the 1990s. The present crisis would be a “bump in the road.”

The authors apply a version of the New Institutional Economics in which beliefs play a central role. Beliefs are the way the “dominant network” understands how the “world works.” Composed of politicians, entrepreneurs, the media and top civil servants, the dominant network builds institutions that they believe will deliver specific economic results.

In the 1960s and ‘70s, Brazil’s dominant network believed that the state was supposed to stimulate industrialization without redistributing wealth. The institutions put in place resulted in rapid growth and rising inequality. Brazil was ruled by a dictatorship and the well-being of the majority did not concern those in power. This changed, however, in the 1980s, when democratization enfranchised the people, so the need to promote social inclusion became part of the dominant network’s beliefs. The book analyzes in detail the 1988 Constitution as an institution forged to redistribute wealth and introduce checks and balances in statecraft. The new constitution extended the public retirement scheme to rural workers, required the state to provide universal free education and healthcare, and professionalized civil servant careers.

The constitution was inclusive but not fiscally sustainable. It required the state to increase expenditure, which resulted in enormous deficits. Four-digit inflation compromised economic growth and lowered real wages in the 1980s. Income concentration reached its record level in the early 1990s. The institutions designed to promote social inclusion failed to do so. Nevertheless, that frustrated outcome opened a “window of opportunity,” which the authors define as a crucial moment in which the dominant network may (or may not) adjust its beliefs and change institutions in order to improve economic results.

The authors claim that institutional change is not automatic: it takes leadership to bring about the transition. They assert that former President Fernando Henrique Cardoso (1995-2002) was such a man to provide it. An influential intellectual and respected politician, Cardoso had the reputation and skills to form a strong coalition that transformed institutions for the better. The Real Plan controlled inflation and the Fiscal Responsibility Law reduced the fiscal deficit. In parallel, the Cardoso administration launched a number of social programs, universalized the access to basic education and privatized inefficient state-owned companies.

Though growth was dismal in the 1990s, price stability redistributed wealth. The public acknowledged the positive outcomes of orthodoxy, so former President Lula (2003-10), a left-wing trade unionist, maintained Cardoso’s main macroeconomic policies once in office. His successor and protégé Dilma Rousseff (2011-16) increased expenditure to boost demand but was impeached based on the fiscal laws approved under Cardoso. The book was released before President Michel Temer took office. As predicted in the foreword, his administration is attempting to rebalance fiscal accounts (though so far without success).

Brazil has indeed become a more inclusive, open society. The authors are persuasive when they assert that the changes in beliefs under Cardoso have driven the country into an institutional deepening process that works in an autopilot mode. Yet the conclusion that this process will transform Brazil into a developed economy is quite a stretch. It is true that development is more than growth, but it takes growth to make a developing economy into a developed economy. The book lacks an economic analysis to back its conclusion. It presents rather limited quantitative evidence. It ignores the consequences of deindustrialization and labor laws that date from the 1940s, when the country was industrializing. Legal rigidities between employers and employees keep productivity low in a service economy, and that has not changed at all.

Brazil’s extremely complex tax system is a fundamental problem for the book’s main argument. Since the 1990s the government has been increasing taxation to match the rise in expenditure that the 1988 Constitution requires. The conjunction of social inclusion and fiscal orthodoxy has pushed Brazil to the wrong side of the Laffer Curve, where companies either evade taxes or go out of business. Taxation alone may block economic development. It explains to a great extent why the investment rate is below 20%, which is far too low for sustainable growth.

Finally, the authors ignore the impact of the demographic bonus in social indicators, from education to income distribution. This is problematic because Brazil experienced one of the world’s quickest falls in fertility in the last six decades (precisely the period under analysis): the number of births per fertile woman fell from 6.2 to 1.8 since 1960. As a Brazilian who intends to retire at some point in life, I am afraid that the improvements in education the book joyfully describes have been too little too late. Schools are not forming the highly productive workers the country will need to support its aging population. The public pension scheme is already bankrupt and Brazil performs rather poorly in international education surveys. We will likely get old before getting rich.

Brazil in Transition has the merit of addressing the present crisis in a historical context. Though Alston, Melo, Mueller and Pereira are right in recognizing the country’s institutional changes since the 1990s, they fail to acknowledge that persistent economic problems are likely to keep it in the mid-income trap. A window of opportunity may appear in the near future, but, as the authors suggest, it will take leadership to make Brazil suitable for growth. This is guesswork rather than history, but it seems highly unlikely that President Temer will be the man to provide it.

Leonardo Weller’s research is on Latin America’s financial history, more specifically sovereign debt crises and rescue loans before the First World War.

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