Otaviano Canuto has observed the boom in Latin American exports of commodities from a variety of positions at the World Bank and the Inter-American Development Bank. In the seminar on “Latin America and the New World Economic Outlook,” organized by the Brazilian Institute of Economics in September, Canuto said the challenge for Latin American countries is to carry out reforms even as their economies are slowing down. For Brazil, he said, “the motto must be pragmatism,” in both external economic relations and domestic policies. Canuto also argued for reducing Brazil’s gross debt in order to increase private investment and reviewing public spending, adding, “From now on, the social or productive return on public spending can make a huge difference for growth and prosperity.”
The Brazilian Economy — You mentioned that the Latin America boom was affected by three major factors: increased production resulting from reallocation of labor to more productive activities, a heavy increase in demand for commodities, and abundant international liquidity. What countries have benefited most from the boom and what factors will affect their future?
Otaviano Canuto — If we look at how countries took advantage of the recent boom in commodity prices to improve their fiscal indicators and investment, most performed better than they did in previous cycles. If we evaluate the quality of economic policy in most countries in the region —Brazil, Colombia, Peru, Paraguay, and Uruguay— they managed the commodity boom well to improve social indicators, accumulate international reserves, and strengthen their external position.
On the other hand, there was a certain complacency about the need for reform, particularly in Brazil. The thrust for institutional reforms that had characterized many countries in the region in the 1990s and especially the early 2000s became secondary because of the relief the commodity boom afforded them.
Countries that resume reforms will now have to adapt to a new international outlook … every country should put together its own reform program to address its main difficulties in raising productivity and competitiveness … . Mexico is a good example; it has reform proposals for infrastructure, the oil sector, the tax code, and education.
In recent years, Latin American countries like Peru and Colombia began to open up their economies, joining Chile and Mexico in trade agreements with the Asia-Pacific region. How will opening up their economies affect their manufacturing industry and integration into regional supply chains?
The manufacturing challenge is common to the region, with the obvious exception of Mexico, because of its integration into North American regional supply chains. In the case of Mexico, however, this integration has not guaranteed higher growth because ultimately the manufacturing sector is not large enough to pull the rest of the economy. In the other countries of the Pacific Alliance as well as Brazil, the manufacturing challenge should not be addressed by protecting domestic industry, as was done in the past. Their prospects of becoming part of regional supply chains will depend in large measure on policies that reduce costs and increase the productivity of local workers. Achieving a significant position in some of the global supply chains requires resources and other things that are out of reach for Latin American countries. Even so, the region would benefit if countries would join forces to explore the comparative advantages of each country, because denser production chains would open opportunities for all.
What is the role of Brazil and Mercosur in the regional context?
Certainly we must leave behind the idea of Mercosur as a self-sufficient system that should operate as a sort of autarchy. Mercosur at least will have to secure smoother integrated production within the bloc without interfering with the operation of competitive markets. Mercosur has to open up, do what it takes to be part of the [world trade] game. The introduction of protectionist trade policies within the bloc certainly does not help. I think we have to revise Mercosur and if appropriate adopt a more flexible approach to the business country members do with the rest of the world.
For Brazil, China has been an important market for commodities but at the same time a competitor in South America’s manufactured goods market. What are the future prospects for Brazil-China relations?
China’s impact extends to both the penetration of Chinese products in the region and the manifest interest in investing in the region … . The Chinese are interested in investing in industries like the automotive industry, urban mobility, and rail, as well as in exploring shale gas opportunities in Argentina. Clearly, China’s importance will extend far beyond its share in the region’s manufactured goods market, which is already significant.
For Brazil, this is a clear demonstration of how Mercosur’s institutional framework has become obsolete … . If there was any intention to protect the Mercosur market as a privileged area for Brazilian companies, the reality is that is not practically feasible. However, Brazil can enhance value-added in activities associated with natural resources, research, and professional services related to natural resources. This is a natural area where Brazil can, like other resource-rich countries in the region, build up significant participation in global supply chains. Trying to be competitive in all segments will not prevent Chinese penetration into other countries in the region.
Brazil has not advanced in trade openness. The trade agreements it has signed are of little relevance, and Brazil’s South-South foreign policy has not brought about significant economic gains. What is your view on Brazil’s trade policy?
The results of the policy orientation have been meager. Basically, it only served to defend a framework of past trade policy to maintain the status quo … . At one point the country made a commitment to a global multilateral negotiating agenda, but that agenda stagnated. … The plain fact is that we are left with neither a better multilateral trade framework nor bilateral free trade agreements that could have been a meaningful improvement.
The motto must be pragmatism. Brazil is a country of global integration … . Diversifying our front lines would be like insuring against risks. Focusing on the countries in the South cannot be at the expense of the ones in the North. Pragmatism should lead Brazil to explore all possibilities on all fronts.
The main challenges facing Brazil today are domestic, such as low savings and productivity. Some argue that these are both directly related to the Brazilian social contract rooted in the 1988 Constitution that encourages public transfers and consumption at the expense of savings and investment. Do you agree?
Today there coexist the manifest desire of the Constitution for more social spending and the preservation of other privileges that determine public spending. In a way, leniency in maintaining unjustified privileges was possible by increasing the tax burden during the commodity boom. The way to protect social spending is to review closely the quality of expenditures and who the beneficiaries are. … It is possible to pursue a policy to increase productivity without conflict with the population’s political desires [for more social spending and better income distribution] as expressed in the Constitution.
What will be the main challenge for the next government in reviving growth and fighting inflation?
It is worth separating short-term and long-term policies. In the short term, … one obvious correction is adjusting controlled prices, including some type of mechanism to avoid price misalignment. Another correction is to prepare the country for a likely increase in the U.S. interest rate and a period of volatility in withdrawals of assets from Brazil and other emerging countries, which will probably put pressure on the exchange rate—especially because today Brazil’s external current account is no longer entirely financed by foreign direct investment. These two corrections—the adjustment of administered prices and the likely depreciation of the exchange rate—will entail additional inflation. As inflation has for some time already been running close to the central bank’s upper target, this will bring up an immediate inflation challenge. To curb inflation, it will be vital that monetary policy is supported by consistent fiscal policy.
Fiscal policy in the short term needs to ensure that public debt and the budget surplus return to a sustainable trajectory. In addition to adjusting administered prices and some exchange rate depreciation, public spending in the last two years will need to be acknowledged more explicitly. At some point, it will be necessary to contain expenses that were postponed. Some liabilities, such as the energy bill, are obvious, and next year they will more than ever be the center of fiscal policy. The medium and long-term policy is what I have already described. We cannot be naïve and imagine that it will be possible to see results in the short term. However, a correct policy signaling the right direction can help to reduce risk premiums.
What is needed to raise investment?
A point I like to emphasize is that for Brazil the only way to see lower interest rates and higher private investment in the future will be to reduce the gross public debt-to-GDP ratio. In Brazil, the bulk of financial assets is in public debt. Since you cannot try to reduce the interest burden by force, the only solid way to do it is to have sufficient fiscal primary surpluses to reduce gross public debt. If we reduce gross debt, whoever wants to make money in Brazil will have to either buy private equity or participate in public-private infrastructure operations. The only way to stop the country being a rentier of the public sector will be to reduce the size of public debt. Any plan to increase private investment and place the Brazilian economy on a sustainable growth path with increased productivity and economic stability must take this route.
