Can MMT Get Brazil Out Of Its Deep Slump?

Brazil’s dismal economic performance since the debt crisis of the 1980s has made it the poster child of the “middle-income trap.”  Over this period, Brazil’s economy, like those of most Latin American countries, stopped converging with developed economies, in sharp contrast to the high-growth emerging markets in East Asia and Eastern Europe. This extended period of economic failure has led to rising anxiety and calls for new approaches from policy makers and intellectuals  of both the left and the right.

Brazil’s Finance Minister Paulo Guedes has argued for a liberal agenda of privatizations, trade liberalization and smaller more efficient government, but he has run into the rock-hard resistance of powerful interest groups which extract benefits from the status quo and he has had only tepid support from his boss, President Bolsonaro. Unfortunately, though Guedes’s “Chicago School” framework would have produced high returns if introduced decades ago  today  it  seems woefully anachronistic in the context of a global reaction against neo-liberalism and the renewed popularity of industrial policy in the U.S. and its allies (WSJ). More in tune with the times, Brazilian financier Andre Lara Resende has caused an intellectual ruckus by advocating that Brazil break out of its torpor by adopting Modern Monetary Theory, the combined expansion of money printing and fiscal expansion that President Biden is pursuing in the U.S.  The underlying premise for both Lara Resende and U.S policy makers is that their respective economies have an abundance of high return public sector investment opportunities (infrastructure, basic research, broadband access, education, etc…) that pay for themselves through higher productivity and GDP growth and are easily financed today given the current extraordinary financial conditions of excess savings and historically low interest rates.

Lara Resende’s thinking reflects a profound change in the popularity of developmentalist economic theories in favor of a more activist state. The phenomenal rise of China with its super interventionist public sector and its sector-targeted industrial policies occurred during a 40-year period of neo-liberal tendencies and public sector retrenchment in the West. But now the pendulum has turned and a new generation of influential economists, such as Carlota Perez and Mariana Mazzucato, are convincing policy makers in the West that the public sector has a critical role to play in inducing innovation and growth. The Biden Administration is particularly smitten with these ideas, believing that these policies will put the U.S. on a higher, socially equitable and greener growth path.

In Brazil, these state-supported developmentalist policies have been deeply out of favor since the 1980s. Even the leftist ideologues of the PT administrations of Lula and Dilma rejected industrial policy in favor of social welfare initiatives. Since the 1980s, the Brazilian state’s capacity for investing in public goods has been severely eroded. Despite chronic fiscal deficits and a near-doubling of the ratio of public debt to GDP over the past decade, almost nothing has been spent on infrastructure. Also, government support for critical sectors through financial subsidies and research and development has dwindled. Over the past decades as government capacity for investing in public goods has fallen Brazil has become increasingly reliant on private capital for the scarce investments made in physical infrastructure, education and healthcare.

But this was not always the case. In fact, the kind of strategies advocated by Lara, Resende, Perez and Mazzucato have a better track in Brazil than neo-liberal ideologues like Guedes would admit. We can point to two of Brazil’s great success stories of the past decades as evidence of this: agroindustry and Embraer.

• Brazil’s world class agro-industrial sector was heavily supported by the public sector which sponsored through the agriculture research institute, Embrapa, innovation breakthroughs in tropical agriculture. Also, a wave of investments in roads and highways and port infrastructure during the 1970s provided the physical backbone for grain exports. Finally, for decades through Banco do Brasil, the government has provided cheap investment and working capital to the farm sector. All of this public sector support has induced the enormous success of thousands of entrepreneurs in the farm sector and related activities (services, meatpacking, etc…).
• Brazil’s aircraft manufacturer Embraer was heavily promoted and subsidized by the military regime (1964-1980) and provided with a captive market for military and civilian planes. The company’s success was always tied to the state-run Aeronautics Institute of Technology (ITA) which partnered with leading global research institutions such as MIT to achieve a high level of academic excellence. ITA has educated the vast majority of the engineers employed by Embraer, and one of its graduates, Ozires Silva, was the driving managerial force behind its success. Embraer and ITA are both based in Sao Jose dos Campos and support a cluster of world-class aeronautics expertise.

In today’s Brazil there are many opportunities to use the public sector to promote strategic industries that generate growth and employment. For example, tourism could benefit from long-term planning, infrastructure investments, vocational training and preferential tax and financial regimes. Green technologies, from ethanol to solar and wind, also would benefit from public support. The automotive industry stands to be thoroughly disrupted by electrification over the coming decade unless the public sector has a plan to maintain the country’s relevance in this industry. Unfortunately , under current circumstances there are serious impediments to pursuing these efforts; namely, the insolvency of the state and chronic fiscal incontinence.

The Impossible Trinity

Lara Resende assures that there is a long list of badly needed investments that would increase growth and productivity and therefore pay for themselves. However, given Brazil’s current high debt levels and chronic fiscal deficits, how do you convince financial markets to accept higher public debt levels? Any indication of increased public spending today, no matter how well intentioned,  would trigger capital flight, a weaker BRL and higher nominal interest rates. Under current circumstances, Brazil is severely constrained by The Impossible Trinity, the concept in economics which states that it is impossible to control the exchange rate, capital movements and monetary policy at the same time. In Brazil, any version of Modern Monetary Theory that pretends to finance stepped-up fiscal spending and debt accumulation  would almost certainly result in a combination of higher inflation and currency devaluation unless capital controls were imposed. Of course, any hint from policy makers that they are thinking of stricter controls on capital flows would accelerate outflows.

Whatever the MMT proponents say, in Brazil, and in many other countries around the world, there is no way to get around the fact that the current very high debt levels are an impediment to growth and tie the hands of policy makers. After a decade of quasi-recession conditions, Brazil will not follow a path of austerity to reduce these debt levels. So, in the end, it will have to follow the path of financial repression like developed countries were able to do in the 1950s and hope to do again this decade. Hopefully, Brazil will not try to inflate the debt away (which would place the adjustment burden on the poor) but rather will find a way to pass the cost to Brazil’s rentier class.