Brazil’s austerity experiment

Scott Alexander recently had this to say about a Vox article on Brazil:

Brazil has just passed the most extreme austerity measure in history in the middle of a recession, locked in with a clause making it impossible to repeal for 10-20 years. A…bold…choice. If nothing else, it’ll provide good data for future generations of macroeconomists. Register your predictions now!

I predict success, in the sense of faster growth.

I doubt, however, that the experiment will actually prove very much, as I know of no theory that predicts Brazil’s austerity would cause slower growth, and I know of no evidence that Brazil will in fact engage in extreme austerity.

Brazil has high interest rates and high inflation, and hence even Paul Krugman would not regard fiscal austerity as being contractionary in Brazil. Instead, the Brazilian central bank determines the rate of Brazil’s nominal GDP growth.

Might austerity hurt the supply-side of Brazil’s economy?  I suppose anything is possible, but it’s hard to see how.  Unlike China, Brazil’s high government spending goes to things like public pensions, not infrastructure.  In addition, Brazil’s government sector spends much more (39.1% of GDP) than other countries that seem to have at least as productive supply-sides, such as Chile (23.2%), Mexico (26.6%), Costa Rica (18.2%), Uruguay (32.6%), and Australia (35.3%).  It’s not clear to me that spending 39.1% of GDP makes your economy more efficient, especially if very little of the money goes to infrastructure.  To be fair, Venezuela spends 40.1%.  So Brazil is the not highest spender.

Perhaps the austerity will fail by increasingly inequality.  Brazil is already very unequal, although a bit less so than 20 years ago.  But that depends on which programs are cut.  In the past, government spending in Brazil has been regressive, mostly going to relatively well off government employees and pensioners.  Unfortunately, the Vox article that Scott links to doesn’t tell us where the cuts will come.

Nor does it say that there will be any cuts at all:

Americans worried that Donald Trump will try to shred the nation’s social welfare programs can take some grim comfort by looking south: No matter what Republicans do, it will pale in comparison with the changes that are about to ravage Brazil.

On Thursday, a new constitutional amendment goes into effect in Brazil that effectively freezes federal government spending for two decades. Since the spending cap can only increase by the rate of inflation in the previous year, that means that spending on government programs like education, health care, pensions, infrastructure, and defense will, in real terms, remain paused at 2016 levels until the year 2037.

A few comments:

1.   Notice that no specific cuts are announced.

2.  A constitutional amendment in Brazil doesn’t have the same meaning as in the US.  It’s more like legislation.  When a government engages in Augustinian promises to do something virtuous, but only far out in the future, it’s a pretty good indication that they have absolutely no intention to fulfill their promise.  Many governments have long range promises to balance the budget, which no one seriously expects to be enacted.  I hope the Brazilians will hold real spending fixed for 20 years (to become a bit more like Chile), but it seems very unlikely that they will do so.

The Vox article is highly misleading in all sorts of ways.  For instance, did you know that Brazil is one of the most highly taxed countries in the developing world? If you did not, you probably would not acquire that information by reading this from the Vox article:

While the amendment does a great deal to limit the expenditure of government funds, it doesn’t do anything to directly address how to generate them directly: taxes.

“The major cause of our fiscal crisis is falling revenues,” Carvalho says, noting that the populist Rousseff, known for her support for government programs, cut taxes for the corporate sector during her time in office over the past few years in an attempt to avoid losing public support.

Carvalho says taking an ax to spending is coming at the expense of discussing “taxing the very rich, who do not pay very much in taxes, or eliminating tax cuts that have been given to big corporations.”

Brazil’s tax code is extraordinarily generous to corporations and the wealthy, and helps buttress its status as one of the world’s most unequal countries. Brazil’s highest income tax rate is just 27.5 percent — for comparison, US tax rates go up to about 40 percent, and in Scandinavia they can exceed 60 percent.

The Vox article doesn’t really provide much context.  Readers are not told that a decade of socialist misrule has driven Brazil into a painful recession. Perhaps Brazilians have noticed the fact that Chile and Mexico are not in depression, and do not have as bloated a government sector.  Maybe they don’t think it’s wise to have a government sector that is almost as large as in Venezuela.

PS.  Over at Econlog I discuss the peculiar views of Trump’s new economic advisor


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16 Responses to “Brazil’s austerity experiment”

  1. Gravatar of Ben Ben
    31. December 2016 at 10:39

    Vox being highly biased example no. 28572

    There are some legitimate concerns though. Usually centre-left governments that implement generous pensions for the wealthy or public sector workers are rarely properly reversed under austerity because they vote. Meanwhile, the uneducated poor normally gets hit the hardest through rises to regressive (more hidden) taxes and cuts to welfare. Brazil is already insanely unequal, that would make it even worse.

    So it definitely won’t be contractionary and it’s insane to compare Brazil to the US or some European country but it might be deeply unfair.

  2. Gravatar of ssumner ssumner
    31. December 2016 at 11:55

    Ben, I agree. They should have waited to see what got cut, and then wrote the post.

  3. Gravatar of Kgaard Kgaard
    31. December 2016 at 13:05

    The insane thing about Brazil is that they have a 14% central bank rate vs. a 7% CPI (and falling). Just cutting the benchmark rate should re-ignite the construction/homebuilding sector in particular. Could be a good year for them.

  4. Gravatar of Rob Rob
    31. December 2016 at 13:27

    It’s a shame – I very much like Yglesias’ content and Klein is okay, but some of the stuff on vox is just low quality. Particularly when it comes to foreign countries.

  5. Gravatar of A A
    31. December 2016 at 16:53

    Rob, the distribution of ability amongst Vox’s writing staff resembles a barbell. I usually read their articles content first, only to find that the frustratingly shallow pieces are usually matched to the same names.

  6. Gravatar of B Cole B Cole
    31. December 2016 at 17:19

    A favorite pastime among pundits is to find some country on earth that is performing well or badly, and then to attribute the failures or successes of that country to the right or wrong policies–as seen by the pundit or macroeconomist.

    It is a bit like saying a baseball game was won by the last home run.

  7. Gravatar of Christian List Christian List
    31. December 2016 at 18:02

    Vox promised to be different but most of the time they are not.

  8. Gravatar of Major.Freedom Major.Freedom
    1. January 2017 at 13:15

    “Unlike China, Brazil’s high government spending goes to things like public pensions, not infrastructure”

    Both are consumptions, as both are not self-sustaining the way a private enterprise is self-sustaining. The biggest dam or bridge financed by taxes is much a consumption as pizzas and beer purchased by public employee pensioners.

    It is no rescue to smuggle in a personal value judgment of “bridges are worth more”. Value is subjective to the individual, and the money stolen from individuals to pay for the bridge, denies those individuals from acting upon their values as much as it would if money were stolen from them to pay for pizzas and beer.

  9. Gravatar of ssumner ssumner
    1. January 2017 at 15:39

    Everyone, Not much to disagree with.

  10. Gravatar of Potato Potato
    1. January 2017 at 20:21

    Yglesias is usually fine as long as he sticks to economics. He usefully pushes back on zoning restrictions, licensing, and rent control. He is knowledgable enough in those issues to put words on digital paper that hopefully liberals read.

    Klein is a lot more thoughtful in interviews and podcasts than the tenor of his publication would suggest. The Aja Romano person is off the deep end, as is whoever Dara Lind happens to be. But I think Klein at some point realized that money comes in clicks, and to get clicks you need controversy, and the SJW well is ever full. Be honest, if any of you were in charge of a liberal publication, would you really do any different ? Jobs and money are at stake.

    Vox is at their worst when they write about foreign affairs or national security, since they have no one on staff that’s even been tangentially involved in either field (in the real world, aka outside of academia and think tanks). I think they make some phone calls to left wing think tanks or staffers and regurgitate whatever line they get. But hey, it’s no worse than the “experts” on the nytimes or national review.

    Anyways, sorry for the completely off topic comment. Great analysis, as usual.

    Happy new year to all.

  11. Gravatar of Rodrigo Rodrigo
    2. January 2017 at 02:34

    The brazilian freeze of expenditures was a political maneuver to make inevitable the more contentious pensions reform that will be subject of legislation in 2017. The high public sector employees of federal government and military are responsible for most of the pensions deficit, but even the private employees have rules that are not sustainable. The Vox article is terrible, they only interviewed Laura Carvalho, which is an heterodox economist connected to the worker’s party; most economists in Brazil supported the bill although fully aware that the present head of the government is probably as corrupt as the former president was.

  12. Gravatar of Jose Jose
    2. January 2017 at 07:51

    President Temer is the most able of any President I have seen in my lifetime, and has control of Congress. Right now, it seems he will be able to approve any legislation he likes.

    That does not mean he will do the “right thing”. As the numbers show in prof. Sumner’s article show, some kind of spending control was necessary, so they did a Constitutional reform. Although prof. Sumner is right that this is kind of ordinary law, there is a difference, Constitutional reform demands a qualified 60% approval in both houses of Congress, and they have to vote 2 times each. They are very difficult to overturn unless there is a broad consensus.

    I would add that 12 month NDGP growth in Brazil has average below 4% in the past 4 quarters, making the current monetary policy the tighest EVER to be applied here. The reason people don’t seem upset is that we had 20% a year not so long ago, and people still use the level of interest rates as an indication of monetary policy stance, something that the readers of this blog know better about.

    I expect the CB to cut rates aggresively as soon as it becomes evident the pensions reform will be approved easily, in the necessary 4 votes, 2 in the senate and 2 in the lower house … Or not! But then, I seriously will consider a decision to leave the country….

  13. Gravatar of Thiago Ribeiro Thiago Ribeiro
    3. January 2017 at 07:20

    “Readers are not told that a decade of socialist misrule has driven Brazil into a painful recession.”

    After a decade of free-market run amok had driven the country in such a painful recession the Socialists had become the lesser evil and won the election. Brazil was the only important South American country where the Left had NEVER won a presidential election. Brazil is not Argentina with its Peronism or Chile with its decades-long Socialist Party influence (remember Allender and Senator Pablo Neruda), the Left had never any real influence in Brazil until the 90’s disaster. It could have been worse:
    Lawrence Summers used to advice Brazil to follow Salinas and Cavallo’s lead. One of them provoked such a collapse that he destroyed the PRI’s so-called “perfect dictatorship”, the other guy basically created the Kirchner couple’s power. We need Brazilian solutions for Brazilian problems, not the latest iteeation of American failed policies. They failed beforw, they will fail again.

  14. Gravatar of Gap Gap
    5. January 2017 at 03:33

    The thing is, there is no austerity in Brazil. Just look at the numbers.

  15. Gravatar of ssumner ssumner
    6. January 2017 at 16:01

    Everyone, thanks for the info.

    Thiago, You said:

    “After a decade of free-market run amok had driven the country in such a painful recession the Socialists had become the lesser evil and won the election.”

    When was that? Was it worse than last year’s recession? I doubt it.

  16. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    8. January 2017 at 08:09

    The last time NGDP growth was this low was in 1998, and it happened during only 2 quarters. After re-elaction in october of 98, President Fernando Henrique Cardoso changed Central Bank head Gustavo Franco (pegged exchange rate) for Arminio Fraga (floating exchange rate, but he had to raise the base rate to 45% for a while). In 2002 the economic problems were self inflicted: to the extent that Lula´s prospects increased, the exchange rate devalued even more, so much so that he had to write the (now infamous) “Letter of Ribeirao Preto” (curiously my home town), influenced by later to be minister Palocci In the letter Lula committed to fiscal responsibility. After the election he kept his promises, and the economy took advantage of the commodities boom up to 2007. The 2002 election was heavily influenced by the energy crisis that happened during 2001, when drought and lack of investment forced electricity rationing. Curiously, Palocci is in jail, and Lula is said to be at least convicted in thenear future for a series of corruption crimes.

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