What's behind Brazil's demonstrations? Poor economic policy.

Brazil demonstrations were sparked by specific grievances against the government. But the underlying frustrations stems from failed economic policies that have slowed productivity growth and hurt entrepreneurialism. 

With their convincing 3-0 win over Spain in the Confederations Cup, Brazilians took to the streets to celebrate – for a change. But ongoing widespread street protests are likely to dissipate the positive glow of the soccer victory. Brazilians are angry about corruption, poor quality public services, and a feeling that money is being wasted on soccer stadiums. These are symptoms of a deeper cause: a Brazilian economic policy that has focused on the welfare of a few privileged producers at the expense of the wide swath of Brazilian consumers.

Having just returned from Brazil for presentations at a number of conferences (and being caught in a demonstration at the Sao Paulo airport), I think it’s clear that Brazilian economic policy is severely off track. Over the last decade Brazilian policymakers have resurrected the failed import substitution policies of the 1960s and '70s in the hopes of growing their economy by reducing imports and favoring national champions. But this policy has clearly failed.

Economic growth comes from raising productivity. Yet, compared to other developing nations (let alone developed ones), Brazil falls far behind. Over the last 15 years, productivity accounted for 84 percent of growth in a sample of 30 low- and middle-income nations (as measured by gross domestic product or GDP), but in Brazil it accounts for only 28 percent.  This is a major reason why Brazilian productivity, and by definition incomes, is just 20 percent of US levels.

This anemic performance was not because Brazil lacked high-productivity industries: Embraer makes jet aircraft while Petrobras is a leader in oil exploration. Indeed, as the McKinsey Global Institute has shown, while Brazilian GDP growth from 1995 to 2005 was just 38 percent of Chinese levels, Brazil should have had higher productivity growth given its higher share of high-productivity industries. Brazil lagged because it had low productivity growth across all its industries.

This should not be a surprise, for the focus of Brazilian economic policy, first under the administration of Luiz Inácio Lula and now under President Dilma Rousseff's, has been to foster import substitution through industry targeting, seeking to raise the price of imports, particularly for capital goods.

Of 54 nations examined by my organization, the Information Technology and Innovation Foundation, in our Global Innovation Policy Index, Brazil had the highest tariff on manufactured products and the third highest level of nontariff barriers to trade. The government also gives preferences to capital goods companies who produce in Brazil despite this raising prices and/or lowering quality. For example, as part of the government’s “IT Maior” plan, Brazil’s effort to develop a strong domestic information technology sector, companies selling IT software and related services to the public sector are certified as to whether they are using “national technology.” Brazilian agencies must pay a price premium to buy this “home-grown” technology. The government does the same thing with pharmaceutical products, paying up to 25 percent more for drugs that are made in Brazil, reducing drug coverage for the population.  And in an effort to reduce imports of e-books from companies like Amazon and Apple, taxes on e-books can be as high as 50 percent.

Publicly owned and regulated companies are also often subject to these requirements. Recent winners of the spectrum auction were required to buy up to 50 percent of their equipment locally. Petrobras, the state champion, has in fact been fined for not buying enough locally produced goods.

On top of this, the government has developed a list of products that get a 95 percent reduction in excise tax breaks for being manufactured locally. Local computer companies are required to buy 90 percent of their memory chips from local producers, regardless of whether this is the best or cheapest technology.  

These restrictions and taxes are one reason why so many Brazilians fly to places like Miami to buy smartphones and other electronics and bring them back home.

Put this together and you get an economy more focused on making “tools” than on using them, even though using more and better tools is the main source of productivity growth. It’s therefore not surprising that Brazilian businesses invest between 40 and 50 percent less in IT than businesses in developing nations like China, South Africa, and Malaysia. And why the Brazilian construction industry uses relatively few tools like electric drills and spray painters.

Even if Brazil continued to restrict imports, its economy would be in better shape if it enabled entrepreneurship. But in an effort to defend favored businesses, Brazil makes it hard to start and run new companies. Of 54 nations, Brazil ranks worst in terms of number of days to start a business (120) and number of procedures to start a business (15). One speaker at the conference I attended who had a small home-based consulting business told how he had to re-register his business and pay a tax amounting to 2 percent of the value of his house when he moved to a new home in the same city. And when it comes to recovering the investment from a failed business, Brazil ranks among the worst, with investors getting on average just 17 percent of the value, compared to 91 percent in Singapore. Couple that with some of the weakest intellectual property rights policies in the world, and it’s a wonder why investors would risk any new capital to fund innovative start-ups.

If the Rousseff administration wants to regain the trust of the Brazilian people, a key step would be renouncing the failed policy of import substitution industrialization and promoting national champions in favor of a policy to expand the welfare of consumers and freedom of entrepreneurs.

– Robert Atkinson is president of the Information Technology and Innovation Foundation.