Seeking Measures to Revive Economic Growth in BraziL

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1 Forum: Economic and Social Council (ECOSOC) Issue: Seeking Measures to Revive Economic Growth in BraziL Student Officer: Divyansh Agarwal Position: President Introduction Brazil, one of the BRICs, was once a favorite of the emerging-market investors due to its exportsdriven growth. Thus, over the past decade, Brazil has experienced rapidly growing foreign capital inflows. However, this flood of hot money flows into Brazil has made its currency one of the costliest in the world, which means that Brazilian exports have become more expensive and hence, demand for Brazilian exports is decreasing, leading to poor economic performance of the export-driven economy 1. This poor performance in recent times is highlighted by the 2% average economic growth over the past three years 2. High rates of inflation in Brazil have slowed investment and increased consumer expenditure, and hence, have led to slower rates of growth. In order to tackle these high rates of inflation, the Brazilian government has increased interest rates rapidly, thus further slowing down investment in the economy. Moreover, as Brazil is one of the most closed economies in the world of emerging economies (total imports account for only 15% of GDP), economic growth has been slow in Brazil. The Brazilian government has also made Brazil a welfare state, with the government spending more on the economy that it can afford. This has meant that the government cannot use its money to invest in infrastructure or other areas that would facilitate economic growth. Moreover, in order to obtain the funds for this kind of spending, the Brazilian government has had to impose high tax rates, which deters investment and training of workers (which means that efficiency of the economy does not improve) from businesses. 1 Sharma, Ruchir. Breakout Nations: In Pursuit of the next Economic Miracles. New York: W.W. Norton, Print. 2 "Brazil GDP Annual Growth Rate." TRADING ECONOMICS. N.p., n.d. Web. 07 July < Research Report Page 1 of 11

2 Definition of Key Terms Dhirubhai Ambani International Model United Nations th of Janurary 1 st of February 2013 GDP (Gross Domestic Product) The monetary value of all the finished goods and services produced within a country's borders in a specific time period. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory. 3 Inflation A sustained increase in average price level of an economy. 4 Interest Rates The interest rate is referred to as the cost of borrowing money. The higher the interest rates, the costlier it is to borrow money, and thus, high interest rates discourage consumer spending and investment as the money needed to finance consumer spending and investment becomes harder to obtain. 5 Background Information High Prices and Persistent Inflation The Brazilian economy is characterized by excessively high prices, with restaurant prices in Sao Paulo being higher than those in Paris, hotel rooms in Rio being costlier than those along the French Riviera, haircuts costing more than they do in London, bike rentals being more expensive than in Amsterdam and movie tickets selling for higher prices than in Madrid. 6 These high prices are the result of persistent inflation that has been prevalent in Brazil. Since 1980, Brazil has had high inflation rates, with hyperinflation occurring in the early 1980s and peaking in Since then, the hyperinflation has been brought under control, but high rates of inflation still persist, with inflation rates in recent times being 6% 7 High rates of inflation lead to uncertainty in the economy and this discourages investment. Moreover, the international competitiveness of an economy is reduced, as its exports become more 3 "Gross Domestic Product (GDP) Definition Investopedia." Investopedia. N.p., n.d. Web. 23 July < 4 Tragakes, Ellie. Economics for the IB Diploma. Cambridge: Cambridge UP, Print. 5 Tragakes, Ellie. Economics for the IB Diploma. Cambridge: Cambridge UP, Print. 6 Sharma, Ruchir. Breakout Nations: In Pursuit of the next Economic Miracles. New York: W.W. Norton, Print. 7 "Brazil s Dilma Rousseff Boosts Welfare Support Ahead of Poll - FT.com."Financial Times. N.p., n.d. Web. 23 July < Research Report Page 2 of 11

3 expensive to foreign buyers while imports become cheaper to domestic buyers. Brazilian exports have fallen, for example, exports to Middle Eastern countries fell from $ 1,745 billion in the first quarter of 2013 fell to just over U.S. $ 1,583 billion in the same period in Furthermore, high rates of inflation can lead to the money illusion effect wherein some people feel better off when their nominal income increases, even though price level may increase at same rate and possible even faster. They thus are under the illusion that they are better off whereas in fact they are not. This could lead to consumers making the wrong spending decisions by spending more than they should. High Interest Rates In order to attempt to control high rates of inflation, the Brazilian government charges high rates of interest. However, this discourages investment by making it more expensive to borrow. Thus, investment rates are relatively low in Brazil, and the lowest amongst the major emerging markets, with investment rates at 18.6% of GDP 9. Low investment rates mean relatively low economic growth. Furthermore, the low investment rate leads to inefficiencies. A low investment rate also means that the Brazilian economy can overheat at low growth rates. For example, due to low investment, the country s supply chain comprises of aging factories and potholed roads, hence, during times of rising demand, supply is not likely to be able to keep up with demand, leading to rise in prices. The low investment rate and the resulting lack of investment also means that the productivity of the Brazilian economy has been growing at a slow pace, with annual productivity growth rate averaging 0.2% between 190 and Rising value of Real The high interest rates in Brazil have attracted foreign money flows into Brazil, driving up the value of the real (the Brazilian currency). The high demand for commodities like iron ore and Brazilian coffee from foreigners, which Brazil exports, has also driven up the value of the real. 8 N.p., n.d. Web. 23 July < 9 "Brazil 6% Second-Quarter Growth Beats Forecast on Investment."Bloomberg.com. Bloomberg, n.d. Web. 23 July < Research Report Page 3 of 11

4 The rising value of the real has made exports more expensive, while it has made imports cheaper, so demand for exports has decreased while demand for imports into Brazil has increased, causing the trade deficit to widen, for example, from a surplus in 2007 to $50 billion deficit in The Trilemma in the Brazilian Economy The Brazilian government faces the challenge of managing and stabilizing high interest rates, currency appreciation, and inflation. The problem they face is that trying to solve one problem they exacerbate the other(s). For example, if the Brazilian government wants to stabilize inflation rates, they must raise interest rates, but this attracts more foreign money flows and drives up the value of the real. Conversely, if they want to make the real more competitive by depreciating it, they must decrease interest rates, but this will trigger more spending (as it becomes easier for consumers to obtain cash), thus causing greater inflation. Skills Shortage Due to the low investment rates in Brazil, not enough schools and colleges are present in the economy. This means that there is a skills shortage in Brazil, since not enough skilled graduates are being produced in the country. Moreover, due to the low supply of skilled workers, with the demand for them being high, the wages are continuously rising. Poor Transport Network Due to lack of investment, the transport network in Brazil is very poor, and many managers at MNCs have to use a network of helicopters to travel from one place to another. This poor transport system means low efficiency, and has also discouraged foreign investment. Excessive welfare spending The Brazilian government has been spending excessively on welfare spending, as is highlighted by the fact that its spending on welfare is more than 40% of GDP. Politicians such as Dilma Rousseff use increased welfare spending to boost their chances of winning elections. 10 To fund this excessive welfare spending, the government has to charge high taxes, with tax revenues being as high as 38% of GDP. Due to high taxes, after tax incomes and profits are relatively low, so there is less left for consumer spending and investments. This again means that economic growth is relatively low. 10 "Brazil s Dilma Rousseff Boosts Welfare Support Ahead of Poll - FT.com."Financial Times. N.p., n.d. Web. 23 July < Research Report Page 4 of 11

5 Moreover, since high taxes mean less investment, this means that there is less investment in new technology and training, so Brazilian industries are relatively less efficient. Trade Barriers Although Brazil has made progress in reducing traditional border trade barriers, tariffs still remain high and favour locally produced goods. Import tariffs range between 50-80% in Brazil. 11 This protectionism not only discourages foreign trade, but also encourages inefficiency and discourages innovation and experimentation (which Brazil lacks) amongst local businesses by limiting their competition. Measures to Increase Investment and Tourism The Brazilian government, in its attempt to revive the economy by attracting investment, pitched successfully for hosting the FIFA World Cup in 2014 and the Olympics in These events will also attracts tourists from all across the world, leading to greater revenues for the Brazilian tourism industry, and hence, greater incomes for its locals. Therefore, while there is greater investment in the economy, there will also be greater consumer spending which will cause aggregate demand in the economy to increase, and hence lead to a higher level of production of real GDP, which means that there will be economic growth, and lesser unemployment, leading to a further rise in incomes and hence standard of living as more people will be employed. Tax Cuts The Brazilian government has cut taxes in an effort to increase disposable incomes and thereby encourage consumer spending. An increase in consumer spending boosts the economy theoretically. Major Countries and Organizations Involved Brazil China Being the country whose economy is under discussion, this is naturally an important country. 11 "Brazil's Trade Barriers - Overcoming Tariffs for Biz Dev Success." Brazil's Trade Barriers - Overcoming Tariffs for Biz Dev Success. N.p., n.d. Web. 23 July < Research Report Page 5 of 11

6 China is one of the biggest importers of Brazilian exports, and would hence want the price of Brazil s exports to come under control. China is also investing heavily in Brazil. Until 2009 Chinese investment amounted to only $50 million, but in 2010, an investment on $19 billion was announced and $12.7 billion worth of investments were finalised. Chinese firms are also starting to build manufacturing units in Brazil. 12 However, the Chinese investors seek lower interest rates, less bureaucracy and a better transport network, saying that it would make them willing to invest further and make it easier for them to invest in Brazil. USA (United States of America) Most of the multinational corporations (MNCs) in Brazil originate in the USA. Thus the USA would want Brazil s economy to grow at a fast pace since it benefits from remittances and also since earnings from MNCs in Brazil constitute the USA s Gross National Income. However, in the event of rapid economic growth in Brazil, the USA government would have to safeguard against excessive outsourcing to Brazil that would mean loss of jobs in the USA. Brazil is also USA s 10 th largest trading partner, and the USA government wants Brazil to ease its trade barriers. Brazil and the USA have recently faced a lot of contentious trade issues, including disputes over agricultural exports, customs and legal procedures, and the enforcement of intellectual property rights in Brazil. 13 The USA wants to start a free trade agreement with Brazil, to formulate a bilateral tax treaty to encourage cross-border investment, and the removal of tariffs and subsidies on renewable energy products. 14 EU (European Union) The EU recognizes Brazil as its most important in Latin America, and wants to address trade and investment issues of bilateral relevance that complement EU-Mercosur discussions. It wants to enhance co-operation in sectors and areas of mutual interest such as economic and financial, issues, information society, air transport, maritime transport, science and technology, satellite navigation, social matters and regional development "Seeking Protection." The Economist. The Economist Newspaper, 14 Jan Web. 23 July < 13 "BRAZIL AND THE UNITED STATES: WORKING TO ADVANCE THEIR COMMON PROSPERITY." N.p., n.d. Web. 23 July < 14 "BRAZIL AND THE UNITED STATES: WORKING TO ADVANCE THEIR COMMON PROSPERITY." N.p., n.d. Web. 23 July < 15 "EU-Brazil: Commission Proposes Strategic Partnership." EUROPA. N.p., n.d. Web. 23 July < Research Report Page 6 of 11

7 New Development Bank The New Development Bank, set-up by the BRICS in 2014, was meant to finance emerging markets, and is controlled by the BRICS, who sought to counter the IMF and the World Bank, which they claim is dominated by Western powers. This bank could thus be an important source of funding for infrastructure for the Brazilian government. Timeline of Events Date January, 2008 August, 2008 October, 2008 November, 2009 August, 2010 October, 2010 June, 2011 August, 2011 November, 2011 June, 2012 April, 2013 Description of event The EU halts all imports of Brazilian beef, saying its foot-and-mouth disease checks are "unacceptable". Government launches scheme offering cash payments and immunity for illegal weapons, in an effort to get 300,000 guns off the streets. Brazil turns down an invitation from Iran to join the OPEC. Rio de Janeiro and Sao Paulo, Brazil s two largest cities, are hit by major blackouts due to problems at a hydro-electric dam. Brazil gives formal approval for construction of controversial hydroelectric dam in the Amazon rainforest, expected to be the world s third largest Dilma Rousseff, of President Lula s Workers Party, wins second round-off to become Brazil s first female president. Brazil launches Brazil Sem Miseria welfare scheme, aimed at lifting millions out of extreme poverty. Rousseff exempts four industrial sectors -- clothing, footwear, software and furniture -- from Brazil s 20 percent payroll tax as part of her Bigger Brazil Program. Brazil s central bank cuts capital requirements for some consumer loans with maturities of as much as five years, including Mantega announces a 6.6 billion reais increase in Brazil s budget to purchase tractors, buses, trucks, other vehicles and equipment from local manufacturers. Brazil s national monetary council reduces loan rates to 3.5 percent from 5 percent for the so-called Transformational Projects that target technological and productive capacity, and form part of the government s PSI investment program. Research Report Page 7 of 11

8 June, 2013 June, 2014 July, 2014 Rousseff announced subsidized credit totaling 18.7 billion reais ($8.8 billion) for 3.4 million low-income families in the country s Minha Casa, Minha Vida housing program to purchase furniture and home appliances. Brazil hosts FIFA World Cup amid protests The agreement over the establishment and functioning of the BRICS bank, called The New Development Bank is announced Relevant UN Treaties and Events No UN resolution regarding the Brazilian economy has been debated. Previous Attempts to solve the Issue The EU and the USA have been pushing for bilateral trade agreements to encourage trade with Brazil. Trade agreements between Brazil and EU and Brazil and the USA would increase competition in the Brazilian economy and would force the inefficient local producers to become more efficient, which would lead to a fall in prices, and could thus bring inflation under control. Increased imports could also help the currency depreciate, and this could boost exports. However, boost in exports could again lead to currency appreciation after a while, although tamed inflation would allow the government reduce interest rates, and therefore lead to reduced hot money flows, and hence currency depreciation. Brazil has also made some progress in reducing trade barriers, for example, by reducing traditional border trade barriers such as tariffs, import licensing, etc., tariff rates in many areas remain high and continue to favour locally produced products. 16 In order to bring investment in state-owned firms to make them more efficient, the Brazilian government has also privatized some state-owned firms which has increased efficiency and productivity in the economy. In order to raise funds, the Brazilian government has hosted the FIFA World Cup, which has boosted its tourism industry and brought the government valuable revenues, and is going to host the Olympics in 2016, which means additional revenue for the government and another boost to the tourism industry and job creation in Brazil.. Possible Solutions 16 "export.gov." Accessed July 21, Research Report Page 8 of 11

9 Brazil must work towards lowering trade barriers. In the long run this will benefit Brazil by encouraging foreign investment. The local businesses will thus face increased competition, and this will push them to innovate. Moreover, increased foreign investment will lower the unemployment rate in the long run, while the increased competition will also push down prices in the long run. This will mean that inflation will also be moderated in the long run. To attract foreign investment, the Brazilian government must use its funds more wisely. It must its funds and income to invest in infrastructure such as roads, as well as in education to produce more skilled labour to match the demand. By producing more skilled labour, the cost of skill labour will go down for businesses, thus allowing them to decrease prices and contain inflation in the long run. The Brazilian government should also decrease spending on unnecessary social welfare programs for the sake of political popularity and instead direct current expenditure towards more useful investments such as infrastructure. This will encourage growth and help the Brazilians obtain jobs and education in the medium and long term. This commitment towards economic prosperity might help them attain an increase political popularity, as it strives to solve the problems frustrating Brazilians today, who are protesting against Brazil hosting the FIFA World Cup and the Olympics since they want the funds used to host those events to be directed towards infrastructure and education. Emerging markets have been witnessing a change attitudes towards politics, as was seen in the case of India, when the population chose the BJP for its Prime Ministerial candidate Narendra Modi, whose mandate was focussed on economic growth, over the ruling Congress Party (which did not have a Prime Ministerial candidate), which championed the poor and minorities through welfare scheme. The UN can also play a bigger role in improving Brazil s economic situation. For example, the UNEP should assist in protecting the Amazon using its funds, so that the Brazilian government does not use up its funds in conserving the Amazon. Instead those funds can be used in increasing investment in the economy, leading to economic growth. The World Bank and the IMF should also give loans at lower interest rates to Brazil on the condition that it achieves certain pre-defined economic targets in terms of growth and unemployment, as this will make it cheaper and easier for the Brazil government to obtain funds to finance development of the economy. The ILO should also work towards achieving its aims of creating productive employment to better the lives of those who are unemployed or whose remuneration from work is inadequate to allow them to escape from poverty 17 in Brazil, which will mean that lesser unemployment benefits will have to be paid, so there will be lesser burden on the government budget of Brazil, while standards of living in Brazil will increased. Lesser social welfare expenses will allow the Brazilian government to increase investment in the economy, thus facilitating economic growth. 17 "Employment Creation." Employment Creation. N.p., n.d. Web. 20 Aug < Research Report Page 9 of 11

10 Bibliography Sharma, Ruchir. Breakout Nations: In Pursuit of the next Economic Miracles. New York: W.W. Norton, Print. "Brazil GDP Annual Growth Rate." TRADING ECONOMICS. N.p., n.d. Web. 07 July < "Gross Domestic Product (GDP) Definition Investopedia." Investopedia. N.p., n.d. Web. 23 July < Tragakes, Ellie. Economics for the IB Diploma. Cambridge: Cambridge UP, Print. "Brazil s Dilma Rousseff Boosts Welfare Support Ahead of Poll - FT.com."Financial Times. N.p., n.d. Web. 23 July < N.p., n.d. Web. 23 July < "Brazil 6% Second-Quarter Growth Beats Forecast on Investment."Bloomberg.com. Bloomberg, n.d. Web. 23 July < "Brazil s Dilma Rousseff Boosts Welfare Support Ahead of Poll - FT.com."Financial Times. N.p., n.d feabdc0.html#axzz37eu2OijS>. Web. 23 July < "Brazil's Trade Barriers - Overcoming Tariffs for Biz Dev Success." Brazil's Trade Barriers - Overcoming Tariffs for Biz Dev Success. N.p., n.d. Web. 23 July < "Seeking Protection." The Economist. The Economist Newspaper, 14 Jan Web. 23 July < "BRAZIL AND THE UNITED STATES: WORKING TO ADVANCE THEIR COMMON PROSPERITY." N.p., n.d. Web. 23 July < Research Report Page 10 of 11

11 "EU-Brazil: Commission Proposes Strategic Partnership." EUROPA. N.p., n.d. Web. 23 July < "Rousseff's Stimulus Measures to Spur Brazil Economy: Timeline."Bloomberg.com. Bloomberg, n.d. Web. 05 Aug < Research Report Page 11 of 11