Brazil's Inertial GDP

April 3, 2015

"Inertia," a widespread term among physicists and economists, is the state of immobility that may characterize an object. Applied to inflation, it means the tendency of prices to remain high, even if the government is actively engaged in bringing them down. Brazil has suffered from greater inflationary inertia in the past than current evidence would suggest. However, domestic prices continue to be stubbornly inert. Part of the reason is that informal indexation mechanisms still prevail as defense strategies against the country's longstanding foe. Adding insult to injury, in recent years the Brazilian government reintroduced perilous formal indexation mechanisms that increase price resistance—backward-looking rules for minimum wage adjustment are an example of this.

According to several empirical studies, Brazil's total factor productivity is stagnating.

But this is not yet another article about inertial inflation. This is a brief reflection on another inertial object that has become ever more rigid in Brazil: GDP—the GDP that barely moves, that cannot change its speed or direction. I am not speaking of the results for 2014, recently published by the National Statistical Office, the IBGE—0.1 percent growth is inert by any measure, but it is also a reflection of the deep imbalances that were diligently construed over the last four years, as are current expectations that the economy will shrink this year. While all of this is obviously relevant, the GDP that matters is not that of some particular occasion or of certain points in time. The GDP that really matters is that which reflects a country's potential, the ability to grow when problems facing the economy are not as daunting as those that currently plague Brazil. This is a loose definition of what economists call potential GDP.

What is Brazil's potential GDP? As economists are always keen to stress, potential GDP is a theoretical construct, one that does not easily lend itself to quantification. That said, attempts to quantify potential GDP are key to formulating and calibrating macroeconomic policies. During the boom years that marked the pre-Dilma period, many believed that Brazil had the potential to grow some 4 or 4.5 percent without creating additional inflationary pressures. The last four years, during President Dilma Rousseff's first mandate, everything changed. Some of the same analysts who believed in the country's 4 percent potential no longer expect that the country can grow more than half of that.

Why? There are several ways to measure a country's potential GDP, from the most sophisticated empirical methods to the most intricate theoretical models. However, what all growth theories have in common is the idea that economies need productivity gains, an expansion of the workforce and effective capital stock increases—both human and productive—in order to grow. Separating each of these components to assess Brazil's growth trajectory leads us to a frustrating conclusion: The country's potential GDP is indeed inertial. According to several empirical studies, Brazil's total factor productivity is stagnating. Moreover, following an extraordinary period of sustained expansion, the workforce is likely to lose impetus, especially as the demographic dividend, the one that Brazil wasted so thoroughly, comes to an end. How did the country waste its demographic dividend? Mainly by not investing in the quality of education, thereby failing to build adequate stocks of human capital. As for productive capital? Productive capital, such as machines and equipment, needs investment. How can one envisage that investment will be restored in a country mired in corruption scandals, plagued by an inoperative government, and characterized as one of the most closed economies in the world? In light of the current political difficulties and hard budget constraints, elaborate plans to rebuild Brazil's infrastructure and transform the country into something more than a slogan—the "Educator Nation" ("Pátria Educadora") exhorted by President Rousseff—seem decidedly far-fetched. Rather, a more fruitful direction would appear to be a move towards greater trade openness and integration with the rest of the world. Opportunities abound, especially as trade accords such as the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership start to come onstream. As many studies published by the Peterson Institute for International Economics show, there is a vast literature linking productivity and openness, openness and growth.

Unfortunately, Brazil is not there yet. The domestic debate is still caught up in discussing the inevitable fiscal adjustment: Is it good or not, will it redeem growth all by itself, or not? Unless Brazil moves beyond endlessly discussing well-established facts, the country might just be doomed to unduly suffer the malaise of inertial GDP.

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Monica de Bolle Senior Research Staff

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