Brazil: Don’t let the IMF ruin yet another country
prudentbear.com
August 6, 2002
“When Brazil calls 1-800-BAILOUT, let the phone ring. Don’t answer it.” – Rudi Dornbusch
Yet again, Brazil has devalued deeply and appears on the brink of collapse. Since the start of the year, the currency has lost almost one-half its value, the capital markets have seized up, and growth has come to a halt. Treasury Secretary Paul O’Neill was virtually crucified in the local press last week after expressing scepticism about the utility of another IMF bailout. The US Treasury Secretary roiled financial markets and created a diplomatic flap when he suggested on the television program "Fox News Sunday" that to obtain additional aid, Latin American nations, such as Brazil, needed policies to "assure that, as assistance money comes, that it does some good and it doesn't just go out of the country to Swiss bank accounts."
While lacking in diplomatic subtlety, for once we agree with the Treasury Secretary’s sentiments, but more on the grounds that the assistance money of which he speaks is likely to come via the IMF, with all of the attendant conditionalities attached to it. In the past, economic life had been constrained by the need to maintain social cohesion. It was conducted in social markets – markets that were embedded in society and subject to many kinds of regulation and restraint. The IMF has worked to demolish these social markets, wherever it has gone. It has had an exceptionally dismal record of failure throughout the 1990s: emerging Asia, Russia, virtually all of Latin America, feature amongst the most conspicuous disasters. Yet somehow the Fund continues to get drawn in to “sort things out”, invariably becoming an international imprimatur for the financial markets without which no further economic aid is usually forthcoming. The foregoing quip at the top of this page by Rudi Dornbusch is a great line, but the wrong way around. Under no circumstances should the Brazilians even think about dialling the 1-800-BAILOUT number of the IMF.
Of course, in the eyes of the market the IMF can still do no wrong, notwithstanding its unenviable track record. Mr. O’Neill’s sharp comments last week engendered a renewed sell-off in the real, but such panic selling abruptly reversed course on Thursday, when Mr. O'Neill publicly retreated from his earlier comments, saying that Brazilian economic leaders had "done a remarkable job of maintaining sound fiscal and monetary policies." Explicitly signaling support for additional aid from the I.M.F. to Brazil — which are in talks now for a multibillion-dollar package — he added, “I continue to favor support for Brazil and other nations that take appropriate steps to build sound, sustainable and growing economies.” After Mr. O'Neill's about-face, the Brazilian real soared by nearly 10 percent, its largest one-day gain.
True, Latin America can ill afford a Brazilian cataclysm, especially against a backdrop of dramatically slowing global growth. And Brazil itself is not in the mess it was in 1998 in regard to burgeoning fiscal and current account deficits. So in theory, additional financial support (with strings attached for the next President) does make sense. But the problem is that such “support” as the IMF provides does not help to build “sound, sustainable” policies for “growing economies”. Almost invariably the “remedies” offered by the Fund have perpetuated a deflationary bias, which does far more damage than good. According to the Economic Commission for Latin America and the Caribbean, regional GDP in Latin America will fall 0.8 per cent this year, after stagnation last year. In fact, per capital GDP is down 2 per cent since 1997. Not uncoincidentally, this period has coincided with continuous resort to IMF bailouts by virtually every single major economy in the region.
Contrast Latin America with the recovery in emerging Asia, which has remained a conspicuous beacon of economic growth over the past three years, in effect rejecting IMF orthodoxy. Brazil needs a growth policy first, perhaps coupled with a resort to Chilean style capital controls to avoid the effects of destabilising short term portfolio flows. This of course runs contrary to the holy neo-liberal writ of the IMF, but the irony is that the IMF, (along with its sister institution, the World Bank), was originally founded to facilitate global economic expansion and development. However, over the past two decades – particularly during the 1990s – the Fund’s policies have generally worked to demolish the social cohesion without which no economic rescue programme can possibly succeed.
At the time of their own financial crisis in 1997/98, the Asian economies had exceedingly deep corporate debt structures. The reversal of external capital flows associated with the devaluations of Asia was a massive financial shock which set off debt deflation dynamics in a highly indebted economy.
By contrast, Brazil’s long history of extremely high inflation and, perhaps more importantly, its history of extremely high corporate borrowing rates in domestic currency, has resulted in generally low levels of corporate indebtedness. Brazil, therefore, did not experience the debt deflation dynamics that so depressed the Asian economies at that time. On the other hand, Brazil also did not have a huge pool of domestic savings on which the country could fall back in the event of economic contagion, as emerging Asia did (the high domestic savings being accounting corollary of high domestic levels).
Nevertheless, in late 1998 Brazil was also facing crisis, as a consequence of an electoral-driven public expenditure binge. In addition, the country which traditionally maintained an undervalued exchange rate and a trade surplus, allowed its currency, the real, to become seriously overvalued, resulting in a large current account deficit. The fiscal deficit, at 8.5 per cent of GDP, reached its highest level in decades. Unemployment rose to record highs.
Things are not as bad this time around: Brazil has a primary public sector surplus above 3.5 per cent of GDP and a flexible exchange rate, thereby avoiding a repetition of the mistakes made in the late 1990s during which the real became seriously overvalued, resulting in a large current account deficit. But the success of policy subsequent to that 1998 debacle has ultimately rested on an illusion. Stable prices and quiescent inflationary expectations were largely predicated on a policy of using the exchange rate as an inflation anchor, without any corresponding institutional or constitutional improvements in other areas, nor any pool of savings. This has made Brazil far more at risk longer term from the precipitous decline in foreign inflows (in contrast to Asia where, after a wrenching economic adjustment, such savings were successfully mobilized to help turn around their economies relatively quickly). Reduced flows of investment are aggravating external pressures, contributing to slower growth and higher unemployment.
In the 1970’s through to the early 90’s, Brazil had endless stabilization plans devised by quite brilliant economic managers. They all failed. This led to deeply ingrained inflationary expectations on the part of the body politic. The authors of the current Real Plan finally succeeded in stabilizing the price level, which greatly changed national psychology. However, this was not supplemented by the constitutional reforms required to cut overall government expenditures, nor any real attempt to curb spending at the national level. Nor were any institutional changes introduced, along the lines of Chile, for example.
Given its history of policy failures, the adverse impact on the psychology of Brazil’s economic agents could be very great in the current context. It is this potential for psychological back-sliding that makes a misconceived and ultimately unsuccessful Fund bailout potentially more destabilizing over the long term than the devaluations of Asia, Argentina or even the Mexico devaluation of 1994.
There is another risk to Brazil. Social conditions in Brazil have become increasingly disruptive over recent decades. Few countries have so potentially chaotic a political system, with strange birds like former President Itamar Franco and current Presidential front-runner Lula. More significantly, the maldistribution of income over decades has resulted in increasing crime, which creates the potential for social chaos. The full impact of the huge rise in unemployment under President Cardoso has yet to be seen in this regard. Rising unemployment, combined with rising inflation, creates a recipe for potentially great social instability, particularly with a recession looming. Now that the US stock market bubble has burst and signs mount of an impending “double dip” recession, this will create yet another deflationary shock to the economies of the Western Hemisphere. This will in turn threaten Brazil with yet more potential social instability.
When economic historians look back on this period in years hence, it may well turn out to be the case that the social cohesion of emerging Asia will have proven to be its greatest asset during this time of turmoil and disaster in the emerging world, while the decentralized, more laissez-faire social orientations of the Latin American economies (so loudly praised by the US Treasury), may prove to be the latter’s undoing. This would indeed be ironic, because today Western investors regard Asian alliance capitalism, with its close government/financial sector/corporate alliances as the source of the region’s problems and believe that Asia will recover only if it reforms and adopts more of the neo-liberal capitalism of the Anglo-Saxon economies. Early in 1998, investors fled Asia for Latin America on the grounds that Latin America’s embrace of these laissez faire policies along the lines proposed by the IMF and Treasury would generate relatively superior results. It did not do so in 1998: the Latin American markets crashed, while Asia recovered. But, of greater significance, the emerging economies of Asia, excluding Indonesia, have weathered economic depressions with none of the social disruptions that were feared a few years ago.
It is our guess that as crises now engulfs Latin America; serious social disruptions will develop. The differences in the social regimes of these two regions may be the central determinants of their future prospects. We expect that the undemocratic, strong-arm tactics of the Chinese, Koreans, and Malaysians will bring the right policies to bear in Asia. There may be little in the way of social and political strife and chaos to impede recovery. Policies may continue to focus on investment in social overheads and human capital despite declines in income, thereby building a solid base for the future. If this happens, a positive outcome will emerge, because of a tendency toward social cohesion.
By contrast, Latin America may be poised for political and social strife if it is engulfed by a serious recession. This may impede the consensus needed to take appropriate policy measures. In Latin America, spending on social overheads and human capital has been lagging for decades; under economic duress, it may get sacrificed further. In the end, Latin America may enter a period that will be bleaker than those of the past, owing to the more Hobbesian social and cultural fabric that has hitherto made it embrace more readily than Asia the capitalist model of which Western investors are so enamoured. Calling in the IMF will do nothing more than catalyse this process, given the Fund’s past form in this area. |
