COVID-19 caused severe human suffering and triggered a deep recession. Rekindling economic activity past the trough intensifies the urgency of addressing underlying policy challenges.
Economic policies reacted in a timely and decisive manner to the COVID-19 crisis, supporting millions of Brazilians. But the pandemic will nonetheless cause GDP to drop by 5% (Table 1).
Source: OECD projections.
A strong recovery from the recession will require long-lasting improvements in economic policies. A rising labour force and strong commodity prices will no longer underpin growth and public revenues. Instead, the boost to growth from demographics since the year 2000 will be fully reversed over the next 25 years (Figure 1). Productivity, which ultimately drives prosperity, will need to become the engine of growth, following decades of virtual stagnation. Without deep structural reforms to boost productivity, the recovery will be protracted and disappointing. Inflation risks have been contained for some time, but formalising the de-facto independence of the Central Bank could lock in this progress.
Source: OECD (2017), OECD Economic Outlook (database).
Financial intermediation is still limited with total credit around 50% of GDP, but the structure of financial markets is improving visibly. Directed lending operations, long at par with free credit, are receding, following a reduction of interest rate subsidies. This is allowing private banks and corporate bond markets to raise their participation in financial markets. Lending spreads are still high and point to scope for stronger competition in the financial sector, but an ambitious policy agenda aiming at reducing financing costs has been put in place.
Deforestation is a major source of greenhouse gas emissions and has recently rebounded. Current laws and protections have proven capable to reduce deforestation in the past and should be preserved. But they will only be effective when coupled with stronger enforcement efforts to combat illegal deforestation, which will require additional resources.
Improving fiscal outcomes remains one of Brazil’s principal challenges given a high debt burden, to which the pandemic has added 15 percentage points of GDP (Figure 2). Fiscal adjustment must resume after the crisis, but can be achieved by improving spending efficiency with no need for higher tax rates or new taxes and without detriment to growth or inclusiveness.
Plenty of scope exists for reviewing tax expenditures, including ineffective subsidies to specific activities and special tax regimes, while a public employment reform could generate savings and improve public administration at the same time. Many current expenditures have increased due to revenue earmarking, mandatory spending floors or indexation mechanisms, shifting spending away from where it is most needed, including investment. Reforming mandatory spending items and indexation rules is inevitable to deliver the needed fiscal adjustment and to avoid breaking fiscal rules, which would trigger confidence losses and could derail the recovery.
Source: OECD projections, BCB, National Treasury.
Raising the efficiency of public spending will not be possible without building on remarkable past progress in the fight against corruption and economic crimes. Strong and autonomous enforcement bodies can ensure this, provided that the law provides a credible threat of prosecution.
Large inequalities along several dimensions affect well-being. The richest 10% of the population earn more than four times as much as the bottom 40%. Inequality and poverty have fallen over the past two decades due to strong growth, improvements in education and social transfers. Social benefits amount to over 15% of GDP and are characterised by poor targeting, with almost half of transfers reaching the highest income quintile (Figure 3).
Reviewing current indexation arrangements could free resources for more efficient transfers and generate significant poverty reductions at a low fiscal cost.
Distribution of social transfer spending by quintile of the income distribution (1=lowest income quintile)
Source: SEAE.
Well-targeted conditional cash transfers could be expanded and converted into a true social safety net by accelerating benefit concessions in the case of dismissal and withdrawing them more gradually to strengthen job search incentives. This would support informal workers, which account for one third of employment and are not covered by unemployment schemes, and could revert the recent rise of poverty rates and inequality (Figure 4).
Source: IBGE.
Realising Brazil’s potential and improving well-being and living standards will only be possible through ambitious structural reforms that boost productivity.
With large parts of the economy shielded from competition, firms face limited incentives to become more productive. Reallocation mechanisms like entry and exit appear weaker than elsewhere, leaving many jobs trapped in firms and activities with little potential for improving productivity and wages. Domestic regulatory burdens and market entry barriers are among the world’s highest (Figure 5).
PMR indicator
Source: OECD PMR Indicators Database.
A fragmented tax system gives rise to one of the world’s highest tax compliance costs and a wide array of exemptions and special regimes reduces fairness and the redistribution effect of taxes. Infrastructure investment has fallen short of depreciation for years, which has made logistics challenging and costly.
Complex legal provisions give rise to excessive litigation and court congestion. Judicial decisions are slow and firms can find them hard to predict, adding to uncertainty and the cost of contract enforcement.
External competition is hampered by high trade barriers that have cut off Brazil from the opportunities of international trade (Figure 6). Trade barriers are even higher for capital goods and intermediate inputs, elevating domestic production costs.
Source: Wits.
Deeper integration into the global economy and rising domestic competition would boost productivity, including by facilitating the movement of jobs towards more productive firms and activities. But these structural changes create challenges for workers. Well-designed training and education policies can go a long way to help workers master the transition.
Opportunities for skill upgrading will facilitate the move into new and better-paying jobs and strengthen productivity at the same time.
Scaling up training policies can be a highly effective way to mitigate local employment effects in trade-exposed regions if course content is aligned with skill demands in local labour markets. Strengthening incentives for training institutions to raise employability of participants can help to achieve a better alignment with market demand. Facilitating a better adoption of vocational content in secondary education could also help to prepare youths effectively for a changing economic environment. Together with an expansion of early-childhood education, this could reduce early drop-out rates and foster inclusiveness.