The Financial and Fiscal Roots of Deforestation in the Amazon

MACROECONOMIC POLICIES, LIVELIHOODS AND SUSTAINABILITY

THE FINANCIAL AND FISCAL ROOTS OF DEFORESTATION IN THE AMAZON

Sergio Schlesinger FASE member Rio de Janeiro, Brazil

Amazon deforestation Credit: Alexander Lees www.dicyt.com

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tarting in the decade of the in debt service and very high infla- 1930s Brazil started on a path tion rates. to industrialization through Simport substitution. In the Latin As a result, macroeconomic policies American region, Brazil was perhaps were no longer oriented towards the B razil : the country that had a good industrial needs of the ISI strategy. The main and technology policy articulated priorities after the eighties responded with import substitution. This was to the need to ensure debt service, to perhaps due to efforts to develop a reduce indebtedness and to curtail strong military industry during some inflationary pressures (Delgado 2008). of the darkest periods of Brazil’s re- After 1983, Brazil accepted the super- cent history. This led to the definition vision of the International Monetary of priorities for backward linkages Fund over its main macroeconomic and technological development, as policy components. Brazil’s policy expressed in the National Develop- makers were captured by the IMF ment Plan which explicitly defined recipes of constrained adjustment. the need for import substitution in There were four main principles the capital goods sector. The policy that would determine macroeco- objectives at that time were not only nomic policy from then on. The first industrial self-sufficiency, but also principle was to cut government ex- to attain scientific and technological penditures in order to reduce infla- autonomy in order to rid the country tionary pressures and to increase the of its dependency in key areas such participation of the private sector in as chemicals and electronics. the economy. The second principle was to contain monetary supply and F inancial L iberalization , iscal The industrialization strategy led to to keep high interest rates, again to the establishment and consolidation control inflation, but also to attract of a strong industrial base. Brazil foreign capital. The third principle became the only Latin American was to control the exchange rate so as country that was able to advance in to maintain it as an effective instru-

P olicy and D eforestation in A mazonia the domestic production of capital ment to fight inflation and to use it goods such as machine tools. But the to promote exports. This meant that conditions that allowed for the con- the exchange rate would have to be tinuity in the industrialization strategy manipulated in order to have periods and the country’s growth pattern of overvaluation and undervaluation, were definitely broken in the eight- according to the needs of the econo- ies as a result of the debt crisis. Some my. The fourth principle was related of the most important consequences of to financial and trade liberalization, the crisis were the loss of access to something that was thought would the international capital markets, to- be an effective tool to attract foreign gether with the significant hikes in investments and further reduce public interest rates and the increased cost expenditure. Trade liberalization in

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itself was seen as subordinate to the of aggregate demand was enforced macroeconomic objectives of price through monetary and fiscal poli- stabilization, rather than respond- cies, as well as the contraction of real ing to the notion of comparative wages. The implementation of these advantages and efficient resource al- policies took place through a drastic location.⁶⁴ Financial and trade liber- contraction of public expenditures, alization were also seen as a way to high interest rates, a tightening of deliver a clear message for all coun- money supply, as well as restrictions tries and international financial in- on credit. In spite of this package of stitutions that Brazil was seriously contractionary policies, stabilization committed to maintaining an open remained an elusive goal. Some tem- economy model. This message was porary successes were attained, but critical to assuage the concerns of the spectre of hyperinflation haunted foreign investors and increase cred- the Brazilian economy since 1987. ibility on Brazil’s intentions. In the early nineties, inflationary pressures really went out of control: Another key objective of macroeco- in 1993-1994 the year to year infla- nomic policy in this period was to tion rate surpassed the 5,000% mark. eliminate the current account deficit It was clear that Brazil had been through significant surpluses in the ensnared in a policy dilemma. The trade balance. For this, the under- trade surplus objective had been at- valuation of the exchange rate was tained in a very adverse internation- used. Thus, the drop in commodi- al context, but the undervaluation of ties’ prices of the eighties was com- the exchange rate had strengthened pensated by a devalued exchange inflationary pressures, in spite of the rate. Thus, a recessive macroeco- recessive fiscal and monetary policy nomic policy was adopted, together postures. with a shift in favour of the sector of tradable goods. In the future, export To meet the challenges of this new led growth would replace the old predicament a new macroeconomic import substitution strategy.⁶⁵ policy package was implemented: the Plano Real was born in 1994. Its In the context of the strategic transfor- most important component was the mation, a highly recessive reduction introduction of a new currency, the

⁶⁴ This is another interesting example of how macroeconomic policy priorities dominate trade liberalization. The same can be said of Mexico’s decision to proceed with trade liberalization. In 1987, when authorities decided the country should become a member of the GATT, the main objective was the need to control inflation through cheaper imports.

⁶⁵ The macroeconomic policy used in the midst of the crisis in the eighties used to main types of approaches: the reduction of aggregate demand (through monetary and fiscal policies) and the shifting of aggregate expenditure (through trade and exchange rate policies). In countries such as Brazil, this latter approach was to modify the composition of domestic aggregate demand and, through this, have some bearing on the trade balance.

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real, which was pegged to the U.S. and growth rates. Unemployment dollar.⁶⁶ This was designed to sta- rates increased from 4.3% in 1994 bilize inflationary expectations and to 7.9% in 1998. Many firms had to thus bring about higher investment close down as they could not com- rates, spurring growth, fiscal reve- plete with the foreign imports that nues and employment. On the fiscal were being buttressed by the over- policy front, the new plan included a valued real. mandatory balanced budget approach which included generalized indexation The contradictions of the open of wages, performance of several economy model that we have exam- key financial assets, taxes and a wide ined above started to play a role in variety of contracts. The objective the Brazilian economy. The capital here was to put a brake on inflation- inflows provided an artificial sup- ary expectations associated to the fiscal port to Brazil’s capacity to continue profligacy of the past decades. It was importing, but they also contributed thought that indexation would bring to appreciate the exchange rate. Of about stabilization and would be critical course, the appreciation of the new for the monetary reform component. currency due to capital inflows was aggravated by the commitment to The Plano Real succeeded in bring- maintain its value pegged to the U.S. ing stability and putting a lid on in- dollar. On top of this, as the dollar flationary pressures. However, the strengthened in the mid-1990s, the reduction of inflation was not instan- real appreciated against other cur- taneous and this led to a significant rencies. In the end, the ability of overvaluation of the new currency. Brazil to sustain large current ac- This deteriorated the trade balance count deficits through a surplus in and the current account deficit con- its capital account was called into tinued to weigh heavily and the cur- question. After the Mexican crisis rency gap had to be covered through in 1994, brought about by a sudden movements in the capital account. reversal of capital flows, it became Thus, the commitments to maintain clear that the Brazilian economy had a strict monetary posture, with high become highly vulnerable to a simi- interest rates and exchange rate sta- lar danger. The Asian crisis in 1997 bility seemed credible enough to the and the Russian bond default in 1998 international financial community increased the perception that risk in for a short period of time. the so-called emerging markets was simply too big. The probability of However, the high interest rates had Brazil suffering a speculative attack very serious implications for investment on its currency was increasing every

⁶⁶ The real’s value was set using a predetermined rate against the dollar. The system included a scheme for daily mini-fluctuations around the target value. This did not prevent the appreciation of the currency.

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year and fund managers that were the drastic fiscal adjustment lead to a taking advantage of arbitraging oppor- better performance in debt service. tunities in Brazil started to doubt the country’s capacity to sustain the real. The historical balance of the Plano Real is a mixed bag of results on Early in 1999 Brazil’s central bank several fronts. Although hyperinfla- decided to widen the mini-band sys- tion was avoided, and stability was tem, a move that amounted to a de fac- restored, the price for that was in- to devaluation. The result was a stam- deed very high. Not only was Brazil pede in capital flight and a much more rendered more fragile and vulner- severe adjustment in the real’s value: able, its economy was slowed down, the exchange rate dropped dramati- with several very negative implica- cally and by February the real was tions. Figure V.7 shows how the pe- trading at 1.80 to the dollar. The deci- riod was marked by very slow rates sion to abandon the mini-band sys- of growth and even drops in income tem was taken and short term interest per capita as the high interest rates rates were increased to 39%. Longer that accompanied the Plan Real took term rates continued to show very their toll. high levels, as shown in Figure V.6, with negative implications for invest- In the end, the Plano Real had left 2.6 ment and growth. This contributed million newly unemployed persons to temporarily stabilize things, and between 1995 and 2002. In spite of

Figure V.6 Real Short Term Rates in Selected Countries (Average, 1996-2002)

Source: Sergio Schlesinger, Brazil Country Study.

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Figure V.7 GDP and GDP Per Capita Growth Rates (1990-2007)

Source: Sergio Schlesinger, Brazil Country Study.

the reduction in inflation rates, in- the US dollar, caused the real to lose come distribution was only margin- in its value. The rapid expansion of ally altered, with the Gini coefficient the Chinese economy contributed evolving from 0.574 to 0.563 with to increase the price of several key GDP increasing 2.3% per year dur- commodities of agricultural and in- ing that period. dustrial origin in the international markets. And a renewed impetus of The most dramatic indicator of fis- capital flows brought helped estab- cal policy was that between 2000 lish a new pattern of stable external and 2007, federal investment, as well accounts. Although imports expand- as expenditures in education and ed by 156% in 2002-2007, exports health represented only 43% of the grew by 166% during the same pe- total amount allocated to interest on riod. Brazil was able to keep more the public debt. than 200 billion USD in reserves by 2008. However, the current account In 2003 the new government of started to deteriorate once again in Lula took office in Brasilia. Several 2008, with a deficit of 10.7 billion in indicators contributed to gener- the first quarter. In addition, the exter- ate an optimistic perspective for the nal debt (public and private) increased future of the Brazilian economy. from 215 in 2007 to 254 billion US Several factors at the international dollars a year later. Servicing this level, including the depreciation of debt continues to weigh heavily on

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the country’s economy. Table V.8 surplus (income over expenditures, below shows how the external debt without considering debt service) of has evolved over the last three decades. 55 billion dollars, a sum that represented 6% of GDP and allowed the To summarize, Brazil’s macroeco- government to surpass the annual nomic policies have been shaped by goal of 3.8% of GDP. But during its debt burden. While monetary that first semester, interest payments policy is obsessed with price stabil- on the Brazilian debt amounted to ity, fiscal policy is dominated by the 56 billion, and this left a total public short term objective of generating deficit of 0.14% of GDP. a primary surplus.⁶⁷ This process constitutes a deviation of resources Financial Liberalization from the real sectors of the economy and Fiscal Policy: (and from the real needs in educa- Changing the Rural tion, health, housing, transporta- Landscape tion, infrastructure and science and Controls over capital flows and invest- technology) to the financial sector ments were part of the macroeconom- of the economy. Consider the fol- ic policy package that accompanied lowing: during the first semester of the ISI strategy. These controls were 2008, Brazil generated a primary established in Brazil as a part of the

Figure V.8 Brazil’s External Debt (1980 – 2007) (USD billions)

Source: Sergio Schlesinger, Brazil Country Study

⁶⁷ This has been a more or less constant in Brazil’s fiscal stance. In 2009, as a result of the international financial crisis, Brazil’s economy weakened and fiscal revenues dropped. Also, the implementation of countercyclical measures (such as tax breaks and increased public spending) will prevent Brazil from reaching the goal of a primary surplus of 2.5% of GDP.

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Bretton Woods regime and they had tablished a degree of financial liber- also served as a buffer from the vola- alization that was unique in Brazil’s tility in the international economy history. Portfolio investments could in the seventies. When the Bret- now benefit from its arbitraging op- ton Woods system was abandoned erations, taking advantage of Brazil’s by the developed economies in the high interest rates and exchange rate world, Brazil kept the old system stability. of controls in place, but gradually started to feel the pressure to relax In the 1990s a second wave of mea- some of these restrictions. It would sures to secure this financial liberal- take several years to dismantle this ization. Foreign financial institutions system and attain full financial lib- were allowed to settle, expand and eralization. consolidate their presence in Brazil. Banks were allowed to obtain exter- As we have seen, in the eighties and nal resources and to carry out swap nineties, Brazil needed to attract foreign operations with foreign entities. And capital in order to close its currency it is precisely in the year 2000 that the gap. In 1988 a currency market with Cargill Bank, as well as other banks floating exchange rates was estab- belonging to foreign multinational lished, access to foreign currency corporations, initiated its operations became easier and greater flexibility in Brazil. Their role was to be the in financial operations was intro- financial and credit arm of their op- duced for all agents. But by far the erations, pushing for deeper market most important measure was taken penetration of their products and in 1992, when free flows of capital strengthening their commercial and and profit remittances by foreigners industrial presence in the country. were authorized. But perhaps more important, these banks were the main instrument to This was the definitive measure for get control over primary production financial liberalization and estab- and thus the source of its main raw lished, for the first time in Brazil, the material. This was seen by corpora- possibility to transfer resources to a tions such as Cargill, Archer Daniels foreign country without the need Midland and Bunge as the way in to show that they had an incoming which they could strengthen their registry or counterpart in the capital industrial, commercial and financial account. Institutional investors were operations. allowed to take part in the privatization program. These and other measures (tax Contract agriculture was a by-prod- exemptions and rebates, allowance uct of the financial predominance of of royalty payments for technology these firms in the regions where rapid and technical assistance between expansion of soybean took place. A subsidiary and head firms, etc.) es- typical contract involves the promise

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to deliver a certain amount of soy- operations severely curtailed. As fis- bean is exchanged with the supply cal policy became dominated by the of inputs even before sowing. Many need to generate a primary surplus, of these operations are coordinated the subsidies that had been chan- by cooperatives, trading companies neled to the agricultural sector via and input producers. In other cases, soft loans and credit by the develop- especially when harvest is going to ment banks almost disappeared. take place, other forms of credit with working capital are more common. If agricultural production received More than 80% of total output of soy- significant public resources in the bean is acquired by five or six large form of credit and subsidies during trading companies (Cargill, Bunge, the seventies and even the eighties, in ADM, Dreyfus and Maggi are the the 1990s those resources were dras- largest of these. tically cut by fiscal policy makers. The most important comparison is The proliferation of these con- the following: in 1985, central gov- tracts is not so much related to the ernment agencies were covering 92% virtues of the crops or technology of credit, but this dropped to 40% and depends more on the lack of in 1988 and 29% in 1989. In value credit and support which was pro- terms, this reduction was even more vided by public agencies in the past. dramatic, with a drop of more than In all cases, farmers lose control of 83% in 1980 - 1990. As the provi- the production process. This was to sion of credit through public agencies become a powerful instrument for collapsed (due to the fiscal crisis), the these companies due to the high cost trading companies and the larger of credit. We have already seen that MNCs with their banks occupied Brazil was maintaining some of the the space that had once been the re- highest interest rates in the world, sponsibility of State agencies.⁶⁸ and because price stabilization was paramount in the agenda of mone- The resources that were used by tary policy, credit was scarce and the these banks were basically chan- banks of the large corporations were neled to rural producers and coop- to play a key role in filling the gap erative firms to cover investments in between demand and supply for com- modernization of productive infra- mercial credit. In addition, in the case structure, as well as for the purchase of agriculture, the withdrawal of State of agricultural inputs. Mostly, these support had already left a huge vacu- loans lead to various forms of com- um as development banks saw their mercial agriculture in which the key

⁶⁸ The subsidies and support that still subsist in Brazil are concentrated in the larger commercial producers and firms, especially those related to exporting agri-business. In the 2004/2005 cycle, for example, big landowners and their firms obtained R$ 39 billion, while the smaller farmers had access to only R$ 7 billion. These smaller farms represent 57% of total farming units, while the medium and large farms represent 13% and 30%.

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decisions on output and the technology corporations took advantage of the mix were taken away from produc- new favorable context in order to ers. The international context made gain access to alternative sources Brazil a country especially attractive of raw materials and land. This last for activities in sectors closer to the resource is of course critical for the natural resource base. Other policy large MNCs in agri-business. The measures reinforced this trend. First, older MNCs (Cargill, Bunge, Drey- there was a lax environmental legis- fus) that had been operating in the lation and a very weak enforcement Brazilian economy since the days of infrastructure. Second, imports for the import substitution strategy react- goods that are important for agri- ed to the evolving context and the business underwent very significant challenge of the newest competitors deregulation. Third, and perhaps (Archer Daniels Midland) by rapidly more important, was the authori- expanding their operations in order zation to harvest genetically modi- to protect their control over the supply fied crops. This was of course related of the commodities that were the to Brazil’s acceptance of the TRIPs most profitable (soybean). agreement in the context of the World Trade Organization. One aspect of this strategy was to take advantage of the deregulation of This combination of factors made the FDI regime and a wave of mergers foreign direct investment the main and acquisitions (M&A) took place. driver for the expansion of a new ag- Many of the local firms, small and ricultural model in various key regions medium producers, were already in in Brazil. Several large multinational bad shape due to the series of crises

Harbor Credit: Marc Ryckaert Wikimedia Commons

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and adjustment measures, lack of credit, global financial crisis, they have very etc. Their underpriced assets offered little resources to act as a buffer between advantages to the expanding MNCs their enterprises and market volatil- as they still had important networks ity. For example, the crisis is expected of suppliers in strategic regions. As the to take a heavy toll on the operations entire sector was being restructured, of the big trading companies and the M&A multiplied: between 1994 and supply of credit is already being drasti- 2003, 312 separate operations were cally reduced. In 2009, it is expected that registered in the food, beverages and a larger part of credit will be supplied tobacco sectors, making it the number directly by producers. Obviously, this one sector in this field. And 80% of means that output will have to fall these operations corresponded to and this will lead to a larger amount MNC’s. The largest four corpora- of defaults on previous loans. In the tions (Cargill, Bunge, Dreyfus and case of agricultural machinery, already ADM) have bought small and medi- the pace of foreclosures has intensified. um firms in all stages of the production process in Brazil. This explains This process has left behind a series of why the share of FDI in the food deep changes in the rural sector and and beverages sectors increased from the environment. Family farms, which 0.6% in 1998 to 11.3% in 2002. are less capital intensive and provide up to 70% of rural jobs, have been one Other branches of the manufacturing of the first casualties. Between 1985 sector were also targets of this expan- and 2005, the number of family farms sion and vertical integration process. dropped significantly and, with this, Many manufacturers and suppliers rural employment also suffered a severe of agricultural machinery and tools, fall. Most of soybean production takes fertilizers and pesticides, as well as in place in large scale commercial op- the field of agro-biotechnology, were erations that are capital intensive bought by the expanding MNCs.⁶⁹ and employment generation is low: Finally, several chains of marketing roughly ten full-time jobs for every firms were also acquired and this sealed thousand hectares, with six of them the vertical integration process, from temporary jobs. Land concentration is primary production (through contract also well documented, with the conse- agriculture) all the way to marketing. quent generation of landless labourers.

By losing control of production de- As a direct consequence of the evolu- cisions, farmers’ vulnerability has in- tion we have analyzed here, soybean creased. In the context of the 2008/2009 production underwent a dramatic

⁶⁹ The agricultural manufacturing sector shows a similar pattern with banks such as New Holland and John Deere acting as suppliers of credit to rural producers and, once again, filling the vacuum left by the withdrawal of State agencies. Brazil’s agri-biotech sector is 100% controlled by MNCs. Monsanto, through its fully owned subsidiary Monsoy, is responsible for 60% of production. Pioneer (controlled by Dupont) controls 14%, and Dow, Zeneca and Agr-Evo control the remaining 10%.

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expansion. In the period 1991-2005, course, is that if these expectations the surface devoted to soybean tripled are not confirmed by market trends and by 2006 this crop was occupy- and prices go down, producers will ing more than 22 million hectares, a likely get stuck in a very difficult situ- surface that was roughly equivalent ation. The experience of these boom to the one devoted to the other four and bust cycles in agriculture is well main staple foods grown in Brazil known, but when liquidity abounds (rice, wheat, beans and millet). Total in international markets, the specula- output of soybean reached 58 million tive tendency actually worsens. The tons, approximately 25% of world social and environmental impact of production. The West Central re- these attacks on entire agro-ecosys- gion in Brazil experienced the most tems parallel the effects of financial rapid rates of growth, advancing on crises as capital flows are reverted. the vegetation of the cerrado biome where 40% of Brazilian soybean Environmental production is taking place. Effects Financial deregulation, combined with It is important to underline that these a restrictive monetary policy that macroeconomic policies combined curtailed credit and a contraction- have also favoured the expansion of ary fiscal policy responding solely to speculative capital in Brazil’s agri- the generation of a primary surplus business. Crops such as sugar, for ex- have led to this extraordinary expan- ample, have expanded at even faster sion of agri-business. There are sev- rates than soybean in some regions eral important environmental impacts due to expectations of ethanol price from this process. The first is the loss in the near future. The problem, of of agro-biodiversity, as the expansion

Amazon Rainforest Credit: Mart St Amant, Creative Commons

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of monoculture takes place. This has of the riches savannas in the world, brought about widespread pollution of with 12,000 plant species and 2,000 soils and aquifers because these crops animal species, many of which are are heavy users of chemical inputs. endemic to the cerrado. This vast region does not have a system capable of Table V.3 shows the ranking of land monitoring environmental degradation use practices in Brazil. By far, live- and resource management practices. stock continues to be the most important activity, but several commer- According to official data, in 2007 cial crops are growing in importance. 39% of the cerrado’s surface has al- The second type of damages comes ready been converted for livestock from the destruction of the cerrado, production (26%) or agriculture a sprawling savanna in central Bra- (10%).⁷⁰ In the states of Mato Grosso do zil that has more than two million Sul Goias, Sao Paulo and the southern square kilometers in Central Brazil part of Minas Gerais, the Cerrado has (about 24% of its territory). The re- already disappeared. gion hosts forty ethnic groups (with 45,000 indigenous people), several of In addition, rates of destruction of the cer- which face the threat of extinction. rado remain at very high levels. In 2004 In terms of biodiversity, this is one Conservation International estimated

Table V.3

Source: Sergio Schlesinger, Brazil Country Study

⁷⁰ The data comes from the Conservation and Sustainable Utilization Project of Brazilian Biological Diversity that was carried out by the Minister of the Environment. A study by Conservation International claims that 55% of the cerrado had been already transformed in 2002. Another WWF study is even more pessimistic, considering that only 19% of the original cerrado vegetation remains untouched.

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that 1.5% of the total surface of the comes from the reallocation of pre- biome was being destroyed every viously deforested areas to soybean year. Another study by the University production. This land was former- of Goiás, The Nature Conservancy ly used for ranching, and the cattle and Conservation International es- raising activities have been displaced timated that rate at a lower level, into regions in the Amazon basin. 0.25% per year, but warned that this Brazil already is the largest producer could accelerate with the expansion of commercial livestock (with two of crops for biofuels. Finally, a study hundred cattle). And because this is by the Cerrado-Pantanal Program done through extensive methods, (it of Conservation International states is estimated that one head of cattle that the region may have already lost requires one hectare) cattle production 13% of its biodiversity. occupies the first place in land usage.

Finally, the third problem is related But the pressure from monoculture to the deforestation of the Amazon crops (soybean and sugarcane) is rain forest. Direct destruction of the having a critical impact in displacing rainforest through the expansion of cattle production from the states in soybean has already been identified Central-West, South and Southeast by Greenpeace and other NGOs. Brazil into the regions of Legal Am- But perhaps the most powerful effect azonia. This is confirmed by official

Deforestation Credit: A. Lees www.dicyt.com

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data which shows that the number fragile regions, with all of its envi- of cattle in the North and Central- ronmental impacts. West of Brazil, precisely where the Amazon rainforest is located. Table This appears to be “logical” step be- V.4 reveals that the fastest growth cause the land in the Amazon basin is rates of cattle are precisely in these not suitable for harvesting commercial

Table V.4 Brazil: Cattle by Region, 1995-2005

Source: Sergio Schlesinger, Brazil Country Study

Wind Farm Cedit: O Tétard, Creative Commons

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monoculture crops such as soybean threatening not only the Amazon and sugarcane. Ranching is expanding rainforest itself, but the last remains in areas where land is cheaper and of the unique biome of the cerrado. competition with commercial crops can be evaded. Ranching is and will continue to be the main driver for deforestation in Amazonia, represent- ing 80% of total deforested land, and this is being intensified by its dis- placement from land reallocated to soybean and sugarcane production.

Macroeconomic policies, in the monetary and fiscal front, as well as financial deregulation, have set the stage for this tragedy. In the context of intense inflationary pressures, high indebtedness, a restrictive monetary policy that curtails credit, financial liberalization and a fiscal policy preoc- cupied solely by generating a primary surplus, the vacuum left by the withdrawal of support for small scale agricultural activities, has been occupied by large consortia. These have brought about a radical trans- Top formation of the rural landscape Archive in Brazil, with deep and long last- financialred.com ing environmental consequences,

bottom Industry Credit: N Bildhauer, Creative Commons

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