SIOD *A a1VNOC Public Disclosure Authorized 'SODfZOJ.S.U. n Public Disclosure Authorized K JUOUOJ3OJJU Public Disclosure Authorized IN2* E: __ W4LJ~~~~~~~~~~~~~~~~1~~W Public Disclosure Authorized I C AIS f D I IN 0N 0D A 04 1JV N A IIV x vEN N'H v '1I 0 M W 0 R L D B A N K COMPARATIVE MACROECONOMIC STUDIES Macroeconomic Crises,Policies, andGrowth in Brazil,1964-90 Macroeconomic Crises,Policies, andGrowth in Brazil,1964-90 DO NA L D V. CO E S THE WORLD BANK, WASHINGTON, D.C. ©31995 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, N.W., Washington, D.C. 20433 All rights reserved Manufactured in the United States of America First printing April 1995 The World Bank Comparative Macroeconomic Studies series emerges from a research project that reviewed the macroeconomic experiences of eighteen developing countries over a period roughly from 1965 to 1990. So that the studies might be published with relatively little delay, the books have been edited outside the World Bank's Office of the Publisher by the Macroeconomic Research Depart- ment. The findings, interpretations, and conclusions expressed in this publication are those of the author and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to the members of its Board of Executive Directors or the countries they represent. The material in this publication is copyrighted. Requests for permission to reproduce portions of it should be sent to the Office of the Publisher at the address shown in the copyright notice above. The World Bank encourages dissemination of its work and will normally give permission promptly and, when the reproduction is for noncommercial purposes, without asking a fee. Permission to copy portions for classroom use is granted through the Copyright Clearance Center, Inc., Suite 910, 222 Rosewood Dr., Danvers, Massachusetts 01923, U.S.A. The complete backlist of publications from the World Bank is shown in the annual Index of Publications, which contains an alphabetical title list and indexes of subjects, authors, and countries and regions. The latest edition is available free of charge from Distribution Unit, Office of the Publisher, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from Publications, The World Bank, 66, avenue d'1lna, 75116 Paris, France. Cover design by Sam Ferro. Donald V. Coes is Professor of International Management, Anderson School of Management, and Associate Director, Latin American Institute, at the University of New Mexico. Library of Congress Cataloging-in-Publication Data Coes, Donald V., 1943- Macroeconomic crises, policies, and growth in Brazil, 1964-90 / Donald V. Coes. p. cm. - (World Bank comparative macroeconomic studies) Includes bibliographical references and index. ISBN 0-8213-2299-0 1. Brazil-Economic policy. 2. Debts, External-Brazil. 3. Brazil-Economic conditions-1964-1985. 4. Brazil-Economic conditions-1985- 5. Monetary policy-Brazil. I. Title. 11. Series. HC187.C586 1995 338.981-dc2O 94-31420 CIP Contents Foreword ir Acknowledgments xi Acronyms xiii Data Notes xl Chapter 1. Introduction I Brazil's Policy Choices of the Post-1964 Period I The Forces at Play 4 Chapter 2. The Postwar Brazilian Economy 8 Antecedents to Crisis, 1945-64 8 Stabilization and Reform, 1964-67 13 Economic Growth and Political Repression in the Milagre Years, 1968-73 15 External Shocks and Postponed Adjustment. 1973-82 17 The Collapse of Foreign Lending, 1982-85 21 Stabilization Attempts and Failures after 1985 22 Chapter 3. Special Features of the Brazilian Economy: Population, Education, and Income Distribution 31 Postwar Brazilian Demographics 31 The Education of the Brazilian Population 34 Urbanization and Political Pressures on Policymakers 34 Regional Disparities 36 Income Distribution 40 Chapter 4. The Political Economy of Brazilian Economic Policy: Populists and Technocrats 45 Brazilian Economic Populism before 1985 46 Technocracy and Economic Policymaking, 1964-85 51 Populism and Technocracy in the Cruzado Plan, 1985-87 54 Chapter 5. The Public Sector and Its Financing 57 The Measurement of Fiscal Trends in Brazil 57 The Public Sector Deficit since 1970 65 The Fiscal Effects of the 1988 Constitution 76 Fiscal Disequilibrium: Does It Matter and Why Does It Persist? 79 1, vi Macroeconomic Crises, Policies, and Growth in Brazil, 1964-90 Chapter 6. Money, Inflation, and Indexation 85 Inflation and the Rise of Indexation in Brazil 86 Did Increases in the Money Supply Cause Inflation? 93 Deficit Financing through the Inflation Tax 97 Conclusion: How Inevitable Is Inflation'? 101 Chapter 7. Extemal Shocks and Brazil's Adjustment: The Boom and Bust in Brazilian Foreign Borrowing 104 The Boom: Capital Inflows, 1964-82 105 Where It Went: Capital Flow Pattems during the Boom 111 The Closure of Extemal Capital Markets to Brazilian Borrowing 115 Extemal Borrowing and "Crowding Out" in a Brazilian Context 117 Chapter 8. The Burden of Adjustment to Extemal Shocks: The Real Exchange Rate and Real Wages 123 The Exchange Rate and Brazilian Extemal Adjustment 124 Extemal Adjustment and the Real Wage 133 Extemal Economic Policies and the Burden of Extemal Adjustment 138 Chapter 9. Investment and Long-term Growth 142 Aggregate Investment in Brazil, 1970-90 142 Recent Evolution of the Brazilian Capital Stock 145 Investment and Output in the Past Two Decades 150 The Composition and Quality of Investment 151 Chapter 10. Conclusion: What Has Been Leamed and What Can Be Done'? 159 The Lessons of Brazil's Experience 159 Tasks for the Future 163 Epilogue. The Piano Real 167 Technical Appendix 173 A. The Real Budget Deficit and Its Financing 173 B. Brazilian National Income Accounts 175 C. Estimation of Inflation Tax Revenue 176 D. Measurement of the Real Exchange Rate 178 Data Appendix 182 A. I Political and Economic Leadership since 1964 183 A.2 Balance of Payments, 1961-90 184 A.3 Medium- and Long-term Extemal Debt, 1965-90 187 A.4 Real Interest Rate on Extemal Debt, 1965-90 188 A.5 Real and Per Capita GDP: Levels and Growth Rates, 1963-90 189 A.6 Principal Components of GDP, 1963-90 190 A.7 Public Sector Spending by Major Category, 1970-90 191 A.8 Tax Collections as a Share of GDP, 1970-90 192 Contents vii A.9 Government Revenue by Level and Source, 1980-90 193 A.10 Change in the General Price Index (IGP-DI), 1964-90 194 A.l 1 Exchange Rates: Official, Parallel, and Premium, 1964-91 196 A. 12 Tradable/Nontradable Price Measures of the Real Exchange Rate, 1964-90 199 A.13 External Terms of Trade, 1962-90 202 A.14 Real Wages: Minimum and Average Wages in Industry and Agriculture, 1960-91 203 A. 15 Real Investment by Sector of Origin, 1970-90 204 A. 16 Estimated Capital per Person and per Worker, 1970-90 205 A.17 Estimated Incremental Capital Output Ratio, 1956-87 206 A.18 Real Investment by Major State Enterprises, 1973-87 207 A.19 Primary, Secondary, and Higher Educational Enrollments, 1970-89 208 Notes 209 Bibliography 221 Index 233 Aos meus colegas Al. Bill, Joe, John, Keith, Linc, Mike, Paul, Peter, Rudi, Sam, Tom, Werner, e todos os outros gringos que ha muito tempo sabem que o Brasil e um pais serio. Foreword This volume is the product of a World Bank project on macroeconomic policy that reviewed the recent experience of eighteen countries as they attempted to maintain economic stability in the face of intemationalprice, interest rate, and demand shocks or domestic crises in the forms of investment booms and related budgetary prob- lems. The project paid particular attention to the 1974-79 period (which included the first and second oil price shocks), the 1980-82 period of worldwide recession and external debt problems for many developing countries, and the 1983-90 period of adjustment to economic difficulties and the resumption of growth. The objective of the project was to glean instructive lessons by analyzing the stabilization and adjustment policies pursued by these countries and assessing the outcomes. The authors of each country study were asked to deal with a common set of questions concerning the nature of the shocks or crises: their origin and degree of seriousness; the fiscal, monetary,exchange rate, and trade policies adopted in hopes of preventing permanent harm to the economy; and the results of the policies. No single computable macroeconomic model was used in the project, but the framework of the open-economy macroeconomic model was followed to ensure consistency in generalizing about results. This intensive study of many episodes generated ideas and suggested relationships showing the causes and effects behind policies, the nature of the shocks and crises, and the governmental response to them. The overall findings of the project are presented in a synthesis volume by 1. M. D. Little, Richard N. Cooper, W. Max Corden, and Sarath Rajapatirana, Boom, Crisis, and Adjustment: The Macroeconomic Experience of Developing Countries. A decade ago it was commonly argued that Brazil's macroeconomic prob- lems were largely due to external shocks. As a major oil importer and user of for- eign savings, Brazil was undoubtedly highly vulnerable to the rises in oil prices and international interest rates of the 1980s. By the early 1990s, however, other Latin American countries began to emerge from the crises of the preceding de- cade, oil prices and interest rates declined, and this diagnosis appeared increasing- ly suspect. With both inflation and internal interest rates at record levels it was hard to continue to argue that Brazil's difficulties were primarily external. Today a more balanced consensus has emerged among many Brazilian econ- omists and policymakers. At the heart of this view, which is shared and supported by this study, is the recognition that the fiscal disequilibrium which has character- ized the public sector is as much to blame for the nation's macroeconomic diffi- ix x MacroeconomicCrises, Policies, and Growth in Brazil, 1964-90 culties as are extemal factors.