Shadow Government

How to Fix Brazil’s Broken Economy

The last two decades made obvious a life’s-not-fair fact: Big countries can get away with bad economic policy. Size matters to investors, global corporations, and entrepreneurs because a winning payout is large and can justify the costs of bureaucracy, compliance, and corruption. China, India, and Brazil attract big investor dollars not because they are business ...

VANDERLEI ALMEIDA/AFP/Getty Images
VANDERLEI ALMEIDA/AFP/Getty Images

The last two decades made obvious a life’s-not-fair fact: Big countries can get away with bad economic policy. Size matters to investors, global corporations, and entrepreneurs because a winning payout is large and can justify the costs of bureaucracy, compliance, and corruption.

China, India, and Brazil attract big investor dollars not because they are business paradises — check out their World Bank’s "Doing Business" rankings. To understand how business leaders think, let’s imagine you built a company with 85 percent market share in more business friendly Estonia. Congrats, they’ll say, those size revenues are in a multinational’s second footnote once removed.

Which brings us to Brazil. Despite its numerical advantages, Brazil has stagnated, and is expected to have just 0.4 percent economic growth this year. What’s wrong? Many analysts have pointed out the obvious: Brazil needs to improve its education, healthcare, and infrastructure. Few economists would disagree, but these are deeply rooted problems with decades-long solutions. Brazilians go to the polls on Sunday to select a president. What reforms can be done during one term to unleash Brazil’s charmed bequest, its size? Here’s the policies we think should be on the agenda.

Tax reform

Brazil loses many of the benefits of its market size because each state levees its own protectionist taxes on goods from other states. Incredibly, there are customs checks at the state borders to confirm those taxes are paid. In addition, goods are all taxed at different rates, using different formulas of calculation, based on their product-description codes, which rival international trade in their complexity. For example, Josh’s company, Gaveteiro.com.br, is an online business-to-business (B2B) distributor. They recently calculated that to fully parameterize the firm’s software for every possible sale nationwide would require a spreadsheet with more than 500,000 cells correctly filled out. That’s four different types of taxes on each good, 27 states, and 9,000 product description codes. You do the math.

Several new proposals would consolidate these different taxes into a single-rate value-added tax (VAT). Though this will not be easy because of the way these revenues are currently proportioned between states, this simplification is the largest possible quick win available to Brazilian policy makers. Overnight it would eliminate politically directed distortions and reduce the gigantic compliance costs.

Labor reform

Brazil’s labor laws have their roots in the 1930s’ Estado Novo (New State) of President Getúlio Vargas. While there could be literally hundreds of reforms to these archaic and obtuse rules, there are two that are especially cumbersome to entrepreneurs.

First, payroll taxes are exorbitantly high. Coming in at approximately 35 percent of an employee’s salary (compared to the United States at 12.4 percent), these high rates create a vast informality in the economy and make hiring skilled workers especially expensive. There is almost certainly a Laffer Curve benefit available to Brazil from increased salaries and reduced informality if the country lowers this tax.

Second, Brazil needs to dramatically reform its termination laws because of the toxic dynamic they create within companies. Brazilian law requires companies to pay a one-time "fine" to employees when they are fired (approximately 3 percent of their cumulative salary since starting plus one additional month of pay). In addition, employees have access to a retirement fund, created in their name and paid by the company, when they are fired.

This creates large incentives for employees to want to get fired! Why would an employee voluntarily leave when they are looking to change jobs or are unhappy with their work if getting fired leads to a payday? Supervisors have had countless conversations with employees where they would ask, "Will you please fire me?" One can imagine how easy it is for an employee to force management’s hand after that request as they start to show up horribly late, treat customers poorly, etc. The loss of productivity from these "zombie" employees combined with the actual financial costs help make many Brazilian industries uncompetitive.

Trade

Finally, Brazil desperately needs freer trade and more competitive ports. The underappreciated lesson of recent decades is the role free trade plays in making industries more competitive through efficiency-driving inputs. Gavetiero.com.br imports industrial vending machines to install in clients’ factories that often reduce their costs on personal protection equipment and tools by 20 to 30 percent. These machines cost $8,000 in the United States, but by the time they arrive in Brazil they cost almost $20,000 due to import taxes and port fees. Naturally, this reduces the customer base for this cost-saving technology significantly.

In basketball they say you can’t coach height. Similarly, you can’t reform country size. You either have it or you don’t. Happily, Brazil does not need to become Chile in order to return to 5 to 7 percent growth rates. Its genes are good enough that even a small batch of reforms will have an outsized effect.

Guest contributor Joshua Kempf is the co-founder and CEO of Gaveteiro.com.br, a Brazilian online distributor focused on the B2B market, and son-in-law to Mark Kennedy.

Mark R. Kennedy is president of the University of North Dakota, author of "Shapeholders: Business Success in the Age of Activism," a member of the Council on Foreign Relations, and chairman of the Economic Club of Minnesota. He previously served three terms in the U.S. House of Representatives, was senior vice president and treasurer of Federated Department Stores (now Macy's), was a member of the Advisory Committee on Trade Policy and Negotiation under Presidents George W. Bush and Barack Obama, and led George Washington University’s Graduate School of Political Management.

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