Getting it together at last A special report on business and finance in Brazil November 14th 2009
Mar 30, 2016
Getting ittogether at lastA special report onbusiness and fi nance in Brazil November 14th 2009
Brazil.indd 1 2/11/09 13:37:32
The Economist November 14th 2009 A special report on business and �nance in Brazil 1
Brazil used to be all promise. Now it is beginning to deliver, says John Prideaux
�ve biggest economies by the middle ofthis century, along with China, America,India and Japan.
Despite the �nancial crisis that hasshaken the world, a lot of good thingsseem to be happening in Brazil right now. Itis already selfsu�cient in oil, and largenew o�shore discoveries in 2007 are likelyto make it a big oil exporter by the end ofthe next decade. All three main ratingagencies classify Brazil’s government paper as investment grade. The governmenthas announced that it will lend money tothe IMF, an institution that only a decadeago attached stringent conditions to themoney it was lending to Brazil. As thewhole world seemed to be heading into along winter last year, foreign direct investment (FDI) in Brazil was 30% up on the yearbefore�even as FDI in�ows into the rest ofthe world fell by 14%.
Much of the country’s current successwas due to the good sense of its recent governments, in particular those of FernandoHenrique Cardoso from 1995 to 2003,which created a stable, predictable macroeconomic environment in which businesses could �ourish (though even nowthe government continues to get in theway of companies trying to earn pro�tsand create jobs). How did this remarkabletransformation come about? And how can
Getting it together at last
BRAZIL has long been known as a placeof vast potential. It has the world’s larg
est freshwater supplies, the largest tropicalforests, land so fertile that in some placesfarmers manage three harvests a year, andhuge mineral and hydrocarbon wealth.Foreign investors have staked fortunes onthe idea that Brazil is indeed the country ofthe future. And foreign investors have lostfortunes; most spectacularly, Henry Ford,who made a huge investment in a rubberplantation in the Amazon which he intended to tap for car tyres. Fordlândia, alongforgotten municipality in the state ofPará, with its faded clapboard houses nowslowly being swallowed up by jungle, isperhaps Brazil’s most poignant monumentto that repeated triumph of experienceover hope.
Foreigners have short memories, butBrazilians have learned to temper their optimism with caution�even now, when thecountry is enjoying probably its best moment since a group of Portuguese sailors(looking for India) washed up on its shoresin 1500. Brazil has been democratic before,it has had economic growth before and ithas had low in�ation before. But it has never before sustained all three at the sametime. If current trends hold (which is a bigif), Brazil, with a population of 192m andgrowing fast, could be one of the world’s
An audio interview with the author is at
Economist.com/audiovideo
A list of sources is at
Economist.com/specialreports
Breaking the habitA brief history of Brazilian meltdowns. Page 3
Survival of the quickestFrequent crises have made for strong banksand nimble �nanciers. Page 4
Arrivals and departuresForeigners are investing in Brazil, Braziliancompanies are going shopping abroad. Page 6
Condemned to prosperityBrazil has learned to love its commoditysector. Page 8
The selfharming stateCompanies are squeezed between an obstructive government and blackmarketcompetitors. Page 10
A better todayBrazil’s growing middle class wants the goodlife, right now. Page 12
Two AmericasBrazil and the United States have more incommon than they seem to. Page 13
Also in this section
AcknowledgmentsThe author would like to express particular thanks fortheir help in preparing this special report to: EduardoMufarej of Tarpon; Eduardo Giannetti and Claudio Haddadof INSPER; Marcelo Carvalho of Morgan Stanley; FernandoReinach of Votorantim; Candido Bracher and JeanMarcEtlin of Itaú BBA; Marcelo Neri of FGV; Alexandre Marinisof Mosaico; Mauro Azeredo of the World Bank; HeinzPeterElstrodt, Stefan Matzinger, Guilherme Lima, Tracy Francis,Fábio Stul and Roberto Fantoni, all of McKinsey; WalterCruz of Marcopolo; Nilson Teixeira of Credit Suisse;Aldemir Bendini of Banco do Brasil; Francisco Valim ofExperian; Damian Fraser of UBS; João Augusto de CastroNeves of CAC; Rodolfo Spielmann of Bain; Norman Gall ofthe Braudel Institute; and David Fleischer of BrasíliaUniversity.
1
A country brie�ng on Brazil is at
Economist.com/brazil
2 A special report on business and �nance in Brazil The Economist November 14th 2009
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1
Brazilian and foreign �rms, from lipstickmakers to investment banks, take advantage of the country’s new stability?
To see why Brazil currently seems so exciting to both Brazilians and foreigners, ithelps to understand just how deep it hadsunk by the early 1990s. Past disappointments also explain three things about Brazil which outsiders sometimes �nd hard tofathom: its suspicion of free markets; itsfaith in the wisdom of government intervention in business and �nance; and persistently high interest rates.
When Brazil became independent fromPortugal in 1825, British merchants, delighted to discover a big new market,�ooded Brazil with manufactures, including, according to one possibly apocryphalstory, iceskates�an early example ofemergingmarket fever. Even so, real income per person remained stagnantthroughout the 19th century, perhaps because an inadequate education systemand an economy dependent on slaves producing commodities for export combinedto get in the way of development. Eversince the Brazilians have tended to viewfree trade with suspicion, despite theircountry’s recent success as an exporter.
In the mid20th century Brazil seemedto have found a formula for stimulatinggrowth and enjoyed what appeared to bean economic miracle. At one point its economy grew faster than that of any other bigcountry bar Japan and South Korea. Thatgrowth relied on a stateled developmentmodel, �nanced with foreign debt within asemiclosed economy. But growth alsobrought in�ation, which crippled Braziluntil the mid1990s and still accounts forsome odd characteristics, such as the country’s painfully high interest rates and itsdisinclination to save. All the same, the�miracle� wrought by the military government persuaded Brazilians that the stateknew best, at least in the economic sphere,and even the subsequent mess did notquite persuade them otherwise.
Unhappy memoriesWhen this development model brokedown amid the oil shocks of the 1970s, Brazil was left without the growth but withhorrendous in�ation and lots of foreigndebt. There followed two volatile decades,when Brazil started being likened to Nigeria instead of South Korea. Productivitygrowth went into reverse. Many of thecountry’s current problems, includingcrime and poor education and health care,either date from that period or were exacerbated by it. Between 1990 and 1995 in�a
tion averaged 764% a year.Then a real miracle happened. In 1994 a
team of economists under Mr Cardoso,then the �nance minister, introduced anew currency, the real, which succeededwhere previous attempts had failed. Within a year the Real Plan had managed tocurb price rises. In 1999 the exchangeratepeg was abandoned and the currency allowed to �oat, and the central bank wastold to target in�ation. The tenyear anniversary of this event has just passed, andalthough there is continuing debate abouthow to make the real less volatile, none ofthe big political parties advocates goingback to a managed rate.
More than that, the reforms broughtdiscipline to the government’s �nances.Both federal and state governments nowhave to live within their means. A requirement to run a primary surplus (before interest payments on the public debt) was in
troduced in 1999, and the federal government has hit the target for it every yearsince, though there is a good chance that itwill miss it this year. This has allowed Brazil to get rid of most of the dollardenominated foreign debt that caused such instability every time the economy wobbled.Now international creditors trust the government to honour its commitments.Moody’s, a rating agency, elevated Brazil’sgovernment paper in September to investment grade just as the governments ofmany richer countries fretted about beingable to meet their obligations.
Yet growth still proved elusive. It took abuoyant world economy and a surge incommodity prices to procure it. AlthoughBrazil’s economy is still relatively closed(trade accounted for a modest 24% of GDP
in 2008, less than 60 years earlier), itsgrowth is closely correlated with commodity prices, the Chinese economy, the BalticDry index and other measures of globaltrade. But at last in 2006 GDP outpaced in�ation for the �rst time in over 50 years.
Lucky Lula’s legacyBrazil’s current president, Luiz Inácio Lulada Silva, has been able to take much of thecredit for the country’s recent growth thatperhaps properly belongs to his predecessor. Yet Lula’s achievement has been tokeep the reforms he was bequeathed andadd a few of his own�not a meagre accomplishment given that for the past sevenyears his own party has been trying to draghim to the left.
Lula is often mocked for beginning hissentences with the phrase, �never beforein the history of this country�. What hispolitical opponents �nd even more infuriating is that he is often right. Brazil was ableto cut interest rates and inject money intothe economy as the world economy faltered at the end of last year, the �rst time ithas been able to do this in a crisis. Whereasothers predicted that world events wouldtip Brazil into recession, Lula reckoned thatthe crisis would amount to nothing morethan a small tide breaking on his country’sbeaches. The economy shrank for onlytwo quarters and is now growing again.The contrast with Brazil’s performance inprevious crises could not be more stark(see box, next page).
Plenty of problems remain. The centralbank’s headline interest rate is 8.75%, oneof the highest real rates anywhere in theworld. If the government wants a longterm loan in its own currency it still has tolink its bonds to in�ation, making debt expensive to service.
Cardoso (left) did Lula a big favour
The Economist November 14th 2009 A special report on business and �nance in Brazil 3
2 Productivity growth is sluggish. Thatmay not seem the end of the world, but itre�ects realities such as the twohour busjourney into work endured by people living on the periphery of São Paulo, thecountry’s largest city, during which they often risk assault before arriving too tired tobe very useful. The government investstoo little and has longstanding gaps in policing and education to �ll. The legal systemis dysfunctional. And so on.
Yet other countries face similar problems, and Brazil has made real progress.In a country where businesses becameused to headline interest rates of 30% ormore, a rate below 9% comes as a relief.�It’s like the di�erence between running amarathon with 50 kilos on your shouldersand 20 kilos,� says Luis Stuhlberger ofCredit Suisse HedgingGri�o, one of Brazil’s most successful fund managers. MrStuhlberger thinks that Brazil’s recent pastwas so awful, and its expansion of education and credit is so young, that the coun
try can reasonably be expected to continueon its current trajectory, even without further big reforms. Even so, he argues, �weare not going to have a Harvard or a Googlehere.� The blame for that, he says, lieslargely with government policies.
Brazil’s economic story could certainly
be made more exciting with some reformsto its business environment. The country’spotential growth without a risk of overheating can only be guessed at, but it isprobably below the 6.8% it reached in thethird quarter of 2008. Most economists putit at 45%. This suggests that interest rateswill not be coming down to levels considered normal in other countries soon.
Still, stability has its own rewards. Edmar Bacha, one of the economists whoworked on the introduction of the real in1994, is pleased that the debates about Brazil’s economy have become so narrow.Back in 1993, when he joined the ministryof �nance, in�ation at one point hit 2,489%.Nowadays, he notes with a wry smile, �thebig debates are about whether interestrates could come down from 8.75% to8.25%; or whether the central bank shouldhave started cutting a month earlier than itdid.� That change has been good for Brazil,and particularly good for its banks and its�nancial system. 7
1The right combination
Source: IBGE
% change on previous year
5.0
2.5
0
2.5
5.0
7.5
0
500
1,000
1,500
2,000
2,500
+
–
1981 85 90 95 2000 05 08
GDP Consumer prices
FOR most of the past few decades Brazilhas been one of the �rst places to go
into a tailspin when things turn nasty elsewhere, as the following list demonstrates.¹ 197379: Oil shocks. The �rst oil shockdoubled Brazil’s import bill within a year.The second set o� uncontrolled in�ation,which reached 110% for 1980. The next 15years were a continuous struggle to bringthat number down. They also saw a sharpincrease in shortterm foreign debt denominated in dollars to pay for oil, heralding a decade and a half of instability.¹ 1982: Default. As Mexico defaulted, Brazil, which had also borrowed a lot fromforeigners, found itself mistrusted too.The government tried to engineer a tradesurplus to reassure creditors, forcing importers to obtain licences and buy dollarsat an in�ated o�cial rate, but failed. In1983 it defaulted on its debt and the cruzeiro plunged against the dollar, making in�ation even worse.¹ 1986: The Cruzado Plan. Three zeroswere chopped o� the currency, and at �rstBrazil seemed to have got on top of in�ation. But it was also in the process of becoming a democracy (the �rst civilian
president in two decades was chosen byCongress in 1985), and conquering in�ation required holding down wages, whichBrazil’s new democrats found hard to do.The Bresser Plan (1987) and the Verão Plan(1989) fared no better. By 1990 in�ationwas running at more than 70% a month.¹ 1990: The Collor Plan. The worst of thelot, this one involved an immediate freezefor 18 months on bank deposits making up80% of the country’s �nancial assets. Theidea was to force prices down by reducingliquidity. Wages were frozen, �nancialtransactions were subjected to punitivetaxes and foreign exchange and tradewere liberalised. The policy set o� a minirecession, causing panic that led to a reversal. High in�ation returned. ¹ 1994: The tequila crisis. Another Mexican devaluation and debt crisis that had aknockon e�ect on Brazil. The central bankresponded to an out�ow of money by increasing interest rates to nearly 50%.¹ 1997: The Asia crisis. Brazil’s commodity exporters were hit by a fall in demandfrom Asia. Once again con�dence plummeted as money left the country. The central bank fought hard to defend the real
which had been introduced in 1994, increasing overnight interest rates to an annual 40% and killing growth.¹ 199899: The Russia and LTCM crisis.While still trying to get back on its feet,Brazil was hit again after Russia defaultedon its debt and a team of Nobel economics laureates nearly fused the �nancialsystem. The government was forced to letthe real �oat freely, which was economically correct but highly unpopular as thecurrency’s value dropped.¹ 200102: The dotcom crash and Argentina’s default. Once again the realdropped on fears about Brazil’s neighbours and general unease about theworld economy and the election of President Lula. In�ation rose to 12.5% and theheadline interest rate went up to 25%. ¹ 2007?: The global �nancial crisis.What appeared to be the worst global recession since the 1930s left Brazil relativelyunscathed. It was able to cut interest ratesand the real held its value. Brazil turnedout to be one of the last countries into thedownturn and one of the �rst out, causingnational celebration and not a little surprise, given what had gone before.
A brief history of Brazilian meltdownsBreaking the habit
4 A special report on business and �nance in Brazil The Economist November 14th 2009
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BRAZILIAN businessmen often say thatthe country’s recent economic past has
strengthened companies, and especiallybanks. The argument goes like this: youneed to be good, or at least inventive, tosurvive and make money when you haveno idea whether in�ation next year will be50% or 500%. Bankers and �nance directors have had to be particularly nimble.One example is Souza Cruz (a subsidiaryof BAT), Brazil’s largest tobacco company,which in the days of high in�ation did nobetter than break even on its cigarettesales. Its pro�ts came from the interest onthe cash it held between being paid by retailers and paying tax fortnightly. Companies used to operating in such unusual circumstances �ourished when life becamemore predictable.
There is some truth to this argument,even though it brushes aside the fact thatuntil the 1990s Brazilian companies did nothave to worry about foreign competitors.No big companies went bust in the recent�nancial crisis, despite losses on foreignexchange derivatives that the Bank for International Settlements estimates at $25billion. Moreover, no big banks wobbled,let alone had to be rescued, though therewere some mergers.
One reason was that a previous roundof bank failures, in 1994, had alreadycleared out the bad ones. Until then banksmade their pro�ts by taking deposits fromcustomers, lending the money to the government overnight and pocketing the difference. With in�ation at several hundredper cent a year, many banks’ balancesheets were hard to decipher. When in�ation came down, it became clear that anumber of them were insolvent. Thesefolded or merged with other banks, leaving only the stronger ones.
Brazil’s �nancial system got a furtherboost from reforms carried out when Arminio Fraga was governor of the centralbank from 1999 until the start of 2003 (he isnow at Gávea Investimentos, an investment �rm). The country’s banksettlementsystem now operates in real time, so allbanks know their cash positions at any given moment and the central bank has anoverall picture of what is happening. Before this system was introduced the central
bank often ended up honouring the debtsof banks that went bust, creating a dangerous incentive to be careless. Both Mr Fragaand his successor as governor, HenriqueMeirelles, have made sure that banks report what is going on in any o�balancesheet vehicles they have funded. This hashelped to keep under control the special investment vehicles, conduits and othermysterious creatures that have caused somuch damage in other countries.
This transparency extends to �nancialmarkets too. All fund managers must disclose the net asset value of their funds toBrazil’s Securities and Exchange Commission (CVM) daily, though with a 48hourdelay. At the end of every month fundsmust disclose what they were holding 90days ago. Anyone can go to the CVM’swebsite and look up these numbers. Fundmanagers may grumble about too muchdisclosure, but most are happy with therules. Maria Helena Santana, who chairsthe CVM, explains that they make it harderto pull o� a scam of the sort run by BernardMado�, whose pyramid scheme was hidden behind a veil of secrecy.
Created equalEquity investors, for their part, have bene�ted from new rules for publicly tradedcompanies brought in by the São Paulostock exchange (Bovespa) in 2002. Big Brazilian companies used to be notorious forabusing shareholders with minoritystakes. Under current guidelines, it is illegal to issue shares that pay out di�erentamounts to di�erent holders in the eventof a takeover. Any disputes between shareholders are judged by the CVM. With theserules in place, foreigners have been happyto buy shares and Brazilian companies thatwere unable to borrow in capital marketsare now able to �nance their expansion.
A boom in initial public o�erings (IPOs)followed. At its height, in 2007, 80% of themoney for IPOs came from foreign investors. This undoubtedly led to some excesses: at one point there were more listedhousebuilders in Brazil than in America.But some of the companies that �oatedwill do well. And the message conveyedby the new rules�that better corporate governance allows people to make money
by selling bits of their companies on thestock exchange�has been good for thefamily businesses that make up the bulk ofBrazil’s mediumsized �rms.
Santander Brasil’s recent IPO was a testof whether investors’ appetite for Brazilhad returned. It proved to be the world’slargest IPO this year, valuing the bank’sBrazilian subsidiary at more than thewhole of Deutsche Bank worldwide. Thegovernment is so worried about foreignportfolio investors pushing up the value ofthe real that it imposed a 2% tax in Octoberto discourage them. IPOs have a widerbene�t because companies that want to�oat all or part of their stock need to gettheir accounts in order, pay their taxes andmake sure their workers are not part of theblack economy.
All this has brought sophistication andliquidity to Brazil’s �nancial markets. SãoPaulo’s futures and options market is oneof the �ve largest in the world by volumetraded. Welldeveloped markets have beengood for consumers too. High interestrates, high in�ation and dysfunctionalcourts once made consumer credit rarerthan snow. Thanks in part to a series of reforms carried out in Lula’s �rst term, credithas grown steadily. Loans for bigger items,such as cars and apartments, have becomeavailable for the �rst time, thanks to a newlaw under which a lender remains theowner of the asset acquired with the loanuntil the last repayment is made, whereaspreviously the money would have had to
Survival of the quickest
Frequent crises have made for strong banks and nimble �nanciers
2000 02 04 06 08
2Squeezed
Sources: Central Bank of Brazil; Credit Suisse
Policy interest rate and bank credit
1999 2001 03 05 07 090
10
20
30
40
50
SELIC interest rate, % Credit, % of GDP
The Economist November 14th 2009 A special report on business and �nance in Brazil 5
2 be chased up through the courts. Lula’s �rst administration also intro
duced a new bankruptcy law that is credited with making it slightly easier to salvagesomething from companies that go under.There was room for improvement: a fewyears ago a World Bank study found thatbankruptcy proceedings in Brazil took anaverage of ten years and left creditors withjust two cents in every dollar owed.
Yet for all this progress, two glaring problems with Brazil’s �nancial system remain. First, credit is very expensive. Second, only the government will lend forlong periods, and not to everyone.
Tax and lendBrazil has a hybrid retail banking system,with statecontrolled and privatesectorbanks competing directly. It is highly concentrated: Itaú Unibanco, the largest private bank, is among the world’s 15 biggest onseveral measures and yet has almost nopresence outside Brazil. Banco do Brasil,the largest statecontrolled bank and oneof the world’s oldest �nancial institutions,vies with it for the title of the country’s biggest bank. All told, credit from statecontrolled banks makes up 37.6% of the totaland has recently been growing.
Despite their di�erent owners, thestatecontrolled and the private banksseem to be behaving in a remarkably similar way. Aldemir Bendini, the chief executive of Banco do Brasil, talks enthusiastically about international expansion. Thebank will soon open �ve agencies inAmerica to serve Brazilian expatriates. Italso wants to help Brazilian multinationalsabroad with localcurrency �nancing.Meanwhile it will keep up its role as an instrument of public policy that does thebidding of the federal government, its biggest shareholder, and also look after the22% of its shareholders who own tradedstock. It looks like an incongruous mixture,but it appears to work. Itaú Unibanco too iskeen on expansion abroad, but makes somuch money at home that it does not seemto be in a rush.
In theory, all this should provide plentyof competition, with the two types of bankkeeping each other honest and makingsure that Brazilians have access to credit. Inpractice it does not quite work like that.Even though Itaú alone has 25,000 cashpoints, more than 500 municipalities inBrazil lack even a single bank branch. Thetwo kinds of bank compete most �ercelyin the comparatively wealthy south andsoutheast of the country. Banco do Brasilrecently added to the geographical concen
tration by buying Nossa Caixa, a São Paulostate savings bank, and a large stake inBanco Votorantim, a privatesector bank.
The government has raised the limit forforeign participation in Banco do Brasil to20% to attract more capital, but the statecontrolled banks are not as well run as theprivatesector ones, so the hopedfor competition has not materialised. The clearestsign of this is spreads�the di�erence between a bank’s cost of borrowing andlending. The Institute for Industrial Development, a lobby group, calculates that average lending rates are 35% higher than deposit rates, against less than 10% in theother BRIC countries. The bankers’ lobbydisputes these �gures, but nobody thinksthat banks’ spreads are thin.
Among the things that make them fatter are a curious tax on bank funding thatincreases costs, and high reserve requirements which mean that banks mustsqueeze more revenue from what they areable to lend. Badloan provisions are hightoo, re�ecting the fact that consumer creditis concentrated among people who are already stretched. And a lot of credit is subsidised, which pushes up costs for the rest.
Brazil’s banks have many things to recommend them; indeed they seem to exemplify what might happen if regulatorselsewhere got their every wish. They aresafe and their lending is wellcapitalisedand pro�table. Twothirds of Brazilian deposits are in local banks, which is unusually high for Latin America and a bigchange from the past, when anyone whohad money kept it out of the country and
in dollars. The banks also o�er some thingsthat would surprise American or European customers. Many ATMs provide awide range of �nancial services, from dispensing cash to providing loans. Even so,for now credit is likely to remain too expensive for the country’s good.
For companies trying to get credit, theproblems are much the same. To make upfor the absence of a market in longtermdebt Brazil created a giant developmentbank, the BNDES, with a balancesheetlarger than the World Bank’s. This is �nanced by an impost on labour and lendspredominantly to Brazil’s biggest companies�the opposite of what you would expect from a leftleaning country.
Because its large loans to Brazil’s bignames carry so little risk, the BNDES ispro�table. It also does some more adventurous lending, although trickier credit assessments are farmed out to private banks,which collect a fee for their pains and alsoassume the risk of loans going bad. TheBNDES was useful to Brazil during the recent crisis as a stable source of funding, butits scale as the lender of choice for Brazil’sbest credit risks is probably impeding thedevelopment of markets in longtermdebt, and the way it is funded seems fundamentally unjust.
Still, compared with the bank failures,frauds, market manipulation, volatility,disregard for contracts and nearabsenceof credit of the past, Brazil’s �nancial sectorhas come a long way. Foreign investorshave noticed, and have recently startedpouring money into the country. 7
Plenty to celebrate
6 A special report on business and �nance in Brazil The Economist November 14th 2009
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TRADING with Brazilians has not always been easy. Jean Lery, who visited
the country in the 1550s, wrote an accountof the trading practices of the Ouetaca people, who liked to exchange goods by placing them on a rock 200 paces away andthen retreating. The trading partner did thesame, and the dance was repeated as eachgroup got what it wanted. �As soon as eachone has returned with his object of exchange, and gone past the boundaries ofthe place where he had �rst come to present himself,� wrote Mr Lery, �the truce isbroken, and it is then a question of whichone can catch the other and take back fromhim what he was carrying away.�
That would have rung a bell with someof Brazil’s foreign investors in more recenttimes, from Daniel K. Ludwig, who repeated Henry Ford’s jungle folly a few decadeslater, to the Japanese banks that tried to enter the market, to US Steel, which discovered Carajás, the world’s largest ironoredeposit, before being forced into a jointventure with a government company andthen selling out of a mine that is still goingstrong 30 years later. Lots of other foreigninvestors have done well, however, andBrazil is enjoying a new wave of trust andoptimism as the world pours in money(see chart 3). It has become the secondlargest destination for FDI �ows into developing countries after China.
Foreign investment in Brazil has a longhistory. British investors built railways atthe end of the 19th century to get commodities to ships and then to market. GE �rstentered this emerging market in 1919. Its local CEO, João Geraldo Ferreira, likes topoint out that GE’s light bulbs illuminatedRio’s famous statue of Christ the Redeemer when it was put up in the 1930s. A waveof foreign investment arrived in the 1950s,when China and India were closed and theKorean peninsula was at war. The car companies that have been in Brazil for a while,such as Fiat, GM and Volkswagen, havedone particularly well recently: for the pasttwo years Brazil has been the world’s fastestgrowing car market.
Earlier this year the Brazilian and Chinese governments announced that ChinaDevelopment Bank and Sinopec, a Chinese oil company, will lend Brazil’s Petro
bras, a statecontrolled but publicly tradedoil company, $10 billion in return for up to200,000 barrels a day of crude oil from thecountry’s new oil �elds for ten years. Given China’s hunger for commodities andBrazil’s openness to investment, more ofthis sort of thing is expected.
Investments in Brazil that have failedtend to have one feature in common. Foreign companies arrive in Brazil full of optimism, pay too much for a local �rm andthen leave when things turn sour, oftenselling the same company back to a Brazilian �rm for a small fraction of what theygave for it. One example is Molson, a Canadian beer company that bought Kaiser, aBrazilian brand, in hopes of refreshing Brazil’s hordes of beer drinkers (though thecompany ended up selling to a Mexican�rm rather than a Brazilian one). GoldmanSachs, the investment bank that inventedthe term �BRICs�, has been in and out ofBrazil a couple of times. UBS bought Pactual, a Brazilian investment bank, beforeselling it back to André Esteves, a formerboss of the bank, earlier this year.
Let’s do the jeitinhoNow that Brazil has become more predictable, fewer foreign investors will fall intothis particular trap, but there are others. Because of the unsatisfactory legal system,commercial disputes with other companies are best avoided. This makes personalties especially important. And once theboss’s children are safely married to theo�spring of the �rm’s business partners,
any company wanting to succeed in Brazilwill still have to learn the art of the jeitinho�a Brazilian knack for getting aroundobstacles to doing business which wouldmake European or American compliancedepartments shudder.
Even as foreigners have been piling intoBrazil, a number of Brazilian �rms havebeen entering markets overseas. For the�rst time Brazil has a crop of companiesthat can be described as multinationals.Some of them are already well known outside Brazil: Petrobras; Vale, one of theworld’s largest mining companies; andEmbraer, the world’s thirdlargest maker ofpassenger jets.
Others may be familiar only to thosewho follow these sectors closely: Gerdauand CSN, two steelmakers; Marco Polo, abus builder; Perdigão and Sadia (soon tomerge into Brasil Foods) and JBSFriboi, allfood companies; WEG, which makes electrical components; Odebrecht and Camargo Corrêa, two construction �rms; Natura, a cosmeticsmaker; Votorantim, anindustrial conglomerate; and Coteminas, atextile �rm.
In the most recent list of 100 companiesfrom emerging markets that are evolvinginto multinationals compiled by the Boston Consulting Group, 14 are based in Bra
Arrivals and departures
Foreigners are investing in Brazil, Brazilian companies are going shopping abroad
3Come hither
Sources: IMF; Haver Analytics
Inflows of foreign direct investment into Brazil$bn
0
10
20
30
40
50
1975 80 85 90 95 2000 05 08
REAL PLAN
Iron rations at Carajás
The Economist November 14th 2009 A special report on business and �nance in Brazil 7
2 zil. At the last count, the Fundação DomCabral, a business school, reckoned therewere more than 40 large Brazilian �rms undertaking valueadding activities in di�erent parts of the world. Many of these companies began their expansion into foreignmarkets decades ago. Most turned �rst tomarkets in neighbouring countries thatwere fairly familiar. Their main motiveseems to have been to hedge against Brazil’s ups and downs, rather than excitement at the potential for growth beyondtheir borders.
The latest wave of expansion is di�erent: both more ambitious in geographicterms (Vale alone has a presence on �vecontinents) and more selfcon�dent. Mostof the companies concerned feel that,much like Brazil’s banks, they have survived and prospered through di�cult decades in a harsh business environmentand are ready to operate in risky markets.
Some of the success stories have bene�ted from privatisation, or at least partprivatisation. One of the puzzles about Brazilis why politicians should feel unable totalk about privatisation despite so manysuccesses. In the most recent presidentialelection, in 2006, Lula accused his main rival, Geraldo Alckmin, of wanting to privatise anything that whirred or beeped, andMr Alckmin promised that he would neversell o� anything.
A private treasureEmbraer is a good example of what privatisation can achieve. Like many of Brazil’sindustrial giants, it was created by the government. In a joint venture with Italy’s Alenia Aermacchi that gave Brazil access to jettechnology for the �rst time, it producedthe AMX �ghter jet in the 1980s. But by the1990s the company was struggling, producing models that nobody wanted to buy.Since privatisation in December 1994 Embraer has turned itself into the world’s biggest manufacturer of midrange passengerjets. In the company’s factory in São Josedos Campos, where sheets of aluminiumare fed into one warehouse and 100seateraircraft come out of another some monthslater, planes are waiting for delivery tocommercial airlines in China, India, Poland and Britain. Some 96% of the company’s revenue now comes from exports.
Although Brazil’s main domestic carriers use aircraft built by Boeing and Airbus,Embraer’s machines have proved popularwith American carriers for shorthaul�ights�so much so that the company isprobably more exposed to the �uctuationsof America’s economy than of Brazil’s. It
also has a good business making militaryplanes and private jets and even producesa small propeller plane for cropspraying,the Ipanema, that runs on ethanol.
CSN, a large steelmaker, was foundedby the Brazilian government in 1941, privatised in the early 1990s and has �ourishedsince. Petrobras has also done well sincepart of its stock was �oated. But perhapsthe best example of privatisation and international expansion is Vale, which started o� private but was nationalised duringthe second world war to help America’swar e�ort by supplying iron ore.
It took its �rst steps abroad in the 1980sand 1990s before being privatised in 1997(though as with Embraer, the Brazilian government still holds a golden share thatwould probably prevent it from being taken over). At the beginning of this decadeVale was a mediumsized mining company with a strong ironore business inBrazil and some interests in forestry andother bits and pieces. Now it is one of theworld’s four biggest mining companies.
Thanks to the commodities boom, Valewould have grown almost whatever it did.But it is doubtful whether it would havecome so far, so fast, had it remained in public hands. Under Roger Agnelli, who hadpreviously been an investment banker,Vale has sold o� its peripheral businessesand is now concentrating on metals, with asideline in electricity generation and, inBrazil, railways. Vale’s $19 billion acquisition of Inco, a large nickel producer basedin Canada, allows the company to provideall the raw materials that steelmakersneed. In 2005 Vale was able to raise pricesfor its iron ore by 71.5% in tough negotiations. It is hard to imagine the old statemining company pulling that o�.
If Brazil’s current government seemshostile to the notion that privatisationtends to improve companies, it does likethe idea of having a number of nationalchampions succeeding abroad. BNDES hasbacked up the government’s rhetorical
support by lending $8 billion so far thisyear to help the expansion of Brazilianmultinationals. This is a big change from 15years ago. Carlos Arruda of the FundaçãoDom Cabral recalls that shortly after he began compiling an economiccompetitiveness survey for the World Economic Forum in 1996, he received a letter from agovernment minister informing him that itwas not in the government’s interest tohave Brazilian companies expand abroad:capital was scarce and jobs had to becreated at home. This view was reinforcedby laws that made it impossible to sendpro�ts from foreign subsidiaries back toBrazil or to recognise losses made abroadin company accounts.
This change in attitude has helped, butBrazilian multinationals are not immuneto the kind of problems that have sometimes caught out foreign investors in Brazil.Petrobras has had some of its Bolivian assets nationalised by that country’s president, Evo Morales. Odebrecht has had asimilar experience in Ecuador. These, however, are relatively trivial compared withEmbraer’s current di�culties in China. Thecompany opened a factory in Harbin in2002 where it has a joint venture with thesnazzily named China Aviation IndustryCorporation II (the only way of gaining access to this big new market). Embraer hadplanned to make only older models in China for fear of losing control of its intellectual property. But the Chinese company is insisting that Embraer produce its newestmodels there, and there is now a chancethat Embraer will withdraw from makingaircraft in China altogether.
No doubt many of Brazil’s new multinationals will encounter similar problemsas they venture abroad. But even if they do,companies that are essentially commodityproducers, consumers or traders (whichmake up a majority of the new multinationals) can rest assured that their builtincomparative advantage is unlikely to beeclipsed soon. 7
Aircraftmaker to the world
8 A special report on business and �nance in Brazil The Economist November 14th 2009
1
NOT many countries are named aftercommodities. There is Argentina,
from the Latin word for silver; Côted’Ivoire, a reminder that nature’s endowments do not always lead to prosperity;Panama and Uruguay, whose names maycome from indigenous words for �sh; andalso Brazil, which became known for itsBrazil wood, the source of a valuable dye.Prior to that Italian merchants apparentlycalled it the land of parrots. Brazil has already lived through several commoditiesbooms: precious metals in the 17th century,sugar in the 18th and co�ee in the 19th. Yetnone of them bene�ted the country asmuch as the current one.
The large discoveries of o�shore oilmade by Petrobras in 2007, which havegenerated so much excitement recently,have made it easy to forget that Brazil is already the world’s largest exporter of co�ee,sugar, chickens, beef and orange juice. Italso exports vast amounts of soya and ironore, as well as other ores and metals. Itscommercial forests are the source of muchof the world’s pulp. If other countriesopened their markets, Brazil would supplythem with ethanol to fuel their cars too. Ahistory of booms and busts in the marketsfor raw materials is written into the country’s landscape.
Yet for a long time Brazil did not capitalise properly on all this wealth. Brazilian intellectuals used to argue that the country’srole as a commodity producer permanently consigned it to the periphery of theworld economy. Then two things changed.
First, improvements in the country’s �nancial system and greater economic stabilityallowed businesses to invest without fearthat some economic catastrophe was likely to befall the country. This is re�ected inthe large share of investment going into thecommodity sector. Second, the worldwideboom in commodities this decade made itmore pro�table to plough �elds and digholes, bringing about a big change in Brazil’s terms of trade (see chart 4).
Plough, scatter, repeatIt is safe to assume that the world’s hungerfor protein is not going to abate. Peoplestart eating lots of meat when they reachan income of about $10,000 per person.Some 80% of the world’s population haveyet to get to that point. As they do so, �nding spare land and increasing the e�ciencyof farming will become ever more important. Brazil has plenty of spare land, evenwithout destroying its forests to createmore, and much of its farming is done bysmall, familyrun businesses that could increase production with more capital andbetter management.
Brazil has already pulled this o� once.Largely thanks to the work of Embrapa, agovernment research agency, Brazilianfarmers in the 1960s and 70s steadily increased the area in which crops could becultivated. Acidic soil, with little phosphorous and lots of toxic aluminium, was rebalanced, and crops were specially bredfor Brazil’s tropical environment. Between1968 and 1997 a total of 116 new varieties ofsoyabeans were launched. In the past fewyears new ones have been added at therate of almost 100 a year.
Among other things, Embrapa, working with privatesector companies, is trying to develop a variety of wheat that willgrow in Brazil. At the moment, reckons Julio Pisa of BrasilAgro, which owns 166,000hectares of farmland in Brazil, the countryhas 20m spare hectares of good productiveland. Not all of this will be as sumptuousas in Rio Grande do Sul state, where somefarmers can harvest a tobacco crop, a corncrop and a bean crop from the same land ina single year (culminating in a lively beanfestival in January), but it will be prettygood. Perhaps more importantly, Mr Pisa
points out, when Brazil exports food it isalso exporting water, and Brazil is fortunate enough to have a surplus of fresh water per head of population.
But before Brazil’s agriculture can reachits full potential, there are a few problemsto overcome. The �rst is a longrunning argument about who has the right to whatpiece of land. Land tenure becomes lessand less certain as you approach the equator. In the Amazon this results in deforestation as farmers cut down trees to establishdefacto ownership of land. In other partsof the country the disputes take the formof farm invasions by the Landless Movement (MST), which has many ideologicalsympathisers in the government, including the president himself.
The MST tends to go for farmland that isnot too far from cities, but Fibria, a big producer of wood pulp, has had trouble withinvasions of forests it owns in remote partsof Bahia state. These invasions can be colourful: one group, made up entirely ofwomen, likes to arm itself with pitchforksbefore descending on farms.
As might be expected of a loosely organised movement in a big country, theMST appears in lots of di�erent guises, depending on the place. One of its oldest settlements, at Pirituba in São Paulo state,now looks a bit like a kibbutz tinged withnewagey environmentalism. By contrast,in the northern state of Pernambuco MST
members shot and killed four men earlierthis year.
Lost highwaysA second problem holding commodityproducers back is Brazil’s patchy infrastructure. After much sifting through data,the World Bank’s Growth Commissionconcluded that, in order to keep growingfast, developing countries should investaround 25% of their GDP, of which about7% should go on infrastructure. Brazil’s investment level has been creeping up towards 20% in recent years, but in 2007 thegovernment invested just 0.1% of GDP onimproving transport.
For some of the biggest companies thisis not a problem. Vale has its own railwaylines, which allow it to get its iron ore fromCarajás to market without much trouble.
Condemned to prosperity
Brazil has learned to love its commodity sector
99 01 03 05 07
4Grist to the mill
Sources: IMF; IBGE
% change on previous year
1998 2000 02 04 06 0815
10
5
0
5
10
15
20
25
+
–
Brazil’s GDP
Non-fuel commodity prices
The Economist November 14th 2009 A special report on business and �nance in Brazil 9
2
1
The company is also a shareholder in MRS
Logística’s railway network in the south ofBrazil, along with CSN and Usiminas, another steel company. Just as in America inthe late 19th century, when Standard Oiland Carnegie Steel used the railroads under their control as a weapon against theircompetitors, these companies are able tomaintain a system that works well forthem but not for others. Some 60% offreight in Brazil goes by road and only 20%by rail, compared with an even split in theUnited States. América Latina Logística’srail network is open to whoever wants touse it but covers only part of the country.
Once goods are loaded into trucks,everything slows down. Brazil’s lorries, onaverage, are 14 years old. Their bumpersare usually adorned with foothigh lettersdeclaring that the driver has put his trust inGod, which is just as well given the state ofthe roads and some of the overtaking thatlorry drivers do.
Brazil has the world’s thirdlargest roadnetwork, but only 12% of it is covered in asphalt. IPEA, a government economicresearch agency, reckons that road deaths pervehicle on the road in Brazil (some 35,000in 2006, the latest available �gure) are sixtimes as frequent as in Japan.
When the trucks eventually make it tothe port, often after spending hours in traf�c jams, everything slows down again.Brazil’s ports tend to be run as o�shoots ofthe civil service rather than as private companies, with all the problems that entails.To speed up the loading and departure ofships, companies sometimes �nd they arerequired to make extra payments, whichpublicly listed multinationals struggle toexplain in their accounts�and to justify totheir shareholders.
Brazil’s ports are both more pro�tableand less e�cient than their peers elsewhere. Competitors who want to enter themarket are discouraged. When Eike Batista,the most swashbuckling of Brazil’s currentcrop of entrepreneurs, applied to build anew port in São Paulo state he was unableto secure an environmental permit for hisproject. There is also a suspicion that Braziloccasionally uses its sluggish customs service to in�uence trade data. Strikes havesometimes coincided with periods whenthe real has been particularly strong andimports have been rising fast.
Many people seem to believe that allthis can be turned around. At the start of2007 the government announced a �programme for accelerating growth�, concentrating on infrastructure, which most agreeis a small step in the right direction. Several
state governments have subcontracted theexpansion and improvement of existingroads to private consortia which are allowed to collect tolls. Infraero, the statecompany that runs Brazil’s airports, is stepping up its investment. Pablo Haberer ofMcKinsey, a management consultancy,reckons that in four or �ve years’ time Brazil’s airports will be better than those ofthe United States.
But even when the federal and stategovernments are behind new infrastructure projects and money has been allocated, often nothing happens. The prospect ofhosting the football World Cup in 2014 andthe Olympics two years later should inspire some action. But it would be a stretchto argue that the roads, airports and stadiums that will be built or renewed for thebene�t of sports enthusiasts will be exactly what Brazil’s exporters need.
Below the saltThese problems have been with Brazil forsome time, and companies mostly �ndways around them. But the discovery ofabundant oil o� the country’s coast posesa di�erent set of challenges.
To begin with, the oil sits three to fourmiles below the sea, between layers ofsalt. This is deeper than any company hastried to drill before. Because it is so deepdown, the oil will come out hot and thencool rapidly as it nears the surface, leavingdeposits of para�n that will clog up pipes.Gases under high pressure will come out atthe same time as the oil. The drilling platforms will be 185 miles out to sea, out ofrange of helicopters. Some combination ofboats, �oating platforms and helicopterswill have to be employed to get rig workersthere and back.
To solve these problems, Petrobras hasannounced the world’s largest capitalexpenditure programme, worth $174 billionover the next few years. This is a boon tocompanies such as GE, which has a $250m
deal with Petrobras to supply Christmastrees (the part that anchors an oil rig to thesea bed). The government has said that itexpects Petrobras to work with oilservices�rms like Schlumberger and Halliburton,as well as with foreign oil companies thatwant to boost their reserves.
No doubt many foreign oil companieswill come to Brazil and partner Petrobras inthe new �elds. Compared with manyplaces where they do business, Brazil is amodel of predictability, good regulationand respect for contracts. However, the calculation has just been made more complicated for them by the federal government’sannouncement that it is getting rid of theregulatory framework that has served thecountry well for ten years and helped tobring about the new discoveries.
The existing system, in which royaltiesare paid to the state, could be tweaked tore�ect the risk of exploration in the �eldsbelow layers of salt (though this appears tobe low). But the government wants to replace it with a new set of rules that wouldinvolve it more directly in the management of exploration and production. Under the latest proposals a new state oilcompany, PetroSal, will take part in allnew ventures. Petrobras will also have aguaranteed stake in each block. Other companies can come in as minority partners.Lula is also insisting that everything usedto extract the oil should be made in Brazil,which will push up costs and slow thingsdown. All this makes it less attractive forforeign investors to get involved, at a timewhen Brazil needs a lot of capital to makethe most of its new discovery.
Although the numbers suggest that Brazil is at last making proper use of its agricultural and mineral riches, there is anotherside to the boom that is not re�ected in the�gures. High commodity prices are correlated with deforestation in the Amazon astrees are cut down to create farmland tofeed Brazil’s domestic market. It is a dread
Running out of road
10 A special report on business and �nance in Brazil The Economist November 14th 2009
2
1
IT IS easy to become depressed when confronted by the waste, incompetence and
downright obstructiveness towards people trying to make a living contained within Brazil’s three layers of government. Soperhaps it is best to start by saying that theBrazilian state does some things very well.It has prevented an AIDS epidemic by deploying sensible public policies. Some ofits ventures into research and development have helped the economy. It has thehighest share of renewable energy in power generation of any big economy.
The state of Minas Gerais has employed privatesector expertise to bringabout what it calls a �management shock�,eliminating de�cits and measuring theperformance of its various departments.Some of the people who worked on thisproject in Minas have been trying to dosomething similar in Rio de Janeiro state.The Centre for Public Leadership, a charitybased in São Paulo, is running courses formayors who want to learn more aboutmanagement techniques.
Even in Brasília, the capital, whichtends to hold out longest against such improvements, things are happening. �WhenI arrived at the ministry of mines and energy there were three engineers and 25chau�eurs,� Dilma Rousse�, one of thefrontrunners in next year’s presidentialelection, told a gathering of foreign reporters recently. �We need to make our civil service professional and meritocratic.�
The Brazilian state’s problem is not somuch that it is overbearing and incompetent, a common complaint, but that it isweak where it ought to be strong andstrong where it should be weak. It canwithhold environmental permits for new
hydroelectric dams or ports, preventingthem from being built, but it cannot stopraw sewage from being pumped into theriver that runs through the country’s largest city, or keep illegal loggers from despoiling its forests. It can make it extremely di�cult for large companies to hire and �reemployees or to pay their taxes, but it cannot prevent some 45,000 of its citizensfrom being murdered each year.
Brazil’s government has a lot of resources to draw on. Tax revenue hasclimbed to 36% of GDP, compared withAmerica’s 28%. Yet its public institutionssometimes resemble nothing so much asthe laboratory of a lunatic alchemist inwhich gold is transformed into lead. Brazilspends about three times as much per person on health care as China does, but itsbasic health indicators are slightly less favourable. Spending on education is respectable, at 5% of GDP, but Brazil’s pupilsroutinely come near the bottom in theOECD’s international comparisons of howmuch they know.
Admittedly Brazil was a late starter inpublic provision of both health care andschooling. As late as 1930 only one in �vechildren went to school. Because of highin�ation in the second half of the 20th century and chaotic government �nances in198094, there was not enough investmentin schools and hospitals. It is something ofa platitude for Brazilian bosses to say thatgetting hold of skilled people is the biggestlongterm challenge heir businesses face,but almost all repeat it.
Yet Brazil is prevented from spendingmore in these two important areas by oddrules governing public expenditure. Theconstitution, written in 1988, after the re
turn of democracy, in parts reads like abudget rather than a description of a set ofinstitutions to govern the country. Writtenbefore in�ation had been brought undercontrol, it is a monument to indexation. Socialsecurity bene�ts are guaranteed under the constitution �to the end that theirreal value is permanently maintained�.The OECD estimates that nearly 90% of thefederal government’s total revenue is earmarked in this way. Publicsector pensions, which account for over half of socialspending, disproportionately bene�t the(relatively) wealthy. Civil servants and politicians alike complain that this deniesthem the �exibility they need to improveservices, yet inertia consistently wins out.
Easy does itMeanwhile the government imposes hightaxes on companies and makes it hard topay them. The World Bank’s most recentsurvey on doing business ranked Brazil150th out of 183 countries on how easy it isto pay taxes. It took the bank’s hypothetical average Brazilian �rm 2,600 hours’work to pay its taxes every year. Any largecompany operating in Brazil has upwardsof 30 people struggling to comply with thetax code. And tax rates are fairly crushingtoo: the World Bank’s hypothetical company faced cumulative taxes amounting to69% of its pro�ts.
Hiring and �ring people is complicatedas well, and if a case is brought to court italmost always �nds for the employee rather than the employer. Brazil’s current labour laws were conceived in the 1940s, at atime when it seemed that in future allworkers would be employed makingthings in big factories belonging to stable
The selfharming state
Companies are squeezed between an obstructive government and blackmarket competitors
fully wasteful process because the thin soilis quickly exhausted and ranchers movefarther into the jungle, leaving a devastatedlandscape behind them. The forests of theCerrado, an area of savannah punctuatedwith trees that once covered much of central Brazil, are disappearing even faster.
As for mining, for every multinationallike Vale that collects data on injuries anddeaths in its mines there are plenty that donot seem to care much about what happens to their workers. Of the ten largest
mining companies operating in Brazil contacted by The Economist, only a couple hadnumbers on deaths and injuries in theirmines. In the informal part of the miningsector, from wildcat goldminers in themiddle of the Amazon to the guseiros whodig for pig iron in Minas Gerais state, thingsare even worse.
Where intellectuals once worried thatBrazil’s natural resources would con�ne itto a marginal place in the world economy,now they are concerned that Brazil’s com
modity wealth will condemn the country’s currency to getting ever stronger,making life impossible for manufacturerswith their sights on exports. They probablyhave a point. But it could be dealt withmuch more easily if Brazilian companiesdid not �nd themselves squeezed betweentwo walls that are constantly pushing in onthem. On one side is a public sector thattaxes too heavily and spends badly. On theother is a large black economy that they�nd it hard to compete with. 7
The Economist November 14th 2009 A special report on business and �nance in Brazil 11
2 companies that would keep them on forlife. Things have not turned out like that,but Brazil has consistently failed to updatethis legislation. Companies must pay hightaxes and compulsory contributions foreach employee on their payroll (over andabove salaries) which in the World Bank’shypothetical company added up to 47% ofpro�ts. Directors of companies in industries with high sta� turnover, such as ITservices, complain that they are held personally liable in dozens of lawsuitsbrought by former employees, and may�nd their bank accounts frozen by thecourts. This happens in the public as wellas in the private sector.
On other measures, from starting abusiness to closing one down, Brazil alsofares badly. When the World Bank releasesits annual business survey, the federal government sometimes grumbles about a foreign conspiracy. But the internationalcompetitiveness survey conducted by theFederation of São Paulo Industries (betterknown as Fiesp) tells a similar story, placing Brazil 37th out of 43 countries surveyed.
If a contract is broken or payment withheld, it is better to give up than rely on thecourts for redress. Brazil’s laws permit almost limitless appeals, so even fairly trivialcases can eventually end up in the Supreme Court. Between them, its 11 justicesreceived over 100,000 cases last year. Thebacklog is enormous, and a good lawyercan often delay a judgment inde�nitely,even in serious cases. Antonio Pimenta Neves, a journalist who was found guilty ofthe murder of his former girlfriend nineyears ago, has yet to go to jail.
The problems that ail the courts areclear from behind the large desk of judgeLuiz Zveiter, the current president of Rio’sTribunal of Justice. The courts employ20,000 people in this state alone (about 75of them just pushing trolleys of sandwiches for sale along the twoandahalfmiles of corridors in the various buildings). Some 800 cases are pending beforethe courts of second instance and 800,000before the courts of �rst instance (whichare least able to cope with the �ow ofcases). The oldest case outstanding datesfrom 1911. �The state often does not wantthese cases to end in case it has to pay up;the citizens often don’t want them to endin case they have to pay �nes. So the courtsend up paying the bill,� explains JudgeZveiter. And yet Rio’s state legal system isthe most e�cient in Brazil. By the end ofthis year it aims to have no cases outstanding from before December 2005. In thecontext that would be a triumph.
Given how di�cult life is for companies that pay taxes and comply with labour laws, it is unsurprising that Brazil hasa large informal economy (see chart 5). Itsblack economy is a place of wonderful invention. The quality of the juice bars andrestaurants in even the most miserableslums often surprises �rsttime visitors.But a large black economy is bad for acountry, and normally it fades away withrising a�uence. This has indeed been happening in Brazil: between 2003 and 2007the number of formalsector jobs grew byjust over 5% a year, a remarkable feat giventhe strength of the forces working againstit. But given Brazil’s level of development itshould be happening faster.
Living in the shadowsThus many companies in the formal economy �nd themselves squeezed between aset of rules that makes it expensive forthem to operate, and competition from informal competitors who do not abide bythose rules. This is not much of a problemin the car industry: nobody has startedmaking Volkswagens at home yet. But inother areas it can be, retailing being theworst o�ender.
A study of Brazil’s informal sector byMcKinsey suggests that informal businesses in Brazil are about half as productive astheir competitors who follow the rules.This is partly because they lack access tocapital, and partly because they �nd itcheaper to add more workers than to buymachines, so long as they pay no taxes onemploying people. Yet despite their relative ine�ciency, these businesses are typically more pro�table than rivals in the formal economy, which is another bene�t ofnot paying tax or obeying productmarket
regulations. There is little incentive forthem to grow, because bigger �rms tend toattract the attention of the taxman. Butthey are hard to compete with.
That competition makes it harder forlawabiding companies to grow. This reduces the government’s tax revenue andcreates two unequal classes of workers:one vociferously defended by unions andenjoying generous bene�ts and job protection in addition to their salaries, the otherwith nothing beyond the cash handed outto them at the end of the week.
All this helps to explain why manyparts of Brazil’s economy are so fragmented. The ethanol business is a good example. You might expect it to be dominated byperhaps ten or 20 big companies, but instead it is splintered into hundreds. Whatstops consolidation is that formal companies seldom agree with informal onesabout what their farms are worth, becausepro�ts look lower when all the costs ofobeying the law are factored in. �In sectorsthat employ threequarters of the labourforce, not counting the government, thereis everything to do,� says Bill Jones Jnr,who advises clients of McKinsey on deals.�But mostly it is tough to actually do any ofit.� This fragmentation holds back Brazil’sgrowth too.
Some companies in the black economyare �nding life less comfortable than theyused to. Informal pharmacies, for example, were hit when suppliers rather than retailers were made responsible for payingtax on their goods. São Paulo’s system ofgiving people a tax rebate when they askfor a receipt that the state government cantrace is having an e�ect on shops and restaurants. A new law introduced in July allows very small businesses with just oneemployee to be given formal status at thecost of 50 reais a month. The developmentof equity markets also encourages formalisation, since companies that want to �oatneed proper accounts. But the best way toturn informal companies and their workforces into taxpayers and citizens would beto make the rules easier to follow and thetaxes less onerous.
All serious politicians in Brazil (as wellas a few who just pay lip service) talkabout changing this. A tax reform has beennear the top of the government’s agendafor as long as anyone can remember. But itis still not happening, leaving many businesses utterly frustrated. Why, then, docompanies and economists around theworld see Brazil as such an exciting placejust now? The answer has a little to do withshopping and a lot with social climbing. 7
5About par for the course
Sources: Friedrich Schneider (2005); UNDP
Informal economy, % of GDP
0 10 20 30 40 50 60 70
Bolivia
Peru
Latin America
Brazil
Colombia
Venezuela
Argentina
India
Chile
China
GDP per person,2007, $’000
1.4
3.8
5.1
6.9
4.7
8.3
6.6
1.0
9.9
2.4
12 A special report on business and �nance in Brazil The Economist November 14th 2009
1
ON A Saturday night in Canudos, atown of 15,000 people in the interior
of Bahia state surrounded on all sides byparched, silvery forest, there is a lot of consumption going on. Everyone has a mobilephone, a few people have new cars, andearlyevening courting is fuelled by branded beers and hot dogs. This place was oncea byword for poverty, sitting as it does inthe middle of Brazil’s drylands. But thispart of the sertão at least has become morebearable over the past decade or so. Thereis a large banana plantation that providesjobs, a freshwater�shing industry andplenty of commerce.
Carlinhos Silveira has returned to Canudos after some time spent working inSão Paulo and now runs a small hotel. Fordecades internal migration in Brazilworked in the opposite direction, as people escaped the hardscrabble northeastfor menial jobs in the more prosperoussouth and southeast. Now it is possible to�nd members of Brazil’s burgeoning middle class even here.
The recent growth of this species hasexcited companies, politicians and sociologists alike, and rightly so. Using data froma giant series collected by IBGE, based onmonthly interviews with 150,000 peoplein the six main metropolitan regions, theFundação Getulio Vargas (FGV), a businessschool, calculates that the share of peoplein social class C increased from 42% of thepopulation in 2004 to 52% in 2008. Class Ccovers households with a monthly incomeranging from 1,064 to 4,591 reais (about$6032,603 at current exchange rates). InBrazil that makes them middleclass, eventhough in richer places these income levelswould not buy that description. Theymostly have jobs in the formal economy,which also brings access to credit, andprobably own a car or a motorbike. Remarkably, their numbers remained steadythrough the �nancial crisis, says MarceloNeri of FGV, as people moved down fromclass B to replace the dropouts.
Perhaps more impressively, Brazil’s recent progress seems to have been evenlyshared. The growth of the middle class,combined with a 100% increase in theminimum wage over recent years andBolsa Família, a programme of cash trans
fers to those lower down the income scalethat bene�ts some 12m families, hascaused inequality to decline. In a countryfamous for its skewed income this is a bigachievement. According to IPEA, extremepoverty halved between 2003 and 2008.Brazil’s score on the Gini coe�cient, a measure of inequality, is falling, getting closerto that of the United States (see chart 6).
The northeast of the country, whosepoverty has prompted successive governments to come up with plans for its revival,in fact grew slightly faster than the rest ofBrazil between 1994 and last year, at an average annual rate of 3.3% (compared with3.1% for the country as a whole). The mainreasons were a large expansion in publicsector employment, pensions and incomeredistribution. The drylands have alsobene�ted from an expansion of fruit andgrain farming and of light industry, saysGustavo Maia Gomes of the Federal University of Pernambuco.
Shopping down to RioBrazilians like to spend. Ti�any, a jeweller,has more stores in São Paulo than anywhere else in the world. Louis Vuitton,which makes expensive bags, until recently got its biggest pro�ts per square footfrom its São Paulo shops. But it is the scaleof the mass consumer market that is opening up�the 1m points of sale for beer, the165m mobile phones�which is raising thebiggest hopes. �If the world is looking forsavers, Brazil is not much good,� says IllanGoldfajn, chief economist of Itaú. �But if it
is looking for consumers, then we might beable to help.�
David Neeleman, who has launched anairline, Azul, to serve all these new consumers, sums up the optimism that thenew entrants to the middle class are creating. �America has an excess of everything:cars, credit,� says Mr Neeleman. �Downhere people are getting their �rst car, �rstcredit card, owning their �rst home. It feelslike the beginning of the cycle.� He is talking about people like Eduardo Lins, wholeft his eight siblings in the interior of Bahia and followed a girlfriend to Salvador,the state capital, when he was 15. Now, 20years later, Mr Lins has a new car, boughton credit, which he is paying o� by drivinga taxi, and has recently bought an apartment in the city. Life has got better.
What Brazil’s middle class wants islargely shaped by what the characters inthe ubiquitous telenovelas (TV soap operasthat reach audiences measured in tens ofmillions) are wearing, consuming anddriving. These programmes are mostlymade in Rio and tend to feature characterswho are richer and whiter than averageand �it around the place dressed in casually expensive clothes and conducting indiscreet love a�airs. They do a good job offeeding the burning desire for more anddi�erent stu� that a market economythrives on.
Luxuries are popular, even in placeswhere there is not much money around.The highest whisky consumption per person is in Recife, capital of the poor northeastern state of Pernambuco (where thedrink is often referred to as professor, a nodto Teacher’s whisky). Retailers have alsodiscovered the importance of �atteringtheir new customers. Walmart, home ofeveryday low prices, employs people at itscheckouts to pack shoppers’ groceries forthem. Casas Bahia, a chain of shops sellingwhite goods and furniture on credit, sitscustomers down and serves them co�eewhile they discuss how they will pay fortheir new television.
Consumer credit has grown by 28% ayear in nominal terms over the past threeyears. The middle class also needs apartments and houses to put its new purchasesin. At the moment mortgage �nance ac
A better today
Brazil’s growing middle class wants the good life, right now
6Unequal contest
Source: USCensus Bureau
*0 indicates perfect equality (everyonereceives an equal income); 1 indicates
perfect inequality (all income isreceived by only one person)
Gini index of income inequality*
0.40
0.45
0.50
0.55
0.60
1992 94 96 98 02 04 062000 08
Brazil
United States
The Economist November 14th 2009 A special report on business and �nance in Brazil 13
2
1
LIVING in Brazil, it is easy to imagine thatyou have been transported into one of
those novels with alternative endings�inthis instance, about how the United Statesmight have developed if a few things hadturned out di�erently. Both are continentsized countries in the western hemispherewith federal democracies in which stategovernments have considerable power.Both were colonised by small Europeanseafaring nations before gaining independence within 50 years of each other. Theirpopulations are made up of the descendants of their original inhabitants, earlycolonists and African slaves, topped up later by European and then Asian migrants. Arecent in�ux from neighbouring countriescompletes the mix. Brazil’s melting pot is, ifanything, even more successful thanAmerica’s. There is no such thing as a hyphenated Brazilian.
Both countries seem surprisingly religious to European eyes, with di�erent
Christian sects competing vigorously forbelievers. The most successful Brazilianmultinational of all may be the UniversalChurch of the Kingdom of God, a Pentecostal out�t that keeps being investigatedfor overenthusiastic marketing andopaque bookkeeping. Both places show astrong preference for consumption oversaving when times are good. Brazil has aculture all of its own, but it looks for inspiration to America more than it does to itsSpanishspeaking neighbours.
A place of paradoxesAnd yet the di�erences are stark. Americais rich, Brazil poor. Brazil is more leftwing.America �ghts wars, Brazil does not. America likes its capitalism as unbridled as possible, Brazil prefers its markets with astrong government presence.
Look more closely, though, and some ofthese distinctions become blurred. Brazil ismore leftwing in theory than in practice.
Next year’s presidential election is likely tocome down to a choice between a candidate from the leftwing Workers’ Party andthe centreleft Party of Brazilian Social Democracy. Even so, most of the money thegovernment spends goes to people whoare comparatively wealthy. The biggest single reason for the di�erence in income distribution between Brazil and America ismore regressive public spending in Brazil.�We live in a paradoxical situation of agovernment that spends a lot and bene�tsa few,� said Antonio Palocci on becoming�nance minister in 2003.
Since then some more public moneyhas found its way to Brazil’s poorest, butproportionately the amounts remainsmall. In fact, Brazil has rather a lot of public policies that would be considered unfair and regressive in America. Childrenwhose parents can a�ord to send them togood private schools tend to get the pick ofplaces at good publicly funded universi
Two Americas
Brazil and the United States have more in common than they seem to
counts for only 2% of GDP, a tiny sum evencompared with, say, Mexico (9%), let aloneAmerica (85%). Brazilian housebuilders believe that as mortgages develop, the housing market will be a pro�table place to be.They seem to have convinced foreign investors, who have provided most of thecapital for Brazil’s listed housebuilders.The government reckons the countryneeds 8m more houses, half to allow families to move out of shared living quartersand half to replace squalid homes. Butmost builders are even keener to provideapartments for Brazilians who are somewhat better o�.
Interest rates will have to come down alot further before the mortgage marketreally takes o�, but already some companies are securitising mortgages with maturities of three or four years and sellingthem to investors. In addition to the needto house Brazil’s existing middle class, saysWilson Amaral of Ga�sa, a large listedhousebuilder, Brazil needs to look to the future: it will have 35m new families by 2030,all of whom will need somewhere to live.Brazil’s population is comparatively youngand still growing, mainly through naturalincrease rather than immigration.
If the next ten years see as much social
and economic progress as the past ten, Brazil will become a very di�erent place. Agood place to see how this might work isDiadema, a formerly rough neighbourhood of São Paulo. In 1999 the murder ratethere reached 141per 100,000 people (compared with 37 per 100,000 in Baltimore,one of America’s more violent cities, lastyear). Diadema became so notorious thatpeople who lived there felt they had to lieabout their address in job interviews.
But since then the murder rate hasdropped steeply. Earlier this year, on a plotof land that was once a cemetery, a sixsto
rey shopping mall opened in Diadema,complete with neoclassical �ourishes andthe odd piece of what looks like marble, asecular monument to less violent times.The mall is still fairly empty, perhaps because it was built so quickly that potentialshoppers are scared to go in case the rooffalls in. But many of the elements of thelowermiddleclass Brazilian dream arehere: the jewellery on credit, the multiscreen cinema due to open soon, the airconditioned atrium. It is a �ne place to eat apão de queijo and re�ect on what this spotwas like only a short decade ago. 7
Going for a bit of froth
14 A special report on business and �nance in Brazil The Economist November 14th 2009
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ties, whereas children from poorer familiesoften have to pay to go to less good places.The BNDES transfers money from lowpaid workers to the balancesheets of Brazil’s large companies. It has supported JBSFriboi’s transformation into the world’slargest producer of protein, which thecompany has accomplished through acquisitions in America. Yet the group remains privately owned: a bizarre appropriation of public resources that would causean outcry in other countries.
Brazilians also have a more Americanapproach to capitalism and free marketsthan they might appear to at �rst sight.Many of their country’s success stories ofthe past 15 years, from the free�oating realand the autonomous central bank to theprivatisation of statecontrolled �rms thathave since �ourished, are products of asimilar way of thinking about what economic arrangements work best. To hiscredit, President Lula has not reversedthese changes, as many feared he might.
The clash between a growing middleclass and a government that often seems tobe blocking its aspirations is creating arather American story about the determined little guy being constantly pulledback by the dead hand of bureaucracy.Many of the younger businessmen andbankers in Brazil have postgraduate quali�cations from American business schools.Quite a few hold views that would not beout of place at the American Enterprise Institute or other freemarket thinktanks.
If America’s doubts about free marketsand Brazil’s con�dence in them both continue to grow, the two may shortly meet(see chart 7). Even President Lula now denounces protectionism, though many foreign governments, noting Brazil’s still fairlyhigh import taxes, are unconvinced. Brazil’s imports and exports taken togetherwere equivalent to 22% of its GDP in 2007,compared with 23% for America. Aboveall, Brazil now seems con�dent that a moreopen economy will not condemn it to arole as co�eemaker to richer countries.
The future of the country of the futureYet if Brazil has at last discovered a formulafor releasing its wealth, it is also true thatmost of the country’s economic successesare clustered around the commodity sector. Brazil has created no car or computercompanies with big sales abroad. Embraeris an isolated example of a big hightechexporter. The same can be said of the services sector. That is a pity for a country vibrant with creativity and invention.
Pockets of the commodity sector, such
as Petrobras’s deepwater drilling, do require high levels of technical expertise. ButBrazil’s obstructive government seems tocon�ne its businesses to competing internationally only in sectors where naturaladvantages make them close to unbeatable. Judged against its own past, Brazil isdoing astonishingly well. Judged againstits potential, it still fares poorly.
Allowing for its size, Brazil spendsmuch less than the OECD average on research and development, and most of thatspending comes from the government: thepublic sector accounts for some 55% of investment in technological innovation.South Korea, with a population a quarterthe size of Brazil’s, registers about 30 timesas many patents. Brazil needs to do some
thing about this: in order to live with thestrong currency that comes with successunder a free�oating exchange rate, it mustraise productivity.
Like America, Brazil is so big and variedthat it often seems to contain at least twoseparate countries. One of these is a placewith ten land borders and no wars wherepeople speak a single language in compressed time zones; where there is no religious con�ict; and where threequarters ofthe population turns out to vote, with election results announced the following day.This country has sophisticated economicpolicymaking and �nancial markets, aswell as a growing collection of worldbeating companies. It runs on sushi and is usually suntanned.
The other Brazil has a stubbornly highmurder rate and a violent police force.Many of its politicians see nothing wrongwith stealing public money or appointingrelatives to jobs within their private kingdoms, and refuse to resign when foundout. It is a place of misery where 17% ofhomes do not have running water and toomany families live in homemade shacksby motorway bridges. A place wheremany people convicted of serious crimesgo unpunished, and those in prison liveout a brutalised existence. And a place ofenvironmental devastation that government is powerless to stop.
Because this special report deals withbusiness and �nance, it has concentratedon the �rst place, but both Brazils are partof the great green elbow that sticks out intothe Atlantic. What makes the country soexciting at the moment is that, thanks to itsnewfound stability, Brazil’s better self nowhas a much greater chance of prevailing. 7
7The system of choice
Source: Pew Research Centre
Are people better off under free markets?% replying ‘Yes’
0 25 50 75
India
China
Britain
USA
Brazil
Germany
Japan
Russia
2002 2007