Encouraging Investors

In August 2011 the Brazilian Central Bank’s monetary policy committee opted to lower the interest rate from 12.5 to 12% — a surprising about-face given its decision to raise the rate in its previous meeting. The committee maintained a downward course from there, dropping it to 7.25% by October 2012, where it stayed until the following April.

At the same time interest rates were falling, the government also began devaluing the country’s exchange rate. Beginning in 2011, the government changed foreign-exchange regulations, imposed new reserve requirements, and raised the tax rates on some financial transactions.

Coupled with the falling interest rate differential and a reduction of international liquidity following the aggravation of the financial crisis in Europe, these measures pushed up the Brazil’s currency, the real.

After reaching the lowest monthly average (1.56 reais per dollar) since the fixed exchange-rate regime was abandoned twelve years ago, in July 2011 the real started to plunge against the dollar, and between May 2012 and May 2013, Brazil’s exchange rate fluctuated around 2 reais per dollar.

These simultaneous moves by the Brazilian state were intended to stimulate investment by undoing two longstanding aspects of orthodox economic policy in the country: extraordinarily high interest rates and an overvalued exchange rate.

For policymakers, the logic was simple — by reducing the cost of capital and by extension the return on financial investments (by lowering interest rates), and improving the competitiveness of national production in foreign markets (by devaluing the real), they could encourage investors to transfer capital to productive activities and thus spur growth.

Economic policy shifts were not restricted to macroeconomic policy. The Brazilian government also attempted to improve the competitiveness of the economy by making it cheaper for firms to operate within the country.

To this end policymakers pushed through a number of changes, including renegotiating the rate of return on public infrastructure contracts, reducing the cost of energy, cutting payroll taxes, and trimming the interest rates charged by public banks in order to impose competitive pressure on private financial institutions. These policies — in combination with the macroeconomic policies — were in part designed to allow for more equitable growth, limiting the profits appropriated by big, concentrated industries.

But these efforts did not bear the expected fruits — output growth and investment remained stagnant. Recent revisions to the national accounts data show that the investment rate, after increasing from 17.3 to 20.6% of GDP between 2006 and 2010, stagnated in the three following years and then fell almost one percentage point last year (see graph below).

Sluggish investment brings down economic growth: the average GDP growth rate almost halved — from 4.05 to 2.14% — between the first two PT governments (2003–2010) and Rousseff’s first term.

Part of the failure stems from declining demand for Brazilian exports, which is most easily demonstrated by looking at the trajectory of the Brazilian economy’s terms of trade (the ratio of export prices to import prices). Between 2004 and 2011, this ratio grew more than 4% annually, on average, demonstrating increased global demand for Brazilian goods and explaining, in part, the output growth acceleration observed in that period.

However, the terms of trade peaked in September 2011 and in the subsequent three years fell at an average annual rate of nearly 4%. This price inversion was caused by a drop in the international prices of several primary products exported by Brazil (a consequence of the Chinese economy’s deceleration).

Brazil’s worsening terms of trade, and the reduction of aggregate demand it indicated, were bad news for the government’s developmentalist policies. Firms that, on the one hand, saw their costs being reduced, watched, on the other, as their stocks piled up. Lacking expectations that demand would recover, Brazilian firms had little incentive to increase productive investment.

Insufficient demand was not exclusively the result of international factors however. Other changes in government policy also played a role, creating obstacles for the developmentalist turn. For example, policies designed to reduce systemic risk adopted from late 2010 on led to a contraction in consumer credit.

There was also a shift in fiscal policy: the government promoted a substantial fiscal contraction in 2011 and when it moved back to fiscal expansion, in 2012, it prioritized tax reduction instead of public investment. These changes reinforced the downward pressure on aggregate demand caused by the falling terms of trade.

Yet, while short-term lack of demand (both global and domestic) is clearly important, it only explains part of the declining investment story. To understand Brazil’s sharp turn toward austerity it is also necessary to consider the political roots of this economic volte-face.

Capitalist Leverage

In his famous 1943 article “The Political Aspects of Full Employment,” Polish economist Michal Kalecki explained why capitalists oppose full employment. Kalecki argued that, even though government policies that boost employment can benefit capital in the short term by guaranteeing demand for their products, in the long term these policies face resistance from capital because they remove a powerful means of shaping government policy — the ability not to invest and create jobs. In the absence of policies to stimulate demand, employment and economic growth depend almost entirely on capitalists’ decision to invest.

In order to avoid the heightened unemployment and economic downturns that could jeopardize their political support, governments develop their policies with the interests of capital in mind. Constant mention of “business confidence” is a manifestation of this blackmail — capitalists can threaten an “investment strike” (to borrow Wolfgang Streeck’s phrase) if governments implement policies that displease them.

There are, of course, limits to this dynamic. Owners continually appropriate the surplus produced by workers in order to reproduce themselves as owners, but if their investment strike goes on for too long their capacity to do so can be dangerously reduced.

Capital almost never bumps up against this limit, however, leaving corporations wide latitude to shape the basic contours of government policy. The stagnation of investment that occurred in Brazil from 2011 onward demonstrates this political dynamic of accumulation.

By changing the interest rate policy, imposing competitive pressure on private banks, and disputing the rate of return on public contracts and in the energy industry, the government antagonized powerful interests. Despite clear incentives to increase investment, business refused to do so.

Investment decisions are not atomized — firms talk to each other and often coordinate their actions. The economic and the political are two sides of the same social reality, and as such, investments are subject to bargaining and negotiation.

Even in a large economy like Brazil’s, it is well known that big corporate groups control a significant share of total investment, and that these groups’ decisions, through their effects on customers and suppliers, have a significant aggregate impact on the economy. Brazil’s corporate titans aren’t shy about publicly using their veto power: a leading representative of São Paulo’s manufacturing industry recently threatened to “shut down the machines” if the government raised taxes on business. In his words, “those who know how to turn on the machines, also know how to shut them down.”

The capacity of capitalists to resist unwanted government policies depends on numerous factors, including their own fragmentation and the degree of social mobilization. The success of the developmentalist strategy was predicated on a split between industrial and financial interests.

In hindsight, it is clear that such a schism was overestimated and that the Brazilian economy is marked by a large interpenetration between industrial and financial capital. There is increasing evidence that a growing share of the industrial firms’ revenues comes from financial transactions.

In the wake of the global financial meltdown, one of the main meat-processing companies in Brazil went down because of its speculative operations in the foreign-exchange market. And big Brazilian banks and pension funds own substantial shares of several nonfinancial corporations.

Moreover, the developmentalist policies were not accompanied by social mobilization from below — they consisted of a set of decisions taken without broad public debate from within a political system that works to impose moderation.

In this context, Brazilian capitalists could trust that the pressure of an investment strike would effectively undermine and reverse the measures in question, and that sooner or later, conventional economic policies would be readopted.

As André Singer has pointed out, a tenuous alliance between trade unions and industrial capital, forged in early 2011, was dropped in favor of a reunification of industrial and financial capital against workers and government policy in late 2012. The Rousseff government’s divide-and-pressure strategy had failed.

With investment flatlining, austerity was soon back on the agenda. By reducing the growth of economic activity, low investment decelerated tax collection, putting pressure on the fiscal policy. At the same time, the exchange-rate devaluation increased inflation and forced the government to retreat from a looser monetary policy.

In April 2013, the central bank’s monetary policy committee kicked off a series of interest rate increases that made servicing public debt more costly. As a consequence, the government faced the dilemma of either increasing its fiscal surplus to compensate for the growing financial obligations or seeing the public debt increase.

Despite their moderate impact, the anti-inequality policies that have been in place for the past decade claim a growing share of the government budget. Until 2010, the fiscal pressure of this redistributive effort was muted by rapid economic growth. But by slowing down economic activity, the investment strike brought the distributive conflict to the surface.

Forced to choose, elites began arguing that the redistributive policies were unsustainable and proposed cuts to social programs and public services. The worldwide trend towards austerity had reached Brazil.

Austerity Going Forward

But who profits from austerity? Or, put differently, why did the critique of the developmentalist policies take the form of a defense of austerity when no balanced analysis of the trajectory of the public debt pointed toward the problematic scenario suggested by the conservatives, according to whom the government indebtedness is on an unsustainable path?

Furthermore, from the state’s point of view, even if a shift in economic policy toward austerity convinces capitalists that they have recovered control over the government, nothing guarantees that, in a scenario of falling demand and piling up stocks, firms will increase investment.

Indeed, the substantial fiscal contraction already announced and partly executed has led to a deteriorated economic situation in Brazil. GDP is expected to fall by more than 2% this year, and a further fall next year is quite likely. Firms’ capacity utilization is very low while stocks keep increasing, unambiguously reducing profitability.

But it would be naïve to think that the proponents of austerity simply ignore, or are unaware of, its effects. As Kalecki himself noted, “obstinate ignorance is usually a manifestation of underlying political motives.”

Two kinds of motivations are possible. The first, more obvious one is to put the brakes on rising wages — and restore firms’ profit margins — by increasing unemployment. Before the turn to austerity, some economists had already proposed this route under the pretext of reducing inflation.

Ilan Goldfajn, for instance, argued in 2013 that it would not be possible to bring down inflation without “temporarily cooling down . . . the labor market.” Armínio Fraga’s  declaration during last year’s electoral campaign that wages in Brazil have increased a lot points in the same direction. The abrupt deterioration of the labor market in recent months, seen in rising unemployment and falling wages, has been astounding and puts the moderate reduction of inequality achieved in the last decade seriously at risk.

The second possible political motive is related to the trajectory of public expenditures. As Samuel Pessôa has suggested, since 1999 public spending has increased faster than GDP, mainly due to redistributive pressures. Almost half of the uptick is due to growing social programs and the financing of public health and education.

In the absence of a fiscal crisis, real or imaginary, which forces a change in the rules of access to social benefits and which contains the expansion of public services provision, the tendency is an increasing tax rate and continuous pressure for the tax burden to be borne by the richest fractions of the population, given the very high level of inequality of income and wealth in Brazil.

Austerity, then, serves to block demands to curb inequality. At the same time, it reestablishes capitalists’ mechanism of control over the government, by curtailing policies to stimulate demand and strengthening the connection between capitalists’ investment decisions and economic growth and employment. As Kalecki said, “the social function of the doctrine of ‘sound finance’ is to make the level of employment dependent on the ‘state of confidence.’”

But the shift towards austerity will not be consolidated without conflict. Rousseff’s about-face drastically reduced her support among traditional left-wing social movements and trade unions. The right-wing opposition opportunistically used this plunging popularity to create a political crisis and call for her ousting.

Also in the mix is a major political scandal, involving a significant fraction of the political parties, the main corporations of the construction industry (among the most powerful business groups in Brazil), and the state-owned oil company, Petrobras.

The seriousness of the political crisis, combined with the economic crisis produced by austerity, guarantees that Brazil will not get out of this turmoil by backstage deals made within the political system.

For the Left, the lesson of Rousseff’s first term should be clear: a progressive government cannot carry out policies against the interests of capital without challenging the social basis of its domination.

The implementation of a program that can actually transform Brazilian society presupposes the opening up of the Brazilian state, so that popular mobilization can have leverage against the pressures of the ruling interests. A technocratic left that disregards the centrality of social struggles beyond the bureaucratic disputes within the finance ministry will not go far.

The impetus to reverse the turn to austerity can only come from the streets. One can only hope that, after a decade of demobilization, the Left can rise to the occasion.