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Braudel
Papers - Nº 16, 1997
The
world economy has been growing into a wider web for centuries. But never before has globalization impacted
local economies so fast and on so large a scale and never
before has it bred such controversy.
While there have been many precursors and beginnings,
the globalization process burst clearly into history in
the 15th and 16th Centuries with the expansion of
European mercantilist capitalism after the great voyages
of discovery.
Globalization is the economic process of tying together
our lives. At the core of the debate over globalization
is the threat of competition, which often evokes
unpleasant feelings.
Competition may be the most disturbing force in
globalization and the source of anxiety about the future
that spreads among many countries. The root of the Greek
word “agony” describes both the phase preceding
death as well as stadium sports; agonistes in Greek means
a contestant. In economics as in stadium sports,
competition yields winners and losers. Why does
competition bear social value? Through anguish and
pressure, competition forces men to do their best and
leads to innovation, invention and reduction of costs.
Competition intensifies in a globalized world in which
national markets tend, at least in theory, to form a
single market. In its most efficient form, competition is
not for all markets, only for free markets.
Is globalization creating more or less wealth and
welfare, and for whom? Are sidelined countries condemned
to the Outer Darkness of autarchic and retrograde
stagnation? Will globalism and localism clash at the
edges of the emerging world system? Or is globalization
threatened more by tensions among the richer core
countries, as happened before the First World War?
Barring such a conflagration, the answers to these
questions ultimately will be decided by the locals. The
conflict between globalism and localism is defined anew
on each territory, usually opposing global strategies of
efficiency with local ideas of security. There are limits
to both security and competition. Both embody legitimate
interests. The important thing is to have the courage and
self-confidence to decide a course of action, to avoid
lingering ambivalence that leads nowhere.
Fernand Braudel called the long-term globalization
process “the highest plane of the economy”
that, in the 16th Century, “bestrode the political
and cultural frontiers which each in its own way
quartered and differentiated the Mediterranean
world.” In those times globalization mainly meant
long-distance trade, slow-moving by today’s
standards, in precious metals, grain and high-priced
consumer goods, as well as an evolving international
payments system based on bills of exchange between
bankers and merchants at distant points of the system.
Braudel defined a world economy as “a sum of
individualized areas, economic and non-economic,
[extending] beyond the boundaries of other great
historical divisions ....The world economy is the
greatest possible vibrating surface, one which not only
accepts the conjuncture but, at a certain depth or level,
manufactures it. It is the world economy at all events
which creates the uniformity of prices over a huge area,
as an arterial system distributes blood throughout a
living organism. It is a structure in itself.”
Angus Maddison, a leading analyst of world economic
growth and a member of our Institute, observes that
“integration of different parts of the world has
grown dramatically since 1820 and the increased openness
has had an important impact on growth potential,”
with exports as a share of world output growing from 1%
in 1820 to 17% in 1995. Despite distortions and
injustices, institutionalized in decades of chronic
inflation, Brazil benefited from this integration,
leading all major economies in growth since 1870,
multiplying its output 108 times. In the now-distant
years of the “miracle” (1968-74), when their
economy grew by 10% yearly, many Brazilians came to feel
that fast economic growth was as naturally part of their
culture as football, samba and the beach. However, times
are different now and the tests are harder, because they
test the quality of human institutions.
From a strictly economic point of view, globalization is
the product of three great movements. The first is the
growth of world trade over the past three decades at
rates faster than the growth of production, indicating
more interdependence. The share of foreign trade in the
U.S. economy rose from 4.7% of gross domestic product (GDP) in 1960 to 11.4% in 1994. China’s trade grew
from negligible amounts in 1978 to 25% of GDP in 1994.
While Brazil’s share of world exports was declining,
shipments from other newly industrializing countries grew
fast, from 0.2% of advanced economies’ GDP in 1970
to 1.6% in 1990, a small share of the importers’
total output that has bred intense political controversy.
According to Paul Krugman of Stanford University, the
reasons for this export growth “are deep and deeply
disputed questions.” A new phenomenon, he explains,
is slicing up the value chain, dividing manufacturing
into geographically separate steps, joined thanks to
technological leaps in transport and communications, with
unfinished goods often exported for final assembly in intra-company trade.
While freer trade is a vital sign of globalization, it is
not synonymous with the broader long-term process. Growth
of trade accelerated after the conclusion in 1993 of the
Uruguay Round of negotiations with a general lowering of
barriers, tending to create a single market the size of
our planet. Tariffs on industrial goods imported by the
rich countries are now less than 10% of those in 1947,
before the first of the eight GATT rounds of multilateral
negotiations took place. Old quantitative restrictions
are disappearing faster than new ones are invented as
sanitary, technical and labor criteria blocking imports.
Celso Lafer, former Brazilian Foreign Minister and now
Ambassador to the World Trade Organization (WTO),
observes that the trade opening “created new freedom
for the government in fighting inflation and promoting
economic modernization, but Brazil’s commitments
within the WTO reduced its use of mechanisms of
commercial defense and practically banned the instruments
of trade and industrial policy that formed the core of
the import-substitution model to which we were
accustomed: quota restrictions, import licences,
administrative measures invoking balance of payments
problems, national content regulations and sectoral
subsidies to stimulate exports.” These practical
issues still must be tested in many countries by politics
and markets. Extreme advocacy of globalization and free
trade breed Utopian ideas that create confusion. Charles
R. Carlisle, former Deputy Director General of GATT
(General Agreement on Tariffs and Trade), warns against
excessive optimism:
The Uruguay Round was not about free trade, but freer
trade, yet it almost failed....Although there has been a
major movement around the world in the last decade toward
freer markets and less regulation of economic activity,
the developing nations, grappling with social and
economic problems that dwarf those in the West, are not
about to accept completely free trade. No country in the
world embraces the belief in free markets and free trade
to the degree that the United States, Britain and the
other English-speaking democracies do. Many would see
global free trade as contrary to their traditions,
doctrines and interests.
The second element of globalization is the enormous
growth of investments, much faster than trade, especially
over the past decade, mainly by transnational companies,
becoming active in very diverse settings, thanks to
improvements in transportation and communications, making
notions of purely national production systems obsolete.
Since the mid-1980s, annual flows of foreign direct
investment (FDI) multiplied four-fold, from $77 billion
to $318 billion in 1995. Geographic location of
production is ruled now by the logic of cost, the
decisive factor of globalization. Today a simple golf
club is made of four parts produced in four different
countries. We only can imagine the national origins of
parts for a car or a computer. This is a new idea that
abandons the fetishes of national content quotas for
manufactured products, embraced so fervently in
Brazil’s recent past.
The third element of globalization, growing much faster
than investment and trade, is the surge of international
financial transactions, which in 1992 dwarfed daily
economic activity that averaged $62 billion in production
and $10 billion in exports. According to the Bank for
International Settlements, turnover in financial
derivatives alone tripled from $123 trillion in 1990 to
$328 trillion in 1995. The New York Clearing House’s
CHIPS electronic payments system,owned by 10 private
banks, handled $1.3 trillion daily in international
transactions among banks in 1996, against only $300
million daily in 1977 and $1.6 billion in 1983. The Bank
of England’s CHAPS system cleared another $400
billion daily and another $500 billion was settled
independently between individual banks. In 1994 the
global market for investment-grade bonds was $14
trillion, or nearly half of world GDP. Since the 1991-92
recession, net international financing has tripled, as
have capital flows to Brazil.
While these statistics may impress
us, we should not
lose our historical perspective. What is happening today
is not without precedent, nor does globalization extend
to all factors of production. Between 1870 and 1914,
there may have been broader globalization in the creation
of what we see today as the modern world economy. Nevertheless, there were important
exceptions. The two
rising industrial powers of those decades, the United
States and Germany, were protected by high tariffs while
playing key roles in the globalization process.
Today’s globalization is a resumption of the
integrating trend interrupted by the three decades
(1914-45) embracing the two World Wars and the Great Depression, when protectionism and autarchy spread among
rich and poor economies alike.
Globalization forms a dynamic
hierarchy of unequal access and exchange
among factors of production. Crowning
this hierarchy are advances in
communication —symbolized by
personal computers, modems, CNN and the
Internet— spreading powerful flows
of information that even the most averse
autarchies find hard to control. Instant
information exchanges tie together world
financial markets as never before,
internationalizing flows of savings that
ease fiscal pressures but make it harder
for governments to conduct independent
monetary policies. Growth of air transport, especially since wide-body
jets started flying in 1967, favors trade
in perishable cargoes such as cut flowers
and fresh fruits as well as fast and
far-reaching travel by salesmen and academics, and by Presidents and Popes,
who now can visit several countries on
different continents in the same week.
Over 40% of U.S. overseas exports and 30%
of imports now go by air. Cargo ships in
1950 were between 5,000 and 10,000 tons,
compared with today’s specialized
ships of 150,000 tons and more, like supertankers, container ships and bulk
carriers and roll-on-roll-off vessels,
greatly reducing costs of shipping and port-handling, especially for low-value
loads. Better communications and travel capacity, along with mobility of capital,
eases international coordination of
production and marketing. Cheap overseas
telephone calls, fax machines and
electronic mail facilitate close
supervision of far-flung production sites
and quick response to changes in design
and demand. Thus the surge in direct
investment in the 1990s. Total FDI
inflows have doubled worldwide since
1991-92. It is striking that, while trade
in services is more restricted than trade
in goods, the fact that services is the
largest sector of the world economy has
enabled it to generate half of all FDI
stock and nearly two-thirds of FDI flows.
Globalization is not a grand design. It
has spread over the past generation,
without much planning or foresight,
thanks to spontaneous demonstrations of
the vitality of capitalism and democracy
while statist systems relapsed into
disorganization and poverty. It has shown, again and
again, a correlation
between increases in trade and foreign
investment and economic growth. The past
two decades proved once more the
stability of the peacetime world economy
with its return to long-term growth trends. Looking backward over the past
135 years, the only big output losses for
the world economy came from war. The
Great Depression was provoked by the
artificial asset inflation and financial
imbalances bred by World War I. “The
aggregate stability in the collective
output in peacetime has been quite impressive,” observed
Maddison. In
the 43 years from 1870 to 1913, there
were only two years [1893 & 1908] of
output loss for the world economy as a whole, and since 1947 only two more years
[1975 & 1982]. Many economists
complain that real world output in the
1980s and 1990s has been growing by
“only” 3% yearly, far slower
than the 4.9% growth in the postwar
“Golden Age” of expansion
(1950-73). These critics fail to consider
that this “Golden Age” was an
exceptional period in economic history.
Growth was driven by rebuilding wartime damage, meeting a backlog of consumer
demand, rapid urbanization and suburbanization, big increases in
government spending, the prolific spread
of new inventions and the expansion of
international business. By now war damage
has been repaired and new infrastructure built. Pent-up demand for consumer
durables for the middle classes has been
met while urbanization reached saturation
levels in many rich and poor countries
and public spending grows more slowly.
Globalization
Is Not Global
Despite the slowdown, inventions continue
to spread and international business
continues to expand, tying together the
world economy as never before. Though
growth of world GDP has fallen below the
spectacular pace of the “Golden
Age,” present rates still are above
long-term trends for both rich countries
and the world economy as a whole.
Expansion of world trade volumes and of
developing economies in the 1990s is
approaching the tempo of the 1960s. For
the first time, developing countries are
generating one-fourth of world trade.
Their trade is growing 3-4% faster than
the world average and increasingly is
among themselves, with the regional trade
among the 10 biggest Asian economies now
approaching the sum of their exchanges
with Europe and the United States.
Slowing of population increase in most of
the world means that, except in Africa
and Eastern Europe, per capita output
continues to rise vigorously, even at
lower rates of overall economic growth
than in the first postwar decades. Per
capita incomes keep growing in Western
Europe (at 1.8% yearly in 1973-92)
despite the cost burdens imposed by the
Welfare State, enlarging public debt and
diverting savings from investment into consumption. Nobody knows how long these
burdens can be sustained. They are
emerging as a focus of conflict between
globalism and localism in both rich and
poor countries.
In
addressing these uncertainties, we must
remember that globalization is far from
global. The bulk of trade and foreign
investment are concentrated in a few countries. UNCTAD’s World Investment
Report 1996 shows that the 11 biggest
host countries (10 OECD members plus
China) received two-thirds of all FDI
inflows and generated 78% of all outflows
in 1995, while the 100 least-favored
countries received less than 1%. The
trend is toward more concentration.
Nearly 90% of the increase in FDI inflows
in 1995 went to developed countries, with
their share rising from 59% in 1994 to
65% in 1995, far exceeding their portion
of world output.
“What is new is the more complex
form that efficiency-oriented strategies
are taking, the extent to which
value-added activities are fragmented and
dispersed and the growing scale on which
this is happening,” UNCTAD observes.
“In complex integration strategies,
any value-added activity can be located,
at least in principle, in any part of a
TNC system, and integrated with other
activities performed elsewhere to produce
goods for national, regional or global markets.” There is a real risk that
countries failing to enter this network
will be sidelined from the growth process, since two-thirds of world trade
is run by TNCs.
The distribution of growth in direct
investments in less-developed countries
tends to follow the slicing of value added, showing that globalization is an
expanding but skewed and selective process. Africa and Central and Eastern
Europe each absorbed only 0.2% of
Japan’s fast-growing FDI stock by
early 1996. In 1995 poorer countries
received $100 billion in FDI, a doubling
in only three years. Of this record
total, $36 billion went to China and
two-thirds to all of Asia. Investment
fever in favored countries like Mexico
and China shows how unstable these flows
can be. FDI flows to Mexico nearly
doubled in 1990-91, only to fall slightly
over the next two years before nearly
doubling again in 1994 after passage of
the North American Free Trade Agreement (NAFTA. They shrank once more during
Mexico’s currency-debt trouble of
1994-95, but have revived again. Latin
America partook weakly of these enlarged flows, its share of developing
countries’ FDI falling from 35% in
1992 to 27% in 1995. All of Africa
received only $4.7 billion in 1995, its
share falling by one fifth, about the
same as Brazil’s alone.
Brazil’s FDI inflows doubled in 1996
to $10.5 billion, triple its share of
poorer countries’ exports. Similarly, Latin America received 8% of
global FDI in 1995, more than twice its
falling share of world exports. These
trade and investment patterns show that
the outside world views Latin
America’s potential more as a market
than as a source of goods and services
for other regions. If they fail to
strengthen their export capacity, Brazil
and the rest of Latin America are headed
for chronic balance of payments troubles
for the foreseeable future. According to
JP Morgan, FDI “in [Brazil’s]
domestically-oriented sectors can
actually hurt the financing picture over
the medium term, in the event that it
promotes dividend withdrawals without
generating exports” to pay for them.
The bulk of FDI growth among developed
countries is in mergers and acquisitions
(M&As) and not in creation of new
production capacity. In 1995, U.S.
companies spent $38 billion to buy
majority stock in cross-border M&As,
or 90% of the equity in FDI outflows from
the United States, a spillover from the
domestic merger fever of the 1980s, when
$2 trillion was spent to buy 55,000 U.S. companies. Small and medium-sized firms
play an increasing role in M&As. However, only 6% of cross-border M&As
involving purchase of majority ownership
took place in the poorer countries. These
flows tend to fluctuate wildly, depending
recently on political decisions on
privatization of state enterprises. Since
1988, three-fifths of the value of
M&As in Brazil and Mexico came from
purely domestic takeovers. In Brazil, however, foreign participation doubled in
each of the past three years as
privatization gained momentum. In 1994,
before Mexico’s currency crisis,
Brazil and Mexico jointly absorbed 88% of
the value of cross-border M&As in
Latin America. Brazil is host to 10,000
affiliates of foreign companies while 800
of its own companies invest abroad.
Investment decisions, especially in
developed countries, are leading to
tighter integration and consolidation of
the world’s industrial structure.
According to UNCTAD’s estimates,
one-third of world trade is now intra-firm sales of
trans-national
companies (TNCs) and another third is
trade between different TNCs. Only the
remaining third is between strictly
national firms, whose room for action is
increasingly restricted. Generating 21%
of world output and 13% of all exports,
the United States is both the biggest
national market and the hub of the
globalization process, absorbing 19% of
all FDI inflows and investing 30% of all outflows. By 1993,
intra-company trade
generated nearly half the imports of U.S.
parent firms and 85% of imports by their
foreign affiliates. Foreign and domestic
sales of affiliates of TNCs equaled 6% of
the world product in 1991 and 128% of exports. Like Coca-Cola in the first
post-war generation, McDonald’s is
now a symbol and caricature of the
globalization process, in 1995 making 47%
of its sales and 54% of its profits from
foreign outlets. Thomas L. Friedman of
The New York Times described how
McDonald’s adapts to new markets:
The way McDonald’s has packaged
itself is to be a “multi-local” company. That is, by insisting on a high
degree of local ownership, and by
tailoring its products just enough for
local cultures, McDonald’s has
avoided the worst cultural backlash that
some other U.S. companies have encountered. Not only do localities now
feel a stake in McDonald’s success,
but more important, countries do. Poland
for instance has emerged as one of the
largest regional suppliers of meat,
potatoes and bread for McDonald’s in
Central Europe. That is real power.
Because McDonald’s is gradually
moving from local sourcing of its raw
materials to regional sourcing to global sourcing. One day
soon, all
McDonald’s meat in Asia might come
from Australia, all of its potatoes from
China. Already, every sesame seed on
every McDonald’s bun in the world
comes from Mexico. That’s as good as
a country discovering oil. This balance
between local and global that
McDonald’s has found is worth
reflecting upon. Because this phenomenon
we call “globalization”
—integration of markets, trade, finance, information and corporate
ownership around the globe— is
actually a very American phenomenon: it
wears Mickey Mouse ears, eats Big Macs,
drinks Coke, speaks on a Motorola phone
and tracks its investments with Merrill
Lynch using Windows 95. In other words,
countries that plug into globalization
are really plugging into a high degree of
Americanization. People will only take so
much of that. Therefore, to the extent
that U.S.-origin companies are able to
become multi-local, able to integrate
around the globe economically without
people feeling that they are being
culturally assaulted, they will be successful. To the extent that they
don’t, they will trigger a real
backlash that will slam not only them but
all symbols of U.S. power.
Trade as a share of world output did not recover its
1913 level until the mid-1970s. In those decades before
the Great Wars, apart from growing trade and capital
mobility among many countries, there also was relatively
free migration of workers. The 4.4 million immigrants to
Brazil in 1821-1932 were more than its whole population
in the early 19th Century. In the century before 1914,
over 60 million Europeans emigrated, 32 million of whom
went to the United States, whose booming economy operated
behind high tariff walls. Today there are fewer barriers
to trade but tighter legal restrictions on labor mobility
among the rich countries, even though we live in one of
the great ages of human migration, both legal and illegal.
McDonald’s will not become
McWorld, yet McDonald’s
is opening new restaurants in the poorer outskirts of
São Paulo, where levels of consumption have improved
since the Real Plan opened the economy and stopped
escalating chronic inflation. Combining economic
openness and fiscal austerity has benefited nations of
Latin America until recently afflicted by chronic
inflation, offering new freedom and stability while
yielding impressive electoral dividends to democratic
governments in Argentina, Bolivia, Brazil, Chile and
Peru.
Two Harvard economists, Jeffrey Sachs and Andrew
Warner, argue that “one dominant global economic
system is emerging....The years between 1970 and 1995,
and especially the last decade, have witnessed the
most remarkable institutional harmonization and
economic integration among nations in world history.”
They add that the driving force of these changes is
trade liberalization, which “not only establishes
powerful direct linkages between the [national]
economy and world system, but also effectively forces
the government to take actions on other parts of the
reform program under pressure of international
competition.” Economic opening spawns an awesome
agenda of institutional reform. Among these reforms
are freeing prices, restructuring taxes and budgets,
privatization, creating judicial systems with
enforceable legal codes and procedures, better
government regulation and revising the social contract
to reduce wasteful and costly privileges while caring
for those most in need.
What are the dangers? The dangers are mainly
institutional, threatening destructive conflict
between globalism and localism. Like many western and
former communist governments and peoples, Brazilians
are embroiled in conflict over acquired rights that
are generous on paper but cannot be sustained within
the present framework of public finance. Over the next
decade we can consolidate political and monetary
stability only by meeting three institutional
challenges. We must enhance the viability of fiscal
federalism, financial markets and the social contract.
We then will be able to conduct our politics in a
framework of more realistic expectations and to
recover our capacity for public investment. We must
create and maintain more effective public institutions
to improve our economic performance and the
productivity of investment. Both public and private
investment are needed urgently for us to participate
more fully in the world economy. The degree to which
we meet these needs is a matter for local decisions
based on our own interests and not on the priorities
of foreign governments, international agencies and
global corporations. All societies, even western ones,
do not equally value competition. Brazil will decide
how much competition it will tolerate. Neither
security nor free competition are absolute values, but
exist in degrees according to viability and priorities
determined locally by economic potential and political
decision. The responsibility for success or failure
lies with ourselves. We now explore related issues of
public finance, privatization of infrastructure and
the social contract to understand better the choices
that lie ahead.
The expanding web of economic activity not only offers
nations and communities a choice of whether or not to
participate, but also demands of them a fusion of the
ways they handle their domestic finances. The most
dramatic result of this fusion is the worldwide fall
in inflation rates since 1990, by half in the advanced
countries and by two-thirds in the rest of the world.
The curbing of inflation opened the way for
convergence of interest rates in the biggest economies
and access to international capital markets for
countries excluded until recently. But many countries,
not only Brazil, now are grappling with growing public
debts and deficits, which could be a prelude to
renewed inflation. One of the most spectacular results
of financial liberalization and deregulation,
intensified capital flows, enables countries to use
short-term foreign borrowing to postpone difficult
political decisions. The globalization of the world
economy may be stalled by the globalization of public
debt.
Brazil’s fiscal problems, and its avoidance of
choice, are moving along the same path as those of
many rich countries, posing the clearest threat to the
economic and trade expansion, fed by cheap money, that
is driving global integration. Among advanced
countries, average levels of gross public debt surged
from 40% of GDP in 1980 to 70% in 1995. Brazil’s
gross public debts (foreign and domestic) rose from
25% to 50% of GDP, and are harder to service because
of its past history of chronic inflation and defaults.
As in the rich countries, Brazil has raised tax
revenues dramatically over the past two decades, from
23% to 31% of GDP, but still cannot contain growth of
public spending. An international consensus is
building among specialists that any reduction of
public debt will have to come from spending cuts.
Sailing until now on a crest of expanding world
liquidity, Brazil has been able to use foreign
financing, much of it short-term, to support its
effort to stop chronic inflation while avoiding
institutional changes needed to keep prices stable.
Historical experience, especially with sudden changes
in perceived risk and international interest rates in
1928-29, 1981-82 and 1994-95, shows how dangerous
dependence on short-term foreign financing can be. The
danger increases if government borrowing in the rich
countries continues to grow, driving up international
interest rates.
Brazil faces tough choices with regard to fiscal
federalism and state capitalism. To stabilize public
debts at their present level, according to one
estimate, Brazil’s federal, state and local
governments together would have to improve their
accounts by 3% of GDP, reflecting a shift from
spending 1.4% more than their receipts into a 9%
surplus. The burden of this shift toward fiscal
balance to stabilize present debt levels would be
borne by state and local governments, which would have
to move from spending 8% more than their income to
generating an 8% surplus just to meet current
obligations. While federal banks are carrying out
massive refinancing of state debts, which in early
1995 were estimated by the World Bank at $140 billion,
there is little chance that rollovers alone will solve
the problem without major changes in the fiscal
structure.
Under Brazil’s 1988 Constitution, federal transfers
to states and municipalities rose enormously. A
tripling of municipalities’ share of public spending
led to creation of more than 1,000 new local
governments to harvest the transfers. Virtually all
this new money went to hire new state and local
employees, most of them enjoying guarantees of job
security under the new Constitution. The legislative
and judicial branches of federal and state
governments, guaranteed “autonomy” by the new
Constitution, gave themselves generous salary
increases and pensions, while teachers, accounting for
one-third of all public employment, continued to earn
the lowest pay as the quality of schooling fell. The
federal payroll was cut deeply since military rule
ended in 1985, but states and municipalities hired
aggressively, with people with less than four years of
schooling generating nearly half the increase. “The
public administration clearly tended to pay its poorly
qualified employees much better than the private
sector and did the opposite with its best-trained
people,” a study by the government’s economic
research institute (IPEA) reported. While the number
of public employees in Brazil is low compared with
rich countries, it is high in many communities
depending on government transfers, salaries and
pensions for survival. This dependence shaped
Brazilian political culture and gave it its
extraordinary resilience. Over the past decade, it
also spawned huge and growing public debts that
threaten to bankrupt the government and to end
economic stabilization. Brazil cannot operate in a
more integrated world economy without ending these
fiscal distortions. This is where the choice lies,
where the conflict between globalism and localism is
clearly engaged.
In some ways, Brazil’s state capitalism spawned
public finance problems akin to those of former
communist countries. These are (1) circular defaults
and chronic payments arrears among state enterprises
and local governments, especially for wages and basic
inputs such as electricity, fuel and telephone
services; (2) huge volumes of non-performing loans
from public banks, often to state governments and
other public agencies, which in Brazil has led to some
of the biggest bank failures in the annals of world
finance; (3) non-payment of taxes and social security
contributions. Both Brazil and the countries of
Eastern Europe have sequestered budgeted funds in
their struggles for fiscal balance and have made
dramatic progress in liberalizing prices and reducing
subsidies, but still face political obstacles to
advancing further. From these experiences, and from
those of Argentina, Bolivia, Chile, Peru and Mexico,
it becomes increasingly clear that the goals of
economic stabilization and deeper participation in the
world economy are neither separate nor separable in
practice.
Globalization of
Public Debt
In many
advanced countries, as in Brazil, net unfunded pension
liabilities exceed the current national debt. Driving
debt growth in the OECD countries was the surge of
transfer payments (public pensions, subsidies and
interest) from 8% of GDP in 1960 to 21% in 1992 caused
by the transformation of targeted social safety nets
into universal benefits. Voters and politicians still
have not reduced their expectations about the level of
benefits that governments can afford to provide for
their citizens. In recent years, large flows of money
have gone to wealthy retirees who need no financial
aid. In the United States, an estimated $64 billion in
Social Security benefits go to households with annual
incomes over $50,000 while aid to the poorest
households is being cut. West European governments
have struggled with some success over the past decade
to stop increases in social spending, which remain
stuck at roughly one-fourth of GDP. In several
countries, notably Austria, Belgium, France, Germany,
Greece, Italy, Netherlands and Spain, social security
contributions by employees and employers are over 40%
of gross earnings. “Perhaps the most important
adverse effect of high social charges is that they
drive a wedge between the formal and informal
components of the labor market (particularly in
low-paid jobs because of contribution ceilings),”
observed the director-general of the International
Labor Organization (ILO), “inducing labor to flow to
those jobs and occupations where social charges can be
most easily avoided, rather than those which are most
productive and profitable.”
Brazilian transfers take varied forms, heightening the
sense of waste and injustice in public finance. They
rose since 1980-85 from 12% to 18% of GDP as overall
government spending increased from 24% to 27% of GDP.
Public pensions in Brazil absorb 8% of GDP, against
10-15% in most European countries, a very high burden
for such a young population. With 40% of the labor
force informally employed, its pool of contributors is
much smaller than the number of present and potential
pensioners. Meanwhile, retirees are divided into two
classes: the plebes and the nobles. The plebes are 87%
of the pensioners, most of whom retire at age 60 with
a monthly social security payment of roughly $120,
equal to the minimum wage. The nobles are the other
13%, absorbing one-third of all benefits as members of
politically influential professions, who can retire
under “special regimes” as early as ages 45 or 50,
with monthly pensions that can run from $7,000 to
$20,000 or more. Many politicians and public officials
accumulate two or more pensions during their working
career. A state attorney in São Paulo can retire in
his 50s with a lifetime monthly pension of
$12,000-14,000, an income beyond the dreams of all but
the wealthiest in the United States or Europe.
Perverse incentives usher public servants into early
retirement with pensions 20% higher than their final
salary, which by custom is topped up with a promotion
shortly before they leave. They then can be rehired by
the same or another public agency to earn a new salary
alongside their pension. The federal government now
pays more to pensioners than to active employees.
Falsified work histories and disability claims breed
widespread fraud to obtain benefits. Evasion of social
security payroll taxes is estimated at 40% of owed
contributions, with many private firms and public
agencies keeping salary deductions for themselves. In
1996 the federal treasury transferred $760 million to
social security in partial payment of $1.2 billion
owed by the federal railway system, roughly equal to
the railroads’ market value for privatization.
For Brazil,
the survival of state capitalism is at issue in
decisions over privatization and new infrastructure,
which are the focus of a big global market. From 1984
to 1995, 86 countries privatized 547 infrastructure
companies worth $357 billion. Also, some 600 new
private projects, worth $308 billion or more, are
underway in 82 countries. Half of all privatizations
and 70% of the new projects are in developing
countries.
Nevertheless, it is becoming clear that privatization
has been oversold by many of its advocates as a
panacea for problems of statism. Privatization breeds
a new generation of institutional problems, mainly
connected with neglected regulation of public
utilities and near-monopolies, that will frustrate
efforts of some countries with weak public
institutions to create viable standards of fairness
and efficiency. The World Bank in 1994 reported: “Developing
countries have virtually no experience with regulation
of private providers because their infrastructure
enterprises have, in the main, been publicly owned and
operated.”
The political and technical complexities of new
regulatory regimes force us, as in many other areas,
to face the problem of education. Brazil’s adult
population averages only 5.2 years of schooling,
comparable with countries that are much poorer and far
below the average of 13-15 years for adults Europe and
18 years in the United States. Only 10% of pupils
entering the first grade complete a secondary
education, with 53% repeating the first grade. In São
Paulo, the world’s third-largest metropolitan area,
52% of all heads of households did not study beyond
the fourth grade. While the poorest fifth of Brazilian
adults have only 2.1 years of schooling, the
dispersion of education among income groups is less
shocking than the fact that the richest 20% of
Brazilian adults have completed only 8.7 years of
school. It is hard to operate a complex society with
an elite invested with such little education. It is
even harder to imagine such a poorly educated elite
exercising politically independent regulatory
authority over privatized public services, involving
legal and technical complexities in calculations and
decisions as well as in negotiations with some of the
most sophisticated private operators in the world. Yet
this is the challenge facing Brazilian authorities
after the current wave of privatizations. The only way
forward is over a long and costly curve of learning by
doing. Globalization is an educational as well as a
competitive process. Brazil and many other countries
need this kind of exposure.
Recent technological innovations —like cellular
telephones and low-cost gas-fired turbines enabling
independent powers producers to gain access to
national electricity grids— have opened new areas of
competition in industries until recently run as “natural”
monopolies, mostly private utilities in the United
States and state corporations elsewhere. While
regulatory reform was driven in large measure by
technological change in the United States,
privatization everywhere has been forced more by the
need to contain public deficits, involving choices
between the fiscal demands of state corporations and
the transfer commitments of the Welfare State.
What may facilitate political solutions is the
flexibility developed over the past two decades by
privatization and regulatory reform. Partners in
economic restructuring, the two processes differ in
origins but can act together to accommodate politics
and markets. Pioneered in Britain, where the
government sold some 50 major businesses for nearly
$100 billion since 1979, privatization is marked by
continuing experiment and improvisation. Governments
seek to sell bulky but unprofitable “assets” on
domestic financial markets, often trying to create “people’s
capitalism” of small shareholders amid heated
political controversy. In Russia and other
ex-communist countries, privatization often has been a
game played by political insiders and state enterprise
managers to gain quick and cheap ownership of public
assets. Experience in both Britain and Chile, leader
of privatization in Latin America, shows that mass
sell-offs demand development of new institutional
investors, such as pension funds, that later may play
a role in corporate governance. In France and Italy as
in Brazil, huge public enterprises dominate
electricity, telecommunications and banking. Europe is
moving along a “stop and go” obstacle course of
privatization that Brazil eventually may follow. In
France, where many state corporations operate in
high-tech sectors and are leaders in their markets,
“stop and go” meant that 31 state banks and
companies were sold for roughly $10 billion in 1986-88
before a Socialist election victory led to a “public
sector breather,” increasing the number of state
enterprises from 2,000 to 2,600 and adding another
400,000 jobs. After the Right won the 1993
parliamentary election, eight more state companies
were fully or partially privatized in the stock
market, yielding another $23 billion. Many countries
try to exclude or limit foreign roles in
privatizations, but the small size of domestic
financial markets often forces them to woo foreign
investors. In France the foreign share in
privatizations rose from 2% in 1986-88 to 12% in the
1990s. In France and Italy as in Brazil, fiscal
pressures for privatization are reinforced by
secondary issues such as corruption, lack of
accountability by management and poor performance of
public enterprises. While Brazil’s federal and state
banks make 55% of all loans, Italy’s public
institutions generate 80% of all bank credit. In both
countries, and in France, government banks are ridden
with bad loans and political scandal, most recently in
the failures, the biggest in financial history, of
Banespa (State Bank of São Paulo) and Credít
Lyonnais, the world’s largest bank outside Japan. As
in Brazil, most Italian public enterprises enjoyed
soft budget constraints and are shielded from
bankruptcy, while their obligations to stakeholders
(the government and other owners and creditors) are
unclear. Private investors are venturing into this
murky and sheltered world with prospects that are not
easy to foresee. “Solving the corporate governance
problems inherent in public management of enterprises
is an explicit goal of privatizations in all market
economies,” Andrea Goldstein and Giuseppe Nicoletti,
two Italian economists, observe, “but tackling the
issues that remain after transferring ownership from
public to private hands has seldom been an overriding
concern.”
In Latin America, privatization has moved forward fast
under fiscal pressure during economic stabilizations
in Argentina, Bolivia, Chile and Peru, but has been
treated with ambivalence by leaders of the biggest
countries, Brazil and Mexico. Among poorer countries,
Latin America has received half of all foreign
privatization capital, as inflows swelled from $183
million in 1989 to $3.7 billion in 1994, but in
1994-95 got only one-tenth of new project finance.
Much of today’s privatization wave involves purchase
by foreign investors of ownership and/or management of
railroads, power stations, telephone companies, water
and sewage systems and other infrastructure built by
British, U.S., French and Canadian firms before
shrinkage of investment and trade flows after 1929. On
the eve of World War II, 35% of all U.S. direct
investment stock in Latin America was in
infrastructure and transport facilities, amounting to
22% all U.S. direct investment worldwide. These
investments now are reviving in response to huge
demand, often involving reprivatization of companies,
like Brazil’s electric utilities, that were
nationalized in recent decades. The World Bank finds
that, at current economic growth rates, East Asia will
need $1.4 trillion in infrastructure investment in the
next decade, $700 billion in China alone. In Latin
America, $600-$800 billion more will be needed. At
Latin America’s current low savings rates, these
investments cannot be funded locally. This is a buyers’
market because international engineering and
construction companies are hungry for business due to
the dearth of new projects in the rich countries.
Public investment in infrastructure in the United
States fell from 3.1% of GDP in the 1960s to 1.4% in
the 1980s. The real choice is either to make deals
with foreign investors, who built Latin America’s
first generation of modern infrastructure, or to allow
more deterioration and obsolescence of the systems
already in place. There are signs that the choice
already has been made.
The world’s biggest new power projects are
concentrated in developing countries. Big projects are
underway in Indonesia, India, Pakistan, Philippines,
Colombia, Hong Kong, China, Turkey and Malaysia. “Limited
recourse” financing of a “special purpose
corporation” imposes severe discipline and shared
risks on all parties, improving repayment and enabling
sponsors to raise large amounts of credit on small
amounts of equity. Banks rely solely on the project’s
cash flow for debt service, for which revenues must
remain at least 40% above loan repayments. Sponsors’
liability is limited to their equity in the project,
usually about 30% of total cost. Performance bonds and
guarantees heavily penalize contractors and suppliers
who fail to meet deadlines as well as wholesale
consumers, often state corporations, that renege on
“take or pay” purchase contracts. Great care is
taken to avoid the kind of tug-of-wars with foreign
investors over tariffs that ended in nationalization
of utilities in Brazil and elsewhere in Latin America.
Complex and painfully-negotiated contracts provide for
international arbitration of disputes and protection
against loss caused by changes in user charges, laws,
taxes, government intervention and currency
devaluation. According to the World Bank, a standard
agreement yielding 20% return on equity and 10% annual
interest could lock in total outflows equal to two to
four times the original investment over a 10-20 year
payout period, generating hard-currency demands for
user charges that can be politically unsustainable. No
wonder that these deals are negotiated at such expense
and difficulty, often in a climate of fear and
mistrust, and that only 20% of private projects in
poorer countries survive the development stage to go
on line. The key words here are hope and desperation.
Despite the difficulties, both new infrastructure
projects and privatizations have gone forward in
several countries. Unbundling of “natural”
monopolies has taken place in Argentina, which led the
way in the 1990s with breakup and privatization of
railroads, telephone, electricity, oil, natural gas,
water supply and civil aviation, ending decades of
huge subsidies to state corporations. The same trend
is underway in Bolivia, Brazil, Colombia, Mexico, Peru
and Venezuela.
It may be that a new institutional environment is
being created. If so, its strength will be tested by
conflicts between globalism and localism. In Brazil
The first major test is in the unbundling and
privatization of the state electricity monopoly, with
asset value of $90 billion and annual revenues of $15
billion. The forces of globalism emerge through the
urgent need for new investment to meet the needs of
economic growth. The forces of localism are felt in
political and bureaucratic resistance to privatization
and in the slowness in developing policy and rules
over tariffs and over unbundling the functions of
generation, transmission and distribution of
electricity that are now concentrated in government
monopolies. The forces of globalism and localism will
contend with each other in future fights over tariffs
and regulation, as they have in the past. Nobody knows
how the new institutional environment will develop.
Brazil is different from the rest of Latin America in
that it belongs to the exclusive club of “monster
countries,” to use George Kennan’s unflattering
term, whose other members are the United States,
China, India and Russia, inward-looking nations of
continental dimensions and big populations, embracing
together 46 million square kilometers and nearly half
the world’s population. Maddison finds “little
evidence that big countries have much of a scale
advantage” with “no significant relationship
between size and productivity performance....Most of
the benefits of specialization and scale can be
obtained by small countries through international
trade.” All big countries need extra administrative
machinery to manage complex federal systems spread
over vast territories. All must struggle to avoid
deterioration of extensive transportation
infrastructures requiring expensive maintenance,
especially in regions of low population density. All
of them are historically ambivalent in dealing with
the rest of the world. Russians have been divided over
“Westernization” for at least three centuries,
since the reforms of Peter the Great. While the United
States is the only “monster country” that has
globalized its economy, perhaps because its market and
corporations drive the globalization process, its
leaders nursed mixed feelings over entanglement in
foreign affairs since gaining Independence two
centuries ago. As recently as 1970, the United States
had the same low import coefficient as Brazil’s, of
less than 4% of GDP. For at least a thousand years,
China has been the paragon of self-sufficiency,
returning to autarchy after suffering humiliations at
foreign hands in the 19th and early 20th Centuries.
Even today, China’s economic opening is limited to a
small part of the country, attracting huge flows of
foreign investment that still feed suspicion and
ambivalence.
Brazil is fortunate among the big countries in that
its linguistic and ethnic frictions are much less of a
threat to political cohesion than in the others. But
its ambivalence toward globalization raises important
questions: What are Brazil’s prospects in a
globalized economy? What are its comparative
advantages? What conditions must Brazil create so that
access to world trade and capital flows can help to
solve internal problems of employment, productivity,
public investment, social protection and living
standards? Can Brazil’s private entrepreneurs
mobilize the initiative and creativity to produce more
satisfactory levels of economic development?
Unfortunately, Brazil’s debate over globalization
rarely addresses these issues.
In one of the few serious research efforts on the
effects of Brazil’s opening to the world economy,
economists at the BNDES (National Bank for Economic
and Social Development) found that “the impacts of
opening went in the expected and desired direction.
Given the industrialization strategy pursued in the
past, a substantial increase in import coefficients
and a general fall in industrial profit margins were
inevitable and healthy, in terms of both welfare and
economic growth. Import-substitution industrialization
promoted an excessive number of sectors in relation to
available resources and bred inefficient market
structures that survived only thanks to high
protection.” There has been some loss of industrial
jobs, especially in São Paulo. This may be part of a
worldwide trend of rising manufacturing productivity
and a shift into employment in services and the
informal sector. This world trend is compounded by a
move of Brazil’s industries away from the
megalopolis and by failure of state and local
authorities in São Paulo to manage problems of scale
and to invest in public transportation, health and
education, failures issuing from the civilizational
problem of chronic inflation. The economic opening
stimulated a big rise in industrial productivity,
generating higher wages and lower consumer prices for
manufactures.
To support their conclusions, the BNDES economists
presented these facts: While Brazil’s trade balance
in manufactures shifted from a $15 billion surplus in
1989 to a $1.5 billion deficit in 1995, these effects
were unevenly distributed among different industries
and represented a small share of total production. The
hardest-hit was the capital goods sector, which was in
deep trouble since the early 1980s and saw imports
rise from 11% to 59% of production in 1989-95, roughly
the same as before intensive import-substitution began
in the 1970s, while the sector’s exports also grew
from 7% to 17% of output. However, other industries
—beverages, pharmaceuticals, cellulose, soaps,
perfumes, dairy products, electrical appliances,
automobiles, cement— benefited from big increases in
domestic demand, driven by a 27% rise in average real
wages since the Real Plan was launched in July 1994.
Poor people now are buying more electrical appliances
and consuming more milk, meat and other forms of
protein than they did three years ago. Big increases
in imports as a share of consumption took place in
machinery, telecommunications equipment, fertilizers,
chemicals, auto parts, textiles and automobiles.
Brazilian manufacturers complain that an overvalued
local currency, cascading taxes and high interest
rates raise their costs at each stage of production
and distribution, impeding them from modernizing and
competing with goods produced abroad with low-interest
financing and imported at low tariffs. The BNDES
economists warned that freeing trade while allowing
domestic currency to appreciate poses great risks to
the economic opening and urged “a return to a
trajectory of real devaluation of the exchange rate.”
Under political pressure, the government granted a 70%
special tariff to protect foreign car manufacturers
operating in Brazil, a level of protection they could
never dream of obtaining in their home countries.
While others pay the 70% tariff to import vehicles,
companies producing locally could import built-up cars
and trucks at a 35% duty. Moreover, barriers were
removed from the previously-protected Brazilian auto
parts industry to strengthen the competetiveness of
local assembly plants.
These are mixed results determined more by past and
present government policies than by outside forces.
However, these results add pressure on Brazil to
adjust its cost structure to win a larger share of
concentrated production and marketing capacity to gain
wealth and efficiency from an expanding global
economy. If Brazil wants to participate more fully in
this expansion, we must develop a clearly defined
trade strategy that strengthens our export capacity.
If Brazil wants to attract the foreign direct
investment that drives globalization, we must take
into account the factors that investors weigh most in
selecting a location: market-size, economic
predictability, stable legal and political rules and
prospects for profit. Until recently, these factors
were missing in Brazil or were not sufficiently
developed. Another obstacle is the high cost of doing
business in Brazil, known as the Custo Brasil, bred by
market distortions and deterioration of highways,
telecommunications and electric power facilities. Lack
of stable financial and institutional mechanisms for
providing and renewing modern infrastructure threatens
a vicious downward spiral of decapitalization:
deficient investment and maintenance sabotages the
viability of existing infrastructure, discouraging in
turn new investment in other industries. Other
elements of the Custo Brasil range from inflexible
labor laws that discourage hiring and firing of
workers and create a huge gap between the total cost
of employing people and a worker’s take-home pay;
slow judicial procedures; a school system that fails
to prepare the population to work in a modern economy,
and low productivity and high costs of cartelized
ports. Today some of these things are changing, but
several economic sectors remain fortified against
efficiency improvements and foreign investment. The
World Economic Forum’s Global Competitiveness Report
1996, using indicators of institutions, infrastructure
and economic policy, ranked Brazil 48th among 49
nations in competitiveness, behind Venezuela and ahead
only of Russia. These rankings may be tendentious and
distorted, based on questionnaires mailed from
Switzerland and filled out with varying degrees of
care and objectivity by thousands of people in
different countries. They seem at odds with the size
of Brazil’s internal market, its pool of business
skills, its agricultural and industrial capacity and
its ability to attract foreign capital. However, these
rankings usefully warn us of institutional weaknesses
that threaten economic progress. UNCTAD observes that,
with trade barriers now lower, “the size of national
markets has decreased in importance. At the same time,
cost differences between locations, the quality of
infrastructure, the ease of doing business and the
availability of skills have become more important.”
What makes the difference between success and failure
in development is not abundance of natural resources.
These privileged endowments occur in such diverse
countries as Brazil, Zaire, Russia and the United
States. The critical difference is in investment in
human resources and, above all, the quality of public
institutions that includes not only the political
system but also the legal and regulatory complex that
create conditions for markets to function. Nobody
today denies that the great engine of development is
the market. But the market needs a minimum of legal
and macro-economic stability that only can be supplied
by the State. Brazil will make its choice about
globalization. The choice will be shaped by the
quality of its public institutions and perceptions of
its own self-interest.
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U.S. AND WORLD ECONOMY