Lula on the Verge

For the first time in decades a country on the American continent is set to elect a progressive president, granting him the mandate to form an executive government and lead the country for four years. That this country is Brazil, the continent’s second largest after the US, with a population of 175 million covering an area larger than the US without Alaska, will make Sunday’s results — if favorable to the Workers’ Party (PT) — nothing less than a historical event. The world’s financial press has stamped the shift in Latin American politics, and in Brazil in particular, as one toward populism. What the PT has proposed to Brazilians, however, is a political, social and economic vision that is all but populist. As we await Sunday’s results, we would all be better off knowing more about the progressive principles of governance it plans to run.

The most recent opinion poll, published on October 23, shows the Brazilian Workers’s party (PT), headed by Lula, as winning the second round of the presidential elections on Sunday with 66% of voter intention, discounting blank and cancelled ballots. Jose Serra of the Social-Democratic Party (PSDB) has lost ground, now sitting at 34%. The Brazilian system is a presidential parliamentary democracy, with the president assuming both prime ministerial and presidential functions. Due namely to the large number of political parties, the 1988 Constitution established the two-round system to prevent the election of minory governments. As Lula failed to reach the 50% margin upon the first round, a runoff was set.

This means that alliances are a fundamental part of the Brazilian election process. A proportional imbalance in Congress favors the large landowners from the Northeast – represented by the PFL, and to a lesser extent the PMDB – over the urban masses of the South and Center East, i.e. Rio de Janeiro, Minas Gerais and Sao Paulo states especially. Given the ultra-conservative nature of the northern parties, notwithstanding former-candidate Ciro Gomes’ populist tendencies, political alliances have bred compromises since the first round, held on October 6.

This history of alliances is a factor that may account for the transformation of the PT from a trade union motivated working-class party critical of Brazil’s economic organization and administration to a social-democratic one striving for economic stability through national unity. Also accountable are the mutations that have affected international progressive parties. Now alone among them, the changes in PT economic policies, namely those in favor of a more subdued state economic administration, have attracted large sectors of Brazilian industry. Still, several leftwing candidates have been elected to the lower house who will be fighting to keep the party’s essence active.

Currently then, the PT is a social-democratic party, whose economic principles are not significantly different to those first proned by out-going President Fernando Henrique Cardoso. Apart from the motivations behind the Plano Real, which pegged the local currency to the US Dollar on roughly a 1:1 ratio, on the social front Cardoso was compelled to form an alliance with the PFL, led by Antonio Carlos Magalaes. Once a leftwing sociologist, Cardoso’s reformist dreams were shot down at that time. But the political astuteness of this president managed to have his partners discredited in a series of corruption scandals.

His social agenda has generated many positive results. There have been net increases in literacy rates and school attendance, as well as in the university research budget allocations despite being centralized in the Sao Paulo area. Health care has also seen net progress with the primary sources of death and life expectancy beginning to approach G7 standards. This also means infant mortality rates have dropped significantly during the nineties and the efficiency of treatment has boomed — as have its costs.

The Plano Real was in fact the brainchild of former president Itamar Franco, in whose government Cardoso was finance minister. Through Cardoso’s first term, the Plan contributed to briefly raising the standard of living of the Brazilian people. Close to a half of them live below the poverty line, and many in African fifth-world <conditions.The> Plan led to a significant rise in the purchasing of household appliances. Still, the cost of the Plano Real has been extremely high. And the wisdom of the IMF guidelines for its implementation have now fallen under great scrutiny. The very poor have suffered and keep suffering. The bottom ten percentile control only 1% of the nation’s wealth as opposed to the top 10 owing 50%.

This is, in a nutshell, the national scenario the PT will be inheriting as they take power. Despite attempts made to the contrary, it will be assuming power cleansed of the responsibility for the recent economic turbulence linked to the speculation on Brazil’s currency. Yet with 95% of next year’s budget already alloted, which is binding for the federal government as entailed by the recently passed Fiscal Responsibility Law, it remains in a stranglehold.

The attack on the Real, coupled with the irresponsible statements made last summer by the US Treasury Secretary Paul O’Neill, forced Brazil’s central bank to seek a bailout package from the IMF. It was the second in four months, the first being June’s US $ 10.7 bn loan. Given the share of Brazil’s external public debt denominated in dollars, as the Real lost roughly a third of its worth since the beginning of the year, Brazil’s ability to service its debt was jeopardized. The size of the bailout surprised everyone. Economic observers have tied its value to the amount Fleet Boston and Citibank have invested in the country (roughly equivalent to $ 20 bn) either as direct investment or in bonds.

There is no strong consensus on the problem Brazil will face in servicing the debts. Separating the external from the internal debt, and the external public debt from the external private debt is a measure that Brazilian financial professionals from the governor of the Central Bank, Arminio Fraga, to the Forbes Brazil columnist Gustavo Loyalo spare no time in doing. Indeed, their general objection to Anglo-American financial consultants and bond rating agencies is that they commit the major mistake of lumping all the debts together.

As a result the evaluation cast onto Brazil is not only unstable. What it reflects is primarily the mood of investors more than the real state of the economy. Separating the debts and calculating appropriately by emphasizing the shifting nature of only one part of the total debt due to its denomination in American currency must be done continually. It is Brazil’s strongest card against the pseudo-scientific rating scale drummed up by Moody’s and JP Morgan. And it completely overlooks the fact that president Cardoso’s team have cut the current account deficit in half from US$ 33 bn in 1998 to US$ 17 bn, financed by direct investment and an astonishing US$ 7 bn trade surplus.

The public sector’s liquid debt is roughly US$ 255 bn, of which roughly 20% is denominated in American currency, and a US$ 95 bn portion of the external public debt is payable over a long term. In terms of total external private debt, there is great disparity between numbers: Gustavo Loyola claims it to be US $70 bn accounting for roughly 120% of annual exports of goods and services, as opposed to Edwin M. Truman’s citing of 310 percent. In addition, compounding the debt to figures such as 310-326 percent of exports matched with the 55 percent ratio of public-sector debt to GDP, assumes that the private debt will be honored by the public sector.

As Brazilian companies have a very low level of domestic debt, there does not seem to be a problem with solvency as long as the currency doesn’t crash. But with the Real under attack, there is little chance for the GDP to rise to its 2000 level. Despite the fact that in 2000 the world economy was in the first dip of its recession and Argentina was approaching meltdown, Brazil had glided through smoothly with 4.4% growth. Underlying the current government’s economic strategy is the central bank governo’s belief that the Real is vastly underrated, with an appreciation to 2.5-2.9 in relation to the dollar being its appropriate exchange rate.

Indeed, one gets the impression that the more Brazilian economists insist on this method of portraying the country’s obligations, the more they see the North as involved either directly or indirectly in a measure to destabilize the country’s money markets due to the rise of the PT. Much of standard liberal market analysis in Brazil would be deemed leftwing were it formulated in North America. The fact of the matter remains that the IMF seems to be playing a double game. It is both the guide of emerging markets and the harbor of institutional speculators, i.e the major investment banks themselves. Its measures have been severely criticized as punishing the local goods and services production sector by preventing a larger margin of public expenditure.

There are of course Brazilians benefitting greatly from this. Unfortunately, wise men such George Soros, again speaking of the global risk posed by Lula in “El Pais” last weekend, spent no time pointed out this dimension to the problem. They spend no time either mentioning that many of the wealthiest spend much of their year living abroad, especially around Miami, where they fail to pay appropriate taxes while shifting their capital around according to what the ‘market’ dictates. Nor do their accuse the power of the banking sector, and of their support for tax havens, largely responsible for capital flight.

The Cardoso government slapped a tax on the use of cheques, which should allow greater transparency in the flow of funds. In so doing, it has attempted to fight this behavior pattern among the rich who run to the US for (tax) shelter. On the other hand, no one is fooled by the collution lying between his government and Brazil’s banks. What the PT must enstore is a massive overhaul of the taxation system diplomatically implemented but done so at all cos —notwithstanding Mr Soros’ forewarning: “were the PT to impose restrictions on capital transactions in order to protect itself, it would trigger the disintegration of the globalized system as we know it.” And apparently nothing less, for so high is the innovation margin the system affords. Having said all that, Mr Soros concluded his interview on a positive note: “Brazil is able to pay off [its debt] without causing excessive damage [to its economy].”

Once the IMF granted the loan in August, all candidates, including the PT, pledged their intention to honor the IMF conditions for receiving the loan programme, parcelled into three separate instalments, two of which fall after the elections. This means keeping a primary fiscal surplus of 3.75% of GDP. Such calculation ensures a declining debt to GDP ratio as long as the inflation-adjusted interest rate paid by the government on its publicly traded debt does not exceed GDP growth by more than 7 percentage points.

For the PT this would apparently compromise their commitment to increasing the minimum wage to R$ 300 over three years, and orienting investment toward a social agenda. Yet according to the PT chief economic advisor, Guido Manteiga, reaching that objective is possible, but conditional on the GDP reaching its projected capacity of 4% growth with inflation held at 3%. Boosting purchasing power should not be a contradiction to either maintaining the primary fiscal surplus nor to keeping inflation in check.

The increase in minimum wage would be financed through the taxes collected on Brazilian exports, a sector that should be freshly stimulated by the resumption of trade credit lines. Overhauling the taxation system, a desperately needed act of political will, will be the other source of financing purchasing power. In other words, the PT has set its priority on economic growth as conditional for government social spending, and resourcing the productive sector of the economy through government planning to raise the standard of living. Tigher fiscal policy is what the PT is aiming for as a means to lower real interest rates and attract direct investment.

In many ways, the PT has no choice over these market economy principles. Given the intermeshed structure of the global economy, and first world investment in the money markets of emerging countries, a decision to break with the IMF by defaulting on loan servicing would condemn Brazil, just as it would wreak havoc on international money markets.

Allow me here to make a first observation. Despite the amount of money investors and creditors have in Brazil, it is absurd to claim that the PT has any intention to economically administer the country in a way that would put the country at risk.

One of the key elements to raising growth are exports. The economic community Brazil belongs to, the Mercosul (in Portuguese, Mercosur in Castilian) is in tatters. Brazil needs to export to wealthier markets, like China, India, and, especially, the NAFTA and EU zones.

Second observation: It is completely inaccurate, indeed a matter of disinformation, to claim that the PT is against free trade. Its political and economic leaders see free trade as instrumental and vital for Brazil’s economic well-being into the future.

The question is: Who’s willing to trade, and on what terms?

Regarding Canada, during a short period in the late 1990’s the Federal Liberal party was able to wean itself from the direct influence of Bombardier. This corresponded to a time when the Brazilian company Embraer, managed a series of successful deals making it the only regional jet manufacturer from an emerging market to penetrate the American field. Canada took Embraer to the WTO on grounds of illegal government subsidies. After winning the first round of the trade dispute, the Canadian government was compelled to grant low-interest loans, through Export and Development Canada to not one, but two, American airlines in exchange for purchasing Bombardier RJs. This allowed Brazil to seek litigation against Canada at the WTO and win. (In a recent report, EDC is gravely concerned about the capacity of Bombardier and Nortel to repay handouts totalling CDN$ 10 bn. So Canada’s attempt to block Embraer’s entry will have a lasting legacy, perhaps trickeling down all the way to the taxpayer. The latter would then be liable to shed even more doubt on a country home to a respected singer-songwriter called Lenin.)

What this case exposed in the questionable posture of Minister Pierre Pettigrew in Seattle back in November 1999, was that for all its talk of free-trade North America is quite unwilling to open its commercial zone to foreign industry. Moreover, it expects foreign countries to open their commercial space to North American exports prior to settling the issues at home.

In addition, since the Bush administration took power, it has hiked tariffs on steel imports and has passed billions in agricultural and military-industrial subsidies. These two unilateral gestures, in addition to already existing tariffs on fruit imports, make the USA anything but a free-trader. To be sure, it is free-trade’s leading advocate. Although it is hardly free-trade’s most earnest player, its importance as a power is trivial. Brazil is a very strong exporter of iron ore, soja, orange juice, though with the current protectionist measures of NAFTA and the EU, its export potential is limited to a dreadfully low 13% of GDP.

It is therefor fantasy to believe that the incumbent PT government is against free trade. On the other hand, it has spoken critically of the FTAA, indicating that under current conditions it will refuse to sign. It has gone as far as to assert that under current conditions the FTAA would mark the end of Brazilian sovereignty. Despite the drama, and given the south-to-north motion of capital over the past 10 years, this is not contradicted by reality. Moreover, Joseph Stiglitz has recently positioned himself strongly against the IMF’s guidelines, seeing them especially as a means to further indebt developing nations and to stiffle growth and innovation.

Regarding FTAA, Lula’s eyes sparkle with his trade unionist’s enthusiasm when speaking of how hard Brazil will fight at the negotiating table. This may tickle Brazilian nationalism, but with the US refusing to budge and creating bilateral agreements behind the scenes, the situation does not look positive for Brazil. Still, the twain shall meet when assuming co-presidency of the FTAA negotiations next month.

This trade-union spirit is not a position unique to the PT. Visibly moved by Lula, Fernando Henrique Cardoso wants to leave behind a fighting-man’s legacy. A month ago, his government took the EU to the WTO on litigation regarding sugar subsidies. Showing its good faith on free trade and globalization, the EU trade officer accused Brazil of wanting to destroy poor countries who are receivers of French aid, which La Republique claims as justifying its agricultural susidies at home. And a week later, Brazil mustered up its courage to take the USA to the WTO on orange juice subsidies, a long pending source of contention.

Third observation: North American neo-liberal conservatives are much more concerned about Brazilian free trade potential, then in winding up with a socialist-run country in Latin America. Of course, they won’t state this outright. Using the socialist-calling card, neo-cons and Democrats alike will try to discredit Brazil ideologically in order to weaken its clout at the FTAA negoating table. Indeed, the US has been active in trying to isolate Brazil from entering the accord as part of a larger trade group, such as the Mercosul.

But have a look, if you will, at the state of the Mercosul: as long as the IMF and US Treasury refuse to help Argentina out of its problems, Brazil will be fighting mostly on its own. However, President Duhalde’s visit in September to Brazil took place to re-affirm Argentina’s commitment to the Mercosul and Brazil as its most important trading partner.

Various economists, including the governor of the central bank and minister of the economy, have stressed the importance of considering the various layers of debt, demonstrating how each is solvent. The fact remains that no microeconomic analysis can portray a way out while the Real continues to lose value. This prompted the Central Bank to increase the prime lending rate from 18% to 21% right in the middle of the election rounds at a time when the government candidate was starting to build up a counter-campaign. Needless to say, such interest rates are crushing Brazilian entrepreneuship and have shifted wealth to Brazilian banks. It has understandably sealed the results of the runoff. On the day the Real was devaluated in January 1999, Brazilian banks earned higher gross profit than during the entire year of 1998. Until last week, Brazilian banks stood firm in bond risk agency ratings. Now, even they have come under Moody’s scrutiny. That’s because the PT’s macroeconomic principles will not allow it to stand by while the banks voraciously swallow the fruits of growth and the GDP.

Many PT policies in this portrait highlight what set apart progressive politics and policies from populism and its artifices. In terms of upcoming macroeconomic policy, namely on the nature of the transitional team and how it will fight the slide of the Real, we’ll just have to wait and see. Given that Mr Stiglitz has estimated the cost of buoying up the Real at US$ 50 bn, many are skeptical about the efficiency of Mssrs Fraga and Malan’s management of the currency. Brazilians are looking to their political leaders and intellectuals with a smart and critical optimism for the future. Now, it’s time for the overlords of the elite and the rich world, not forgetting their protege Mr Otto Reich, to come around to showing their good will. Gentlemen…

NORMAN MADARASZ is a Canadian philosopher. He lives in Rio de Janeiro and welcomes comments at: