The China Temptation

What a difference a year makes.

In August 2011, as the European debt crisis raised fears of another international financial panic, Brazilian officials were bragging about their country’s impressive economic strength and record-low unemployment rate. “This is the second time that a crisis affects the world,” said President Dilma Rousseff, “and it is the second time that Brazil doesn’t shake.” The perception of Brazil as a booming economy that was insulated from the global turmoil had prompted an influx of foreign businessmen hoping to get rich (or richer). “If the rest of the world is cratering,” a Rio-based American banker told the New York Times, “this is a good place to be.”

In August 2012, amid a slowdown in China and other developing countries, Brazil is teetering on the brink of recession, largely because of an overvalued currency and sluggish exports. Its economy barely grew at all (0.2 percent) in the first quarter of this year, and its persistent weaknesses have suddenly been magnified. Even the Brazilian services sector, which had been buoying the economy, is now slumping: Its activity index (as measured by the financial giant HSBC) hit a three-year low in July. As for Brazilian industrial production (approximately one-third of the national economy), it has “failed to respond to government stimulus measures and a series of aggressive interest rate cuts,” notes the Wall Street Journal. Writing in the Miami Herald last week, Latin America expert Susan Kaufman Purcell declared that “Brazil’s economic future does not look nearly as bright as its recent past.” Indeed, while unemployment remains relatively low (for now), Brazil is no longer seen as an unstoppable economic powerhouse.

In other words, the country has arrived at a crossroads. The good news is that Brazil has an opportunity to strengthen its economic fundamentals by adopting certain long-overdue structural reforms. The bad news is that many Brazilian policymakers would rather embrace the type of state-led capitalism practiced in China.

“It used to be that all of Latin America looked to Europe as its ideal model,” a Brazilian diplomat recently told the Financial Times. “But now, given the eurozone crisis, that is no longer the case. And, increasingly, China is becoming a more attractive or plausible model.”

Of course, the Brazilian government already plays a large role in the economy, and Brazil ranks much lower than Chile, Peru, Colombia, and Mexico in the Heritage Foundation’s Index of Economic Freedom. The current Brazilian economic model is somewhere between the free-market Chilean model and the state-led Chinese model, but closer to the latter, albeit with a fully democratic political system and the rule of law, both of which are conspicuously absent in China.

The question is: Will Brazil become more like Chile or more like China? The answer will have profound implications for a country of nearly 200 million people that fashions itself a rising superpower.

To understand the best course for Brazil, simply consult the World Economic Forum’s 2011–12 Global Competitiveness Report, which lists the seven “most problematic factors for doing business” in Brazil as follows: (1) “tax rates,” (2) “tax regulations,” (3) “inadequate supply of infrastructure,” (4) “restrictive labor regulations,” (5) “inefficient government bureaucracy,” (6) “inadequately educated workforce,” and (7) “corruption.” The report affirms that such factors “hinder [Brazil’s] capacity to fulfill its tremendous competitive potential.” In the Global Competitiveness Index, Brazil ranks behind Chile, Puerto Rico, Barbados, and Panama.

Meanwhile, in the World Bank’s 2012 Ease of Doing Business Index, Brazil ranks 126th, behind all but six Latin American and Caribbean nations (Honduras, Ecuador, Bolivia, Suriname, Haiti, and Venezuela). For that matter, it ranks well behind China (91st), both overall and in the category of paying business taxes (where Brazil ranks 150th and China 122nd).

The notorious “Brazil cost” — that is, the cost of doing business in South America’s largest country — reflects a policy environment urgently in need of improvement. To that end, President Rousseff should champion structural reforms aimed at making the Brazilian tax and regulatory systems more efficient and more supportive of entrepreneurship, job creation, and private investment. (Since 1988, the total tax burden has increased from 22 percent of the economy to 36 percent, with the tax code simultaneously becoming more and more Byzantine.) Rousseff should also push for the education reforms necessary to cultivate a more skilled workforce that can compete in a globalized economy. (In the 2009 Program for International Student Assessment test, which graded the performance of students in 65 different countries and school systems, Brazilian pupils finished 53rd in reading and science, and 57th in math.)

Admittedly, fixing Brazil’s infrastructure problems will require more effective government spending. But that does not mean Brazil should seek to emulate China. Quite the opposite, actually. The China model has produced wasteful spending and capital misallocation on a truly massive scale. Does Brazil really want ghost towns, ghost airports, and trains to nowhere?

Beijing’s economic strategy has also fostered rampant corruption, which is not surprising, given its reliance on state-owned enterprises. (China ranks below Brazil in the Transparency International Corruption Perceptions Index.) And it has created “pretty much the biggest emerging market property bubble ever” (in the words of MoneyWeek editor Merryn Somerset Webb), a bubble that may already be in the process of bursting.

Communist officials have responded to the recent Chinese economic slowdown by rolling out a new wave of government stimulus policies, including more gigantic infrastructure projects. While these stimulus measures “will succeed in keeping high single-digit growth going for a time,” writes Berkeley economist Barry Eichengreen, “they will do so by aggravating the economy’s imbalances and storing up problems for the future. This is not good news for those of us concerned with China’s longer run prospects.”

Such concerns are apparently shared by many of China’s wealthiest citizens. According to a newly published report cited by The Economist, more than 16 percent of all Chinese with personal wealth above $1.6 million “have already emigrated, or handed in immigration papers for another country,” and another 44 percent “intend to do so soon.” In addition, more than 85 percent “are planning to send their children abroad for their education, and one-third own assets overseas.”

Simply put, state-led capitalism is not a long-term solution for China’s economic problems, and it’s certainly not a long-term solution for Brazil’s problems. Let’s hope anxious Brazilian officials understand that.

(You can read this article in Spanish here.)