A special report on business and fi nance in Brazil

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Getting ittogether at A special report onbusiness and nance in BrazilNovember 14th 2009


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The Economist November 14th 2009 A special report on business and nance in Brazil 1

Brazil used to be all promise. Now it is beginning to deliver, saJohn Prideaux

ve biggest economies by the middle of

this century, along with China, America,India and Japan.Despite the nancial crisis that has

shaken the world, a lot of good thingsseem to be happening in Brazil right now. Itis already self-su cient in oil, and largenew oshore discoveries in 2007 are likelyto make it a big oil exporter by the end ofthe next decade. All three main ratingagencies classify Brazils government pa-per as investment grade. The governmenthas announced that it will lend money tothe IMF , an institution that only a decadeago attached stringent conditions to themoney it was lending to Brazil. As thewhole world seemed to be heading into along winter last year, foreign direct invest-ment ( FDI ) in Brazil was 30% up on the yearbefore even as FDI in ows into the rest ofthe world fell by 14%.

Much of the countrys current successwas due to the good sense of its recent gov-ernments, in particular those of FernandoHenrique Cardoso from 1995 to 2003,which created a stable, predictable macro-economic environment in which busi-nesses could ourish (though even nowthe government continues to get in theway of companies trying to earn pro ts

and create jobs). How did this remarkabletransformation come about? And how can

Getting it together at last

BRAZIL has long been known as a place

of vast potential. It has the worlds larg-est freshwater supplies, the largest tropicalforests, land so fertile that in some placesfarmers manage three harvests a year, andhuge mineral and hydrocarbon wealth.Foreign investors have staked fortunes onthe idea that Brazil is indeed the country ofthe future. And foreign investors have lostfortunes; most spectacularly, Henry Ford,who made a huge investment in a rubberplantation in the Amazon which he in-tended to tap for car tyres. Fordlndia, along-forgotten municipality in the state ofPar, with its faded clapboard houses nowslowly being swallowed up by jungle, isperhaps Brazils most poignant monumentto that repeated triumph of experienceover hope.

Foreigners have short memories, butBrazilians have learned to temper their op-timism with caution even now, when thecountry is enjoying probably its best mo-ment since a group of Portuguese sailors(looking for India) washed up on its shoresin 1500. Brazil has been democratic before,it has had economic growth before and ithas had low in ation before. But it has nev-er before sustained all three at the sametime. If current trends hold (which is a big

if), Brazil, with a population of 192m andgrowing fast, could be one of the worlds

An audio interview with the author is at

Economist.com/audiovideo

A list of sources is at

Economist.com/specialreports

Breaking the habitAbrief history of Brazilian meltdowns.Page 3

Survival of the quickestFrequent crises have made for strong banksand nimble nanciers. Page 4

Arrivals and departuresForeigners are investing in Brazil, Braziliancompanies are going shopping abroad.Page 6

Condemned to prosperityBrazil has learned to love its commoditysector. Page 8

The self-harming stateCompanies are squeezed between an ob-structive government and black-marketcompetitors. Page 10

A better todayBrazils growing middle class wants the goodlife, r ight now. Page 12

Two AmericasBrazil and the United States have more incommon than they seem to. Page 13

Also in this section

AcknowledgmentsThe author would like to express particular thanks fortheir help in preparing this special report to: EduardoMufarej of Tarpon; Eduardo Giannetti and Claudio Haddadof INSPER; Marcelo Carvalho of Morgan Stanley; FernandoReinach of Votorantim; Candido Bracher and Jean-MarcEtlin of Ita BBA; Marcelo Neri of FGV; Alexandre Marinis

of Mosaico; Mauro Azeredo of the World Bank; Heinz-PeterElstrodt, Stefan Matzinger, Guilherme Lima, Tracy Francis,Fbio Stul and Roberto Fantoni, all of McKinsey; WalterCruz of Marcopolo; Nilson Teixeira of Credit Suisse;Aldemir Bendini of Banco do Brasil; Francisco Valim ofExperian; Damian Fraser of UBS; Joo Augusto de CastroNeves of CAC; Rodolfo Spielmann of Bain; Norman Gall ofthe Braudel Institute; and David Fleischer of BrasliaUniversity.

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A country brie ng on Brazil is at

Economist.com/brazil


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2 A special report on business and nance in Brazil The Economist November 14th 2009

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Brazilian and foreign rms, from lipstick-makers to investment banks, take advan-

tage of the countrys new stability?To see why Brazil currently seems so ex-citing to both Brazilians and foreigners, ithelps to understand just how deep it hadsunk by the early 1990s. Past disappoint-ments also explain three things about Bra-zil which outsiders sometimes nd hard tofathom: its suspicion of free markets; itsfaith in the wisdom of government inter-vention in business and nance; and per-sistently high interest rates.

When Brazil became independent fromPortugal in 1825, British merchants, de-lighted to discover a big new market,ooded Brazil with manufactures, includ-

ing, according to one possibly apocryphalstory, ice-skates an early example ofemerging-market fever. Even so, real in-come per person remained stagnantthroughout the 19th century, perhaps be-cause an inadequate education systemand an economy dependent on slaves pro-ducing commodities for export combinedto get in the way of development. Eversince the Brazilians have tended to viewfree trade with suspicion, despite theircountrys recent success as an exporter.

In the mid-20th century Brazil seemedto have found a formula for stimulating

growth and enjoyed what appeared to bean economic miracle. At one point its econ-omy grew faster than that of any other bigcountry bar Japan and South Korea. Thatgrowth relied on a state-led developmentmodel, nanced with foreign debt within asemi-closed economy. But growth alsobrought in ation, which crippled Braziluntil the mid-1990s and still accounts forsome odd characteristics, such as the coun-trys painfully high interest rates and itsdisinclination to save. All the same, themiracle wrought by the military govern-

ment persuaded Brazilians that the stateknew best, at least in the economic sphere,and even the subsequent mess did notquite persuade them otherwise.

Unhappy memoriesWhen this development model brokedown amid the oil shocks of the 1970s, Bra-zil was left without the growth but withhorrendous in ation and lots of foreigndebt. There followed two volatile decades,when Brazil started being likened to Nige-ria instead of South Korea. Productivitygrowth went into reverse. Many of thecountrys current problems, includingcrime and poor education and health care,

either date from that period or were exac-erbated by it. Between 1990 and 1995 in a-

tion averaged 764% a year.Then a real miracle happened. In 1994 a

team of economists under Mr Cardoso,then the nance minister, introduced anew currency, the real, which succeededwhere previous attempts had failed. With-in a year the Real Plan had managed tocurb price rises. In 1999 the exchange-ratepeg was abandoned and the currency al-lowed to oat, and the central bank wastold to target in ation. The ten-year anni-versary of this event has just passed, and

although there is continuing debate abouthow to make the real less volatile, none ofthe big political parties advocates goingback to a managed rate.

More than that, the reforms broughtdiscipline to the governments nances.Both federal and state governments nowhave to live within their means. A require-ment to run a primary surplus (before in-terest payments on the public debt) was in-

troduced in 1999, and the federal govern-ment has hit the target for it every yearsince, though there is a good chance that itwill miss it this year. This has allowed Bra-zil to get rid of most of the dollar-denomi-nated foreign debt that caused such insta-bility every time the economy wobbled.Now international creditors trust the gov-ernment to honour its commitments.Moodys, a rating agency, elevated Brazilsgovernment paper in September to invest-ment grade just as the governments ofmany richer countries fretted about beingable to meet their obligations.

Yet growth still proved elusive. It took abuoyant world economy and a surge incommodity prices to procure it. AlthoughBrazils economy is still relatively closed(trade accounted for a modest 24% of GDP

in 2008, less than 60 years earlier), itsgrowth is closely correlated with commod-ity prices, the Chinese economy, the BalticDry index and other measures of globaltrade. But at last in 2006 GDP outpaced in-ation for the rst time in over 50 years.

Lucky Lulas legacyBrazils current president, Luiz Incio Lulada Silva, has been able to take much of thecredit for the countrys recent growth thatperhaps properly belongs to his predeces-

sor. Yet Lulas achievement has been tokeep the reforms he was bequeathed andadd a few of his own not a meagre accom-plishment given that for the past sevenyears his own party has been trying to draghim to the left.

Lula is often mocked for beginning hissentences with the phrase, never beforein the history of this country . What hispolitical opponents nd even more infuri-ating is that he is often right. Brazil was ableto cut interest rates and inject money intothe economy as the world economy fal-tered at the end of last year, the rst time ithas been able to do this in a crisis. Whereasothers predicted that world events wouldtip Brazil into recession, Lula reckoned thatthe crisis would amount to nothing morethan a small tide breaking on his countrysbeaches. The economy shrank for onlytwo quarters and is now growing again.The contrast with Brazils performance inprevious crises could not be more stark(see box, next page).

Plenty of problems remain. The centralbanks headline interest rate is 8.75%, oneof the highest real rates anywhere in theworld. If the government wants a long-term loan in its own currency it still has to

link its bonds to in ation, making debt ex-pensive to service.

Cardoso (left) did Lula a big favour


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2Productivity growth is sluggish. That

may not seem the end of the world, but it

re ects realities such as the two-hour busjourney into work endured by people liv-ing on the periphery of So Paulo, thecountrys largest city, during which they of-ten risk assault before arriving too tired tobe very useful. The government investstoo little and has longstanding gaps in pol-icing and education to ll . The legal systemis dysfunctional. And so on.

Yet other countries face similar pro-blems, and Brazil has made real progress.In a country where businesses becameused to headline interest rates of 30% ormore, a rate below 9% comes as a relief.Its like the dierence between running a

marathon with 50 kilos on your shouldersand 20 kilos, says Luis Stuhlberger ofCredit Suisse Hedging-Grio, one of Bra-zils most successful fund managers. MrStuhlberger thinks that Brazils recent pastwas so awful, and its expansion of educa-tion and credit is so young, that the coun-

try can reasonably be expected to continueon its current trajectory, even without fur-ther big reforms. Even so, he argues, weare not going to have a Harvard or a Googlehere. The blame for that, he says, lieslargely with government policies.

Brazils economic story could certainly

be made more exciting with some reformsto its business environment. The countryspotential growth without a risk of over-heating can only be guessed at, but it isprobably below the 6.8% it reached in thethird quarter of 2008. Most economists putit at 4-5%. This suggests that interest rateswill not be coming down to levels consid-ered normal in other countries soon.

Still, stability has its own rewards. Ed-mar Bacha, one of the economists whoworked on the introduction of the real in1994, is pleased that the debates about Bra-zils economy have become so narrow.Back in 1993, when he joined the ministryof nance, in ation at one point hit 2,489%.Nowadays, he notes with a wry smile, thebig debates are about whether interestrates could come down from 8.75% to8.25%; or whether the central bank shouldhave started cutting a month earlier than itdid. That change has been good for Brazil,and particularly good for its banks and itsnancial system.

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1The right combination

Source: IBGE

% change on previous year

5.0

2.5

0

2.5

5.0

7.5

0

500

1,000

1,500

2,000

2,500

+

1981 85 90 95 2000 05 08

GDP Consumer prices

FOR most of the past few decades Brazilhas been one of the rst places to go

into a tailspin when things turn nasty else-where, as the following list demonstrates.1973-79: Oil shocks . The rst oil shock

doubled Brazils import bill within a year.The second set o uncontrolled in ation,which reached 110% for 1980. The next 15years were a continuous struggle to bringthat number down. They also saw a sharpincrease in short-term foreign debt de-nominated in dollars to pay for oil, herald-ing a decade and a half of instability.1982: Default . As Mexico defaulted, Bra-

zil, which had also borrowed a lot fromforeigners, found itself mistrusted too.The government tried to engineer a tradesurplus to reassure creditors, forcing im-porters to obtain licences and buy dollarsat an in ated o cial rate, but failed. In1983 it defaulted on its debt and the cruzei-ro plunged against the dollar, making in-ation even worse.1986: The Cruzado Plan . Three zeros

were chopped o the currency, and at rstBrazil seemed to have got on top of in a-tion. But it was also in the process of be-

coming a democracy (the rst civilian

president in two decades was chosen byCongress in 1985), and conquering in a-tion required holding down wages, whichBrazils new democrats found hard to do.The Bresser Plan (1987) and the Vero Plan(1989) fared no better. By 1990 in ationwas running at more than 70% a month.1990: The Collor Plan . The worst of the

lot, this one involved an immediate freezefor 18 months on bank deposits making up80% of the countrys nancial assets. Theidea was to force prices down by reducingliquidity. Wages were frozen, nancialtransactions were subjected to punitivetaxes and foreign exchange and tradewere liberalised. The policy set o a mini-recession, causing panic that led to a rever-sal. High in ation returned.1994: The tequila crisis . Another Mexi-

can devaluation and debt crisis that had aknock-on eect on Brazil. The central bankresponded to an out ow of money by in-creasing interest rates to nearly 50%.1997: The Asia crisis . Brazils commod-

ity exporters were hit by a fall in demandfrom Asia. Once again con dence plum-meted as money left the country. The cen-

tral bank fought hard to defend the real

which had been introduced in 1994, in-creasing overnight interest rates to an an-nual 40% and killing growth.1998-99: The Russia and LTCM crisis .

While still trying to get back on its feet,Brazil was hit again after Russia defaultedon its debt and a team of Nobel econom-ics laureates nearly fused the nancialsystem. The government was forced to letthe real oat freely, which was economi-cally correct but highly unpopular as thecurrencys value dropped.2001-02: The dotcom crash and Argen-

tinas default . Once again the realdropped on fears about Brazils neigh-bours and general unease about theworld economy and the election of Presi-dent Lula. In ation rose to 12.5% and theheadline interest rate went up to 25%.2007-?: The global nancial crisis .

What appeared to be the worst global re-cession since the 1930s left Brazil relativelyunscathed. It was able to cut interest ratesand the real held its value. Brazil turnedout to be one of the last countries into thedownturn and one of the rst out, causingnational celebration and not a little sur-

prise, given what had gone before.

Abrief history of

Brazilian meltdownsBreaking the habit


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BRAZILIAN businessmen often say thatthe countrys recent economic past has

strengthened companies, and especiallybanks. The argument goes like this: youneed to be good, or at least inventive, tosurvive and make money when you haveno idea whether in ation next year will be50% or 500%. Bankers and nance direc-tors have had to be particularly nimble.One example is Souza Cruz (a subsidiaryof BAT ), Brazils largest tobacco company,which in the days of high in ation did nobetter than break even on its cigarettesales. Its pro ts came from the interest onthe cash it held between being paid by re-tailers and paying tax fortnightly. Compa-nies used to operating in such unusual cir-cumstances ourished when life becamemore predictable.

There is some truth to this argument,even though it brushes aside the fact thatuntil the 1990s Brazilian companies did nothave to worry about foreign competitors.

No big companies went bust in the recentnancial crisis, despite losses on foreign-exchange derivatives that the Bank for In-ternational Settlements estimates at $25billion. Moreover, no big banks wobbled,let alone had to be rescued, though therewere some mergers.

One reason was that a previous roundof bank failures, in 1994, had alreadycleared out the bad ones. Until then banksmade their pro ts by taking deposits fromcustomers, lending the money to the gov-ernment overnight and pocketing the dif-ference. With in ation at several hundredper cent a year, many banks balance-sheets were hard to decipher. When in a-tion came down, it became clear that anumber of them were insolvent. Thesefolded or merged with other banks, leav-ing only the stronger ones.

Brazils nancial system got a furtherboost from reforms carried out when Ar-minio Fraga was governor of the centralbank from 1999 until the start of 2003 (he isnow at Gvea Investimentos, an invest-ment rm). The countrys bank-settlementsystem now operates in real time, so allbanks know their cash positions at any giv-en moment and the central bank has an

overall picture of what is happening. Be-fore this system was introduced the central

bank often ended up honouring the debtsof banks that went bust, creating a danger-ous incentive to be careless. Both Mr Fragaand his successor as governor, HenriqueMeirelles, have made sure that banks re-port what is going on in any o-balance-sheet vehicles they have funded. This hashelped to keep under control the special in-vestment vehicles, conduits and othermysterious creatures that have caused somuch damage in other countries.

This transparency extends to nancialmarkets too. All fund managers must dis-close the net asset value of their funds toBrazils Securities and Exchange Commis-sion ( CVM ) daily, though with a 48-hourdelay. At the end of every month fundsmust disclose what they were holding 90days ago. Anyone can go to the CVM swebsite and look up these numbers. Fundmanagers may grumble about too muchdisclosure, but most are happy with therules. Maria Helena Santana, who chairs

theCVM

, explains that they make it harderto pull o a scam of the sort run by BernardMado, whose pyramid scheme was hid-den behind a veil of secrecy.

Created equalEquity investors, for their part, have bene-ted from new rules for publicly traded

companies brought in by the So Paulostock exchange (Bovespa) in 2002. Big Bra-zilian companies used to be notorious forabusing shareholders with minoritystakes. Under current guidelines, it is ille-gal to issue shares that pay out dierentamounts to dierent holders in the eventof a takeover. Any disputes between share-holders are judged by the CVM . With theserules in place, foreigners have been happyto buy shares and Brazilian companies thatwere unable to borrow in capital marketsare now able to nance their expansion.

Aboom in initial public oerings ( IPO s)followed. At its height, in 2007, 80% of themoney for IPO s came from foreign inves-tors. This undoubtedly led to some ex-cesses: at one point there were more listedhousebuilders in Brazil than in America.But some of the companies that oatedwill do well. And the message conveyed

by the new rules that better corporate go-vernance allows people to make money

by selling bits of their companies on thestock exchange has been good for thefamily businesses that make up the bulk ofBrazils medium-sized rms.

Santander Brasils recent IPO was a test

of whether investors appetite for Brazilhad returned. It proved to be the worldslargest IPO this year, valuing the banksBrazilian subsidiary at more than thewhole of Deutsche Bank worldwide. Thegovernment is so worried about foreignportfolio investors pushing up the value ofthe real that it imposed a 2% tax in Octoberto discourage them. IPO s have a widerbene t because companies that want tooat all or part of their stock need to get

their accounts in order, pay their taxes andmake sure their workers are not part of theblack economy.

All this has brought sophistication andliquidity to Brazils nancial markets. SoPaulos futures and options market is oneof the ve largest in the world by volumetraded. Well-developed markets have beengood for consumers too. High interestrates, high in ation and dysfunctionalcourts once made consumer credit rarerthan snow. Thanks in part to a series of re-forms carried out in Lulas rst term, credithas grown steadily. Loans for bigger items,such as cars and apartments, have becomeavailable for the rst time, thanks to a newlaw under which a lender remains theowner of the asset acquired with the loan

until the last repayment is made, whereaspreviously the money would have had to

Survival of the quickestFrequent crises have made for strong banks and nimble nanciers

2000 02 04 06 08

2Squeezed

Sources: Central Bank of Brazil; Credit Suisse

Policy interest rate and bank credit

1999 2001 03 05 07 09

0

10

20

30

40

50

SELIC interest rate, % Credit, % of GDP


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2be chased up through the courts.

Lulas rst administration also intro-

duced a new bankruptcy law that is credit-ed with making it slightly easier to salvagesomething from companies that go under.There was room for improvement: a fewyears ago a World Bank study found thatbankruptcy proceedings in Brazil took anaverage of ten years and left creditors with

just two cents in every dollar owed.Yet for all this progress, two glaring pro-

blems with Brazils nancial system re-main. First, credit is very expensive. Sec-ond, only the government will lend forlong periods, and not to everyone.

Tax and lend

Brazil has a hybrid retail banking system,with state-controlled and private-sectorbanks competing directly. It is highly con-centrated: Ita Unibanco, the largest priv-ate bank, is among the worlds 15 biggest onseveral measures and yet has almost nopresence outside Brazil. Banco do Brasil,the largest state-controlled bank and oneof the worlds oldest nancial institutions,vies with it for the title of the countrys big-gest bank. All told, credit from state-con-trolled banks makes up 37.6% of the totaland has recently been growing.

Despite their dierent owners, the

state-controlled and the private banksseem to be behaving in a remarkably simi-lar way. Aldemir Bendini, the chief execu-tive of Banco do Brasil, talks enthusiastical-ly about international expansion. Thebank will soon open ve agencies inAmerica to serve Brazilian expatriates. Italso wants to help Brazilian multinationalsabroad with local-currency nancing.Meanwhile it will keep up its role as an in-strument of public policy that does thebidding of the federal government, its big-gest shareholder, and also look after the22% of its shareholders who own tradedstock. It looks like an incongruous mixture,but it appears to work. Ita Unibanco too iskeen on expansion abroad, but makes somuch money at home that it does not seemto be in a rush.

In theory, all this should provide plentyof competition, with the two types of bankkeeping each other honest and makingsure that Brazilians have access to credit. Inpractice it does not quite work like that.Even though Ita alone has 25,000 cashpoints, more than 500 municipalities inBrazil lack even a single bank branch. Thetwo kinds of bank compete most ercelyin the comparatively wealthy south and

south-east of the country. Banco do Brasilrecently added to the geographical concen-

tration by buying Nossa Caixa, a So Paulostate savings bank, and a large stake in

Banco Votorantim, a private-sector bank.The government has raised the limit forforeign participation in Banco do Brasil to20% to attract more capital, but the state-controlled banks are not as well run as theprivate-sector ones, so the hoped-for com-petition has not materialised. The clearestsign of this is spreads the dierence be-tween a banks cost of borrowing andlending. The Institute for Industrial Devel-opment, a lobby group, calculates that av-erage lending rates are 35% higher than de-posit rates, against less than 10% in theother BRIC countries. The bankers lobbydisputes these gures, but nobody thinksthat banks spreads are thin.

Among the things that make them fat-ter are a curious tax on bank funding thatincreases costs, and high reserve require-ments which mean that banks mustsqueeze more revenue from what they areable to lend. Bad-loan provisions are hightoo, re ecting the fact that consumer creditis concentrated among people who are al-ready stretched. And a lot of credit is subsi-dised, which pushes up costs for the rest.

Brazils banks have many things to re-commend them; indeed they seem to ex-emplify what might happen if regulators

elsewhere got their every wish. They aresafe and their lending is well-capitalisedand pro table. Two-thirds of Brazilian de-posits are in local banks, which is unusu-ally high for Latin America and a bigchange from the past, when anyone whohad money kept it out of the country and

in dollars. The banks also oer some thingsthat would surprise American or Euro-pean customers. Many ATM s provide awide range of nancial services, from dis-pensing cash to providing loans. Even so,for now credit is likely to remain too ex-pensive for the countrys good.

For companies trying to get credit, theproblems are much the same. To make upfor the absence of a market in long-termdebt Brazil created a giant developmentbank, the BNDES , with a balance-sheetlarger than the World Banks. This is -nanced by an impost on labour and lendspredominantly to Brazils biggest compa-nies the opposite of what you would ex-pect from a left-leaning country.

Because its large loans to Brazils bignames carry so little risk, the BNDES ispro table. It also does some more adven-turous lending, although trickier credit as-sessments are farmed out to private banks,which collect a fee for their pains and alsoassume the risk of loans going bad. TheBNDES was useful to Brazil during the re-cent crisis as a stable source of funding, butits scale as the lender of choice for Brazilsbest credit risks is probably impeding thedevelopment of markets in long-termdebt, and the way it is funded seems fun-damentally unjust.

Still, compared with the bank failures,frauds, market manipulation, volatility,disregard for contracts and near-absenceof credit of the past, Brazils nancial sectorhas come a long way. Foreign investorshave noticed, and have recently startedpouring money into the country. 7

Plenty to celebrate


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TRADING with Brazilians has not al-ways been easy. Jean Lery, who visited

the country in the 1550s, wrote an accountof the trading practices of the Ouetaca peo-ple, who liked to exchange goods by plac-ing them on a rock 200 paces away andthen retreating. The trading partner did thesame, and the dance was repeated as eachgroup got what it wanted. As soon as eachone has returned with his object of ex-change, and gone past the boundaries ofthe place where he had rst come to pre-sent himself, wrote Mr Lery, the truce isbroken, and it is then a question of whichone can catch the other and take back fromhim what he was carrying away.

That would have rung a bell with someof Brazils foreign investors in more recenttimes, from Daniel K. Ludwig, who repeat-ed Henry Fords jungle folly a few decadeslater, to the Japanese banks that tried to en-ter the market, to US Steel, which discov-ered Carajs, the worlds largest iron-ore

deposit, before being forced into a jointventure with a government company andthen selling out of a mine that is still goingstrong 30 years later. Lots of other foreigninvestors have done well, however, andBrazil is enjoying a new wave of trust andoptimism as the world pours in money(see chart 3). It has become the second-larg-est destination for FDI ows into develop-ing countries after China.

Foreign investment in Brazil has a longhistory. British investors built railways atthe end of the 19th century to get commod-ities to ships and then to market. GE rstentered this emerging market in 1919. Its lo-cal

CEO, Joo Geraldo Ferreira, likes to

point out that GE s light bulbs illuminatedRios famous statue of Christ the Redeem-er when it was put up in the 1930s. A waveof foreign investment arrived in the 1950s,when China and India were closed and theKorean peninsula was at war. The car com-panies that have been in Brazil for a while,such as Fiat, GM and Volkswagen, havedone particularly well recently: for the pasttwo years Brazil has been the worlds fast-est-growing car market.

Earlier this year the Brazilian and Chi-nese governments announced that China

Development Bank and Sinopec, a Chi-nese oil company, will lend Brazils Petro-

bras, a state-controlled but publicly tradedoil company, $10 billion in return for up to200,000 barrels a day of crude oil from thecountrys new oil elds for ten years. Giv-en Chinas hunger for commodities andBrazils openness to investment, more of

this sort of thing is expected.Investments in Brazil that have failedtend to have one feature in common. For-eign companies arrive in Brazil full of opti-mism, pay too much for a local rm andthen leave when things turn sour, oftenselling the same company back to a Brazil-ian rm for a small fraction of what theygave for it. One example is Molson, a Cana-dian beer company that bought Kaiser, aBrazilian brand, in hopes of refreshing Bra-zils hordes of beer drinkers (though thecompany ended up selling to a Mexicanrm rather than a Brazilian one). Goldman

Sachs, the investment bank that inventedthe term

BRICs , has been in and out of

Brazil a couple of times. UBS bought Pac-tual, a Brazilian investment bank, beforeselling it back to Andr Esteves, a formerboss of the bank, earlier this year.

Lets do the jeitinhoNow that Brazil has become more predict-able, fewer foreign investors will fall intothis particular trap, but there are others. Be-cause of the unsatisfactory legal system,commercial disputes with other compa-nies are best avoided. This makes personalties especially important. And once the

bosss children are safely married to theospring of the rms business partners,

any company wanting to succeed in Brazilwill still have to learn the art of the jei-tinho a Brazilian knack for getting aroundobstacles to doing business which wouldmake European or American compliancedepartments shudder.

Even as foreigners have been piling intoBrazil, a number of Brazilian rms havebeen entering markets overseas. For therst time Brazil has a crop of companies

that can be described as multinationals.Some of them are already well known out-side Brazil: Petrobras; Vale, one of theworlds largest mining companies; andEmbraer, the worlds third-largest maker ofpassenger jets.

Others may be familiar only to thosewho follow these sectors closely: Gerdauand CSN , two steelmakers; Marco Polo, abus builder; Perdigo and Sadia (soon tomerge into Brasil Foods) and JBS -Friboi, allfood companies; WEG , which makes elec-trical components; Odebrecht and Ca-

margo Corra, two construction rms; Na-tura, a cosmetics-maker; Votorantim, anindustrial conglomerate; and Coteminas, atextile rm.

In the most recent list of 100 companiesfrom emerging markets that are evolvinginto multinationals compiled by the Bos-ton Consulting Group, 14 are based in Bra-

Arrivals and departuresForeigners are investing in Brazil, Brazilian companies are going shopping abroad

3Come hither

Sources: IMF; Haver Analytics

Inflows of foreign direct investment into Brazil$bn

0

10

20

30

40

50

1975 80 85 90 95 2000 05 08

REAL PLAN

Iron rations at Carajs


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2zil. At the last count, the Fundao DomCabral, a business school, reckoned therewere more than 40 large Brazilian rms un-dertaking value-adding activities in dier-ent parts of the world. Many of these com-panies began their expansion into foreignmarkets decades ago. Most turned rst tomarkets in neighbouring countries thatwere fairly familiar. Their main motiveseems to have been to hedge against Bra-zils ups and downs, rather than excite-ment at the potential for growth beyondtheir borders.

The latest wave of expansion is dier-ent: both more ambitious in geographicterms (Vale alone has a presence on vecontinents) and more self-con dent. Mostof the companies concerned feel that,much like Brazils banks, they have sur-vived and prospered through di cult de-cades in a harsh business environmentand are ready to operate in risky markets.

Some of the success stories have bene-ted from privatisation, or at least part-pri-

vatisation. One of the puzzles about Brazilis why politicians should feel unable totalk about privatisation despite so manysuccesses. In the most recent presidentialelection, in 2006, Lula accused his main ri-val, Geraldo Alckmin, of wanting to priva-tise anything that whirred or beeped, and

Mr Alckmin promised that he would neversell o anything.

Aprivate treasureEmbraer is a good example of what privati-sation can achieve. Like many of Brazilsindustrial giants, it was created by the gov-ernment. In a joint venture with Italys Ale-nia Aermacchi that gave Brazil access to jettechnology for the rst time, it producedthe AMX ghter jet in the 1980s. But by the1990s the company was struggling, produc-ing models that nobody wanted to buy.Since privatisation in December 1994 Em-braer has turned itself into the worlds big-gest manufacturer of mid-range passenger

jets. In the companys factory in So Josedos Campos, where sheets of aluminiumare fed into one warehouse and 100-seateraircraft come out of another some monthslater, planes are waiting for delivery tocommercial airlines in China, India, Po-land and Britain. Some 96% of the com-panys revenue now comes from exports.

Although Brazils main domestic carri-ers use aircraft built by Boeing and Airbus,Embraers machines have proved popularwith American carriers for short-haulights so much so that the company is

probably more exposed to the uctuationsof Americas economy than of Brazils. It

also has a good business making militaryplanes and private jets and even producesa small propeller plane for crop-spraying,the Ipanema, that runs on ethanol.CSN , a large steelmaker, was foundedby the Brazilian government in 1941, priva-tised in the early 1990s and has ourishedsince. Petrobras has also done well sincepart of its stock was oated. But perhapsthe best example of privatisation and in-ternational expansion is Vale, which start-ed o private but was nationalised duringthe second world war to help Americaswar eort by supplying iron ore.

It took its rst steps abroad in the 1980sand 1990s before being privatised in 1997(though as with Embraer, the Brazilian gov-

ernment still holds a golden share thatwould probably prevent it from being tak-en over). At the beginning of this decadeVale was a medium-sized mining com-pany with a strong iron-ore business inBrazil and some interests in forestry andother bits and pieces. Now it is one of theworlds four biggest mining companies.

Thanks to the commodities boom, Valewould have grown almost whatever it did.But it is doubtful whether it would havecome so far, so fast, had it remained in pub-lic hands. Under Roger Agnelli, who hadpreviously been an investment banker,Vale has sold o its peripheral businessesand is now concentrating on metals, with asideline in electricity generation and, inBrazil, railways. Vales $19 billion acquisi-tion of Inco, a large nickel producer basedin Canada, allows the company to provideall the raw materials that steelmakersneed. In 2005 Vale was able to raise pricesfor its iron ore by 71.5% in tough negotia-tions. It is hard to imagine the old statemining company pulling that o.

If Brazils current government seemshostile to the notion that privatisationtends to improve companies, it does likethe idea of having a number of national

champions succeeding abroad.BNDES

hasbacked up the governments rhetorical

support by lending $8 billion so far thisyear to help the expansion of Brazilianmultinationals. This is a big change from 15years ago. Carlos Arruda of the FundaoDom Cabral recalls that shortly after he be-gan compiling an economic-competitive-ness survey for the World Economic Fo-rum in 1996, he received a letter from agovernment minister informing him that itwas not in the governments interest tohave Brazilian companies expand abroad:capital was scarce and jobs had to becreated at home. This view was reinforcedby laws that made it impossible to sendpro ts from foreign subsidiaries back toBrazil or to recognise losses made abroadin company accounts.

This change in attitude has helped, butBrazilian multinationals are not immuneto the kind of problems that have some-times caught out foreign investors in Brazil.Petrobras has had some of its Bolivian as-sets nationalised by that countrys presi-dent, Evo Morales. Odebrecht has had asimilar experience in Ecuador. These, how-ever, are relatively trivial compared withEmbraers current di culties in China. Thecompany opened a factory in Harbin in2002 where it has a joint venture with thesnazzily named China Aviation IndustryCorporation II (the only way of gaining ac-cess to this big new market). Embraer hadplanned to make only older models in Chi-na for fear of losing control of its intellectu-al property. But the Chinese company is in-sisting that Embraer produce its newestmodels there, and there is now a chancethat Embraer will withdraw from makingaircraft in China altogether.

No doubt many of Brazils new multi-nationals will encounter similar problemsas they venture abroad. But even if they do,companies that are essentially commodityproducers, consumers or traders (whichmake up a majority of the new multina-tionals) can rest assured that their built-in

comparative advantage is unlikely to beeclipsed soon.7

Aircraft-maker to the world


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1

NOT many countries are named aftercommodities. There is Argentina,

from the Latin word for silver; CtedIvoire, a reminder that natures endow-ments do not always lead to prosperity;Panama and Uruguay, whose names maycome from indigenous words for sh; andalso Brazil, which became known for itsBrazil wood, the source of a valuable dye.Prior to that Italian merchants apparentlycalled it the land of parrots. Brazil has al-ready lived through several commoditiesbooms: precious metals in the 17th century,sugar in the 18th and coee in the 19th. Yetnone of them bene ted the country asmuch as the current one.

The large discoveries of oshore oilmade by Petrobras in 2007, which havegenerated so much excitement recently,have made it easy to forget that Brazil is al-ready the worlds largest exporter of coee,sugar, chickens, beef and orange juice. Italso exports vast amounts of soya and iron

ore, as well as other ores and metals. Itscommercial forests are the source of muchof the worlds pulp. If other countriesopened their markets, Brazil would supplythem with ethanol to fuel their cars too. Ahistory of booms and busts in the marketsfor raw materials is written into the coun-trys landscape.

Yet for a long time Brazil did not capital-ise properly on all this wealth. Brazilian in-tellectuals used to argue that the countrysrole as a commodity producer perma-nently consigned it to the periphery of theworld economy. Then two things changed.

First, improvements in the countrys nan-cial system and greater economic stabilityallowed businesses to invest without fearthat some economic catastrophe was like-ly to befall the country. This is re ected inthe large share of investment going into thecommodity sector. Second, the worldwideboom in commodities this decade made itmore pro table to plough elds and digholes, bringing about a big change in Bra-zils terms of trade (see chart 4).

Plough, scatter, repeatIt is safe to assume that the worlds hungerfor protein is not going to abate. Peoplestart eating lots of meat when they reachan income of about $10,000 per person.Some 80% of the worlds population haveyet to get to that point. As they do so, nd-ing spare land and increasing the e ciencyof farming will become ever more impor-tant. Brazil has plenty of spare land, evenwithout destroying its forests to create

more, and much of its farming is done bysmall, family-run businesses that could in-crease production with more capital andbetter management.

Brazil has already pulled this o once.Largely thanks to the work of Embrapa, agovernment research agency, Brazilianfarmers in the 1960s and 70s steadily in-creased the area in which crops could becultivated. Acidic soil, with l ittle phospho-rous and lots of toxic aluminium, was re-balanced, and crops were specially bredfor Brazils tropical environment. Between1968 and 1997 a total of 116 new varieties ofsoyabeans were launched. In the past fewyears new ones have been added at therate of almost 100 a year.

Among other things, Embrapa, work-ing with private-sector companies, is try-ing to develop a variety of wheat that willgrow in Brazil. At the moment, reckons Ju-lio Pisa of BrasilAgro, which owns 166,000hectares of farmland in Brazil, the countryhas 20m spare hectares of good productiveland. Not all of this will be as sumptuousas in Rio Grande do Sul state, where somefarmers can harvest a tobacco crop, a corncrop and a bean crop from the same land ina single year (culminating in a lively bean

festival in January), but it will be prettygood. Perhaps more importantly, Mr Pisa

points out, when Brazil exports food it isalso exporting water, and Brazil is fortu-nate enough to have a surplus of fresh wa-ter per head of population.

But before Brazils agriculture can reachits full potential, there are a few problemsto overcome. The rst is a long-running ar-gument about who has the right to whatpiece of land. Land tenure becomes lessand less certain as you approach the equa-tor. In the Amazon this results in deforesta-tion as farmers cut down trees to establishde-facto ownership of land. In other partsof the country the disputes take the formof farm invasions by the Landless Move-ment ( MST ), which has many ideologicalsympathisers in the government, includ-ing the president himself.

The MST tends to go for farmland that isnot too far from cities, but Fibria, a big pro-ducer of wood pulp, has had trouble withinvasions of forests it owns in remote partsof Bahia state. These invasions can be col-

ourful: one group, made up entirely ofwomen, likes to arm itself with pitchforksbefore descending on farms.

As might be expected of a loosely or-ganised movement in a big country, theMST appears in lots of dierent guises, de-pending on the place. One of its oldest set-tlements, at Pirituba in So Paulo state,now looks a bit like a kibbutz tinged withnew-agey environmentalism. By contrast,in the northern state of Pernambuco MST

members shot and killed four men earlierthis year.

Lost highways

A second problem holding commodityproducers back is Brazils patchy infra-structure. After much sifting through data,the World Banks Growth Commissionconcluded that, in order to keep growingfast, developing countries should investaround 25% of their GDP , of which about7% should go on infrastructure. Brazils in-vestment level has been creeping up to-wards 20% in recent years, but in 2007 thegovernment invested just 0.1% of GDP onimproving transport.

For some of the biggest companies thisis not a problem. Vale has its own railway

lines, which allow it to get its iron ore fromCarajs to market without much trouble.

Condemned to prosperityBrazil has learned to love its commodity sector

99 01 03 05 07

4Grist to the mill

Sources: IMF; IBGE

% change on previous year

1998 2000 02 04 06 0815

10

5

0

5

10

15

20

25

+

Brazils GDP

Non-fuel commodity prices


10/15


2

1

The company is also a shareholder in MRS

Logsticas railway network in the south ofBrazil, along with CSN and Usiminas, an-other steel company. Just as in America inthe late 19th century, when Standard Oiland Carnegie Steel used the railroads un-der their control as a weapon against theircompetitors, these companies are able tomaintain a system that works well forthem but not for others. Some 60% offreight in Brazil goes by road and only 20%by rail, compared with an even split in theUnited States. Amrica Latina Logsticasrail network is open to whoever wants touse it but covers only part of the country.

Once goods are loaded into trucks,everything slows down. Brazils lorries, onaverage, are 14 years old. Their bumpersare usually adorned with foot-high lettersdeclaring that the driver has put his trust inGod, which is just as well given the state ofthe roads and some of the overtaking thatlorry drivers do.

Brazil has the worlds third-largest roadnetwork, but only 12% of it is covered in as-phalt. IPEA , a government economic-re-search agency, reckons that road deaths pervehicle on the road in Brazil (some 35,000in 2006, the latest available gure) are sixtimes as frequent as in Japan.

When the trucks eventually make it to

the port, often after spending hours in traf-c jams, everything slows down again.Brazils ports tend to be run as oshoots ofthe civil service rather than as private com-panies, with all the problems that entails.To speed up the loading and departure ofships, companies sometimes nd they arerequired to make extra payments, whichpublicly listed multinationals struggle toexplain in their accounts and to justify totheir shareholders.

Brazils ports are both more pro tableand less e cient than their peers else-where. Competitors who want to enter themarket are discouraged. When Eike Batista,the most swashbuckling of Brazils currentcrop of entrepreneurs, applied to build anew port in So Paulo state he was unableto secure an environmental permit for hisproject. There is also a suspicion that Braziloccasionally uses its sluggish customs ser-vice to in uence trade data. Strikes havesometimes coincided with periods whenthe real has been particularly strong andimports have been rising fast.

Many people seem to believe that allthis can be turned around. At the start of2007 the government announced a pro-gramme for accelerating growth , concen-

trating on infrastructure, which most agreeis a small step in the right direction. Several

state governments have subcontracted theexpansion and improvement of existingroads to private consortia which are al-lowed to collect tolls. Infraero, the statecompany that runs Brazils airports, is step-ping up its investment. Pablo Haberer ofMcKinsey, a management consultancy,reckons that in four or ve years time Bra-zils airports will be better than those ofthe United States.

But even when the federal and stategovernments are behind new infrastruc-ture projects and money has been allocat-ed, often nothing happens. The prospect ofhosting the football World Cup in 2014 andthe Olympics two years later should in-

spire some action. But it would be a stretchto argue that the roads, airports and stadi-ums that will be built or renewed for thebene t of sports enthusiasts will be exact-ly what Brazils exporters need.

Below the saltThese problems have been with Brazil forsome time, and companies mostly ndways around them. But the discovery ofabundant oil o the countrys coast posesa dierent set of challenges.

To begin with, the oil sits three to fourmiles below the sea, between layers ofsalt. This is deeper than any company hastried to drill before. Because it is so deepdown, the oil will come out hot and thencool rapidly as it nears the surface, leavingdeposits of para n that will clog up pipes.Gases under high pressure will come out atthe same time as the oil. The drilling plat-forms will be 185 miles out to sea, out ofrange of helicopters. Some combination ofboats, oating platforms and helicopterswill have to be employed to get rig workersthere and back.

To solve these problems, Petrobras hasannounced the worlds largest capital-ex-penditure programme, worth $174 billion

over the next few years. This is a boon tocompanies such as GE , which has a $250m

deal with Petrobras to supply Christmastrees (the part that anchors an oil rig to thesea bed). The government has said that itexpects Petrobras to work with oil-servicesrms like Schlumberger and Halliburton,

as well as with foreign oil companies thatwant to boost their reserves.

No doubt many foreign oil companieswill come to Brazil and partner Petrobras inthe new elds. Compared with manyplaces where they do business, Brazil is amodel of predictability, good regulationand respect for contracts. However, the cal-culation has just been made more compli-cated for them by the federal governmentsannouncement that it is getting rid of the

regulatory framework that has served thecountry well for ten years and helped tobring about the new discoveries.

The existing system, in which royaltiesare paid to the state, could be tweaked tore ect the risk of exploration in the eldsbelow layers of salt (though this appears tobe low). But the government wants to re-place it with a new set of rules that wouldinvolve it more directly in the manage-ment of exploration and production. Un-der the latest proposals a new state oilcompany, Petro-Sal, will take part in allnew ventures. Petrobras will also have aguaranteed stake in each block. Other com-panies can come in as minority partners.Lula is also insisting that everything usedto extract the oil should be made in Brazil,which will push up costs and slow thingsdown. All this makes it less attractive forforeign investors to get involved, at a timewhen Brazil needs a lot of capital to makethe most of its new discovery.

Although the numbers suggest that Bra-zil is at last making proper use of its agricul-tural and mineral riches, there is anotherside to the boom that is not re ected in thegures. High commodity prices are corre-

lated with deforestation in the Amazon as

trees are cut down to create farmland tofeed Brazils domestic market. It is a dread-

Running out of road


11/15


2

1

IT IS easy to become depressed when con-fronted by the waste, incompetence and

downright obstructiveness towards peo-ple trying to make a living contained with-in Brazils three layers of government. Soperhaps it is best to start by saying that theBrazilian state does some things very well.It has prevented an AIDS epidemic by de-ploying sensible public policies. Some ofits ventures into research and develop-

ment have helped the economy. It has thehighest share of renewable energy in pow-er generation of any big economy.

The state of Minas Gerais has em-ployed private-sector expertise to bringabout what it calls a management shock ,eliminating de cits and measuring theperformance of its various departments.Some of the people who worked on thisproject in Minas have been trying to dosomething similar in Rio de Janeiro state.The Centre for Public Leadership, a charitybased in So Paulo, is running courses formayors who want to learn more aboutmanagement techniques.

Even in Braslia, the capital, whichtends to hold out longest against such im-provements, things are happening. WhenI arrived at the ministry of mines and ener-gy there were three engineers and 25chaueurs, Dilma Rousse, one of thefront-runners in next years presidentialelection, told a gathering of foreign report-ers recently. We need to make our civil ser-vice professional and meritocratic.

The Brazilian states problem is not somuch that it is overbearing and incompe-tent, a common complaint, but that it isweak where it ought to be strong and

strong where it should be weak. It canwithhold environmental permits for new

hydroelectric dams or ports, preventingthem from being built, but it cannot stopraw sewage from being pumped into theriver that runs through the countrys larg-est city, or keep illegal loggers from despoil-ing its forests. It can make it extremely di -cult for large companies to hire and reemployees or to pay their taxes, but it can-not prevent some 45,000 of its citizensfrom being murdered each year.

Brazils government has a lot of re-sources to draw on. Tax revenue hasclimbed to 36% of GDP , compared withAmericas 28%. Yet its public institutionssometimes resemble nothing so much asthe laboratory of a lunatic alchemist inwhich gold is transformed into lead. Brazilspends about three times as much per per-son on health care as China does, but itsbasic health indicators are slightly less fa-vourable. Spending on education is re-spectable, at 5% of GDP , but Brazils pupilsroutinely come near the bottom in theOECD s international comparisons of howmuch they know.

Admittedly Brazil was a late starter inpublic provision of both health care andschooling. As late as 1930 only one in vechildren went to school. Because of highin ation in the second half of the 20th cen-tury and chaotic government nances in1980-94, there was not enough investmentin schools and hospitals. It is something ofa platitude for Brazilian bosses to say thatgetting hold of skilled people is the biggestlong-term challenge heir businesses face,but almost all repeat it.

Yet Brazil is prevented from spendingmore in these two important areas by odd

rules governing public expenditure. Theconstitution, written in 1988, after the re-

turn of democracy, in parts reads like abudget rather than a description of a set ofinstitutions to govern the country. Writtenbefore in ation had been brought undercontrol, it is a monument to indexation. So-cial-security bene ts are guaranteed un-der the constitution to the end that theirreal value is permanently maintained .The OECD estimates that nearly 90% of thefederal governments total revenue is ear-

marked in this way. Public-sector pen-sions, which account for over half of socialspending, disproportionately bene t the(relatively) wealthy. Civil servants and pol-iticians alike complain that this deniesthem the exibility they need to improveservices, yet inertia consistently wins out.

Easy does itMeanwhile the government imposes hightaxes on companies and makes it hard topay them. The World Banks most recentsurvey on doing business ranked Brazil150th out of 183 countries on how easy it isto pay taxes. It took the banks hypotheti-cal average Brazilian rm 2,600 hourswork to pay its taxes every year. Any largecompany operating in Brazil has upwardsof 30 people struggling to comply with thetax code. And tax rates are fairly crushingtoo: the World Banks hypothetical com-pany faced cumulative taxes amounting to69% of its pro ts.

Hiring and ring people is complicatedas well, and if a case is brought to court italmost always nds for the employee rath-er than the employer. Brazils current la-bour laws were conceived in the 1940s, at atime when it seemed that in future all

workers would be employed makingthings in big factories belonging to stable

The self-harming state

Companies are squeezed between an obstructive government and black-market competitor

fully wasteful process because the thin soilis quickly exhausted and ranchers move

farther into the jungle, leaving a devastatedlandscape behind them. The forests of theCerrado, an area of savannah punctuatedwith trees that once covered much of cen-tral Brazil, are disappearing even faster.

As for mining, for every multinationallike Vale that collects data on injuries anddeaths in its mines there are plenty that donot seem to care much about what hap-pens to their workers. Of the ten largest

mining companies operating in Brazil con-tacted by The Economist, only a couple hadnumbers on deaths and injuries in theirmines. In the informal part of the miningsector, from wildcat gold-miners in themiddle of the Amazon to the guseiroswhodig for pig iron in Minas Gerais state, thingsare even worse.

Where intellectuals once worried thatBrazils natural resources would con ne itto a marginal place in the world economy,now they are concerned that Brazils com-

modity wealth will condemn the coun-trys currency to getting ever stronger,making life impossible for manufacturerswith their sights on exports. They probablyhave a point. But it could be dealt withmuch more easily if Brazilian companiesdid not nd themselves squeezed betweentwo walls that are constantly pushing in onthem. On one side is a public sector thattaxes too heavily and spends badly. On theother is a large black economy that theynd it hard to compete with. 7


12/15


2companies that would keep them on forlife. Things have not turned out like that,

but Brazil has consistently failed to updatethis legislation. Companies must pay hightaxes and compulsory contributions foreach employee on their payroll (over andabove salaries) which in the World Bankshypothetical company added up to 47% ofpro ts. Directors of companies in indus-tries with high sta turnover, such as IT

services, complain that they are held per-sonally liable in dozens of lawsuitsbrought by former employees, and maynd their bank accounts frozen by the

courts. This happens in the public as wellas in the private sector.

On other measures, from starting abusiness to closing one down, Brazil alsofares badly. When the World Bank releasesits annual business survey, the federal gov-ernment sometimes grumbles about a for-eign conspiracy. But the international-competitiveness survey conducted by theFederation of So Paulo Industries (betterknown as Fiesp) tells a similar story, plac-ing Brazil 37th out of 43 countries surveyed.

If a contract is broken or payment with-held, it is better to give up than rely on thecourts for redress. Brazils laws permit al-most limitless appeals, so even fairly trivialcases can eventually end up in the Su-

preme Court. Between them, its 11 justicesreceived over 100,000 cases last year. Thebacklog is enormous, and a good lawyercan often delay a judgment inde nitely,even in serious cases. Antonio Pimenta Ne-ves, a journalist who was found guilty ofthe murder of his former girlfriend nineyears ago, has yet to go to jail.

The problems that ail the courts areclear from behind the large desk of judgeLuiz Zveiter, the current president of RiosTribunal of Justice. The courts employ20,000 people in this state alone (about 75of them just pushing trolleys of sand-wiches for sale along the two-and-a-half-miles of corridors in the various build-ings). Some 800 cases are pending beforethe courts of second instance and 800,000before the courts of rst instance (whichare least able to cope with the ow ofcases). The oldest case outstanding datesfrom 1911. The state often does not wantthese cases to end in case it has to pay up;the citizens often dont want them to endin case they have to pay nes. So the courtsend up paying the bill, explains JudgeZveiter. And yet Rios state legal system isthe most e cient in Brazil. By the end ofthis year it aims to have no cases outstand-

ing from before December 2005. In thecontext that would be a triumph.

Given how di cult life is for compa-nies that pay taxes and comply with la-bour laws, it is unsurprising that Brazil hasa large informal economy (see chart 5). Itsblack economy is a place of wonderful in-vention. The quality of the juice bars andrestaurants in even the most miserableslums often surprises rst-time visitors.But a large black economy is bad for acountry, and normally it fades away withrising a uence. This has indeed been hap-pening in Brazil: between 2003 and 2007the number of formal-sector jobs grew by

just over 5% a year, a remarkable feat giventhe strength of the forces working againstit. But given Brazils level of development itshould be happening faster.

Living in the shadowsThus many companies in the formal econ-omy nd themselves squeezed between aset of rules that makes it expensive forthem to operate, and competition from in-formal competitors who do not abide bythose rules. This is not much of a problemin the car industry: nobody has startedmaking Volkswagens at home yet. But inother areas it can be, retailing being theworst oender.

A study of Brazils informal sector byMcKinsey suggests that informal business-

es in Brazil are about half as productive astheir competitors who follow the rules.This is partly because they lack access tocapital, and partly because they nd itcheaper to add more workers than to buymachines, so long as they pay no taxes onemploying people. Yet despite their rela-tive ine ciency, these businesses are typi-cally more pro table than rivals in the for-mal economy, which is another bene t ofnot paying tax or obeying product-market

regulations. There is little incentive forthem to grow, because bigger rms tend toattract the attention of the taxman. Butthey are hard to compete with.

That competition makes it harder forlaw-abiding companies to grow. This re-duces the governments tax revenue andcreates two unequal classes of workers:one vociferously defended by unions andenjoying generous bene ts and job protec-tion in addition to their salaries, the otherwith nothing beyond the cash handed outto them at the end of the week.

All this helps to explain why manyparts of Brazils economy are so fragment-ed. The ethanol business is a good exam-ple. You might expect it to be dominated byperhaps ten or 20 big companies, but in-stead it is splintered into hundreds. Whatstops consolidation is that formal compa-nies seldom agree with informal onesabout what their farms are worth, becausepro ts look lower when all the costs ofobeying the law are factored in. In sectorsthat employ three-quarters of the labourforce, not counting the government, thereis everything to do, says Bill Jones Jnr,who advises clients of McKinsey on deals.But mostly it is tough to actually do any of

it. This fragmentation holds back Brazilsgrowth too.

Some companies in the black economyare nding life less comfortable than theyused to. Informal pharmacies, for exam-ple, were hit when suppliers rather than re-tailers were made responsible for payingtax on their goods. So Paulos system ofgiving people a tax rebate when they askfor a receipt that the state government cantrace is having an eect on shops and res-taurants. A new law introduced in July al-lows very small businesses with just oneemployee to be given formal status at thecost of 50 reais a month. The developmentof equity markets also encourages formal-isation, since companies that want to oatneed proper accounts. But the best way toturn informal companies and their work-forces into taxpayers and citizens would beto make the rules easier to follow and thetaxes less onerous.

All serious politicians in Brazil (as wellas a few who just pay lip service) talkabout changing this. A tax reform has beennear the top of the governments agendafor as long as anyone can remember. But itis still not happening, leaving many busi-nesses utterly frustrated. Why, then, docompanies and economists around theworld see Brazil as such an exciting place

just now? The answer has a little to do withshopping and a lot with social climbing. 7

5About par for the course

Sources: Friedrich Schneider (2005); UNDP

Informal economy, % of GDP0 10 20 30 40 50 60 70

Bolivia

Peru

Latin America

Brazil

Colombia

Venezuela

Argentina

India

Chile

China

GDP per person,2007, $000

1.4

3.8

5.1

6.9

4.7

8.3

6.6

1.0

9.9

2.4


13/15


1

ON A Saturday night in Canudos, atown of 15,000 people in the interior

of Bahia state surrounded on all sides byparched, silvery forest, there is a lot of con-sumption going on. Everyone has a mobilephone, a few people have new cars, andearly-evening courting is fuelled by brand-ed beers and hot dogs. This place was oncea byword for poverty, sitting as it does inthe middle of Brazils drylands. But thispart of the serto at least has become morebearable over the past decade or so. Thereis a large banana plantation that provides

jobs, a fresh-water- shing industry andplenty of commerce.

Carlinhos Silveira has returned to Ca-nudos after some time spent working inSo Paulo and now runs a small hotel. Fordecades internal migration in Brazilworked in the opposite direction, as peo-ple escaped the hardscrabble north-eastfor menial jobs in the more prosperoussouth and south-east. Now it is possible to

nd members of Brazils burgeoning mid-dle class even here.The recent growth of this species has

excited companies, politicians and sociol-ogists alike, and rightly so. Using data froma giant series collected by IBGE , based onmonthly interviews with 150,000 peoplein the six main metropolitan regions, theFundao Getulio Vargas ( FGV ), a businessschool, calculates that the share of peoplein social class C increased from 42% of thepopulation in 2004 to 52% in 2008. Class C

covers households with a monthly incomeranging from 1,064 to 4,591 reais (about$603-2,603 at current exchange rates). InBrazil that makes them middle-class, eventhough in richer places these income levelswould not buy that description. Theymostly have jobs in the formal economy,which also brings access to credit, andprobably own a car or a motorbike. Re-markably, their numbers remained steadythrough the nancial crisis, says MarceloNeri of FGV , as people moved down fromclass B to replace the drop-outs.

Perhaps more impressively, Brazils re-cent progress seems to have been evenlyshared. The growth of the middle class,combined with a 100% increase in the

minimum wage over recent years andBolsa Famlia, a programme of cash trans-

fers to those lower down the income scalethat bene ts some 12m families, hascaused inequality to decline. In a countryfamous for its skewed income this is a bigachievement. According to IPEA , extremepoverty halved between 2003 and 2008.Brazils score on the Gini coe cient, a mea-sure of inequality, is falling, getting closerto that of the United States (see chart 6).

The north-east of the country, whosepoverty has prompted successive govern-ments to come up with plans for its revival,in fact grew slightly faster than the rest ofBrazil between 1994 and last year, at an av-erage annual rate of 3.3% (compared with3.1% for the country as a whole). The mainreasons were a large expansion in public-sector employment, pensions and incomeredistribution. The drylands have alsobene ted from an expansion of fruit andgrain farming and of light industry, saysGustavo Maia Gomes of the Federal Uni-versity of Pernambuco.

Shopping down to RioBrazilians like to spend. Tiany, a jeweller,has more stores in So Paulo than any-where else in the world. Louis Vuitton,which makes expensive bags, until recent-ly got its biggest pro ts per square footfrom its So Paulo shops. But it is the scaleof the mass consumer market that is open-ing up the 1m points of sale for beer, the165m mobile phones which is raising thebiggest hopes. If the world is looking forsavers, Brazil is not much good, says IllanGoldfajn, chief economist of Ita. But if it

is looking for consumers, then we might beable to help.

David Neeleman, who has launched anairline, Azul, to serve all these new con-sumers, sums up the optimism that thenew entrants to the middle class are creat-ing. America has an excess of everything:cars, credit, says Mr Neeleman. Downhere people are getting their rst car, rstcredit card, owning their rst home. It feelslike the beginning of the cycle. He is talk-ing about people like Eduardo Lins, wholeft his eight siblings in the interior of Ba-hia and followed a girlfriend to Salvador,the state capital, when he was 15. Now, 20years later, Mr Lins has a new car, boughton credit, which he is paying o by drivinga taxi, and has recently bought an apart-ment in the city. Life has got better.

What Brazils middle class wants islargely shaped by what the characters inthe ubiquitous telenovelas (TV soap operasthat reach audiences measured in tens of

millions) are wearing, consuming anddriving. These programmes are mostlymade in Rio and tend to feature characterswho are richer and whiter than averageand it around the place dressed in casual-ly expensive clothes and conducting indis-creet love aairs. They do a good job offeeding the burning desire for more anddierent stu that a market economythrives on.

Luxuries are popular, even in placeswhere there is not much money around.The highest whisky consumption per per-son is in Recife, capital of the poor north-eastern state of Pernambuco (where thedrink is often referred to as professor, a nodto Teachers whisky). Retailers have alsodiscovered the importance of atteringtheir new customers. Walmart, home ofeveryday low prices, employs people at itscheckouts to pack shoppers groceries forthem. Casas Bahia, a chain of shops sellingwhite goods and furniture on credit, sitscustomers down and serves them coeewhile they discuss how they will pay fortheir new television.

Consumer credit has grown by 28% ayear in nominal terms over the past threeyears. The middle class also needs apart-

ments and houses to put its new purchasesin. At the moment mortgage nance ac-

A better todayBrazils growing middle class wants the good life, r ight now

6Unequal contest

Source: USCensus Bureau

*0 indicates perfect equality (everyonereceives an equal income); 1 indicates

perfect inequality (all income isreceived by only one person)

Gini index of income inequality*

0.40

0.45

0.50

0.55

0.60

1992 94 96 98 02 04 062000 08

Brazil

United States


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2

1

LIVING in Brazil, it is easy to imagine thatyou have been transported into one of

those novels with alternative endings inthis instance, about how the United Statesmight have developed if a few things hadturned out dierently. Both are continent-sized countries in the western hemispherewith federal democracies in which stategovernments have considerable power.Both were colonised by small Europeanseafaring nations before gaining indepen-dence within 50 years of each other. Theirpopulations are made up of the descen-dants of their original inhabitants, earlycolonists and African slaves, topped up lat-er by European and then Asian migrants. Arecent in ux from neighbouring countriescompletes the mix. Brazils melting pot is, ifanything, even more successful thanAmericas. There is no such thing as a hy-phenated Brazilian.

Both countries seem surprisingly reli-gious to European eyes, with dierent

Christian sects competing vigorously forbelievers. The most successful Brazilianmultinational of all may be the UniversalChurch of the Kingdom of God, a Pente-costal out t that keeps being investigatedfor overenthusiastic marketing andopaque book-keeping. Both places show astrong preference for consumption oversaving when times are good. Brazil has aculture all of its own, but it looks for inspi-ration to America more than it does to itsSpanish-speaking neighbours.

Aplace of paradoxesAnd yet the dierences are stark. Americais rich, Brazil poor. Brazil is more left-wing.America ghts wars, Brazil does not. Amer-ica likes its capitalism as unbridled as pos-sible, Brazil prefers its markets with astrong government presence.

Look more closely, though, and some of

these distinctions become blurred. Brazil ismore left-wing in theory than in practice.

Next years presidential election is likely tocome down to a choice between a candi-date from the left-wing Workers Party andthe centre-left Party of Brazilian Social De-mocracy. Even so, most of the money thegovernment spends goes to people whoare comparatively wealthy. The biggest sin-gle reason for the dierence in income dis-tribution between Brazil and America ismore regressive public spending in Brazil.We live in a paradoxical situation of a

government that spends a lot and bene tsa few, said Antonio Palocci on becomingnance minister in 2003.Since then some more public money

has found its way to Brazils poorest, butproportionately the amounts remainsmall. In fact, Brazil has rather a lot of pub-lic policies that would be considered un-fair and regressive in America. Childrenwhose parents can aord to send them to

good private schools tend to get the pick ofplaces at good publicly funded universi-

Two Americas

Brazil and the United States have more in common than they seem to

counts for only 2% of GDP , a tiny sum evencompared with, say, Mexico (9%), let aloneAmerica (85%). Brazilian housebuilders be-lieve that as mortgages develop, the hous-ing market will be a pro table place to be.They seem to have convinced foreign in-vestors, who have provided most of thecapital for Brazils listed housebuilders.The government reckons the countryneeds 8m more houses, half to allow fam-ilies to move out of shared living quartersand half to replace squalid homes. Butmost builders are even keener to provideapartments for Brazilians who are some-what better o.

Interest rates will have to come down alot further before the mortgage marketreally takes o, but already some compa-nies are securitising mortgages with matu-rities of three or four years and sellingthem to investors. In addition to the needto house Brazils existing middle class, saysWilson Amaral of Ga sa, a large listedhousebuilder, Brazil needs to look to the fu-ture: it will have 35m new families by 2030,all of whom will need somewhere to live.Brazils population is comparatively youngand still growing, mainly through naturalincrease rather than immigration.

If the next ten years see as much social

and economic progress as the past ten, Bra-zil will become a very dierent place. Agood place to see how this might work isDiadema, a formerly rough neighbour-hood of So Paulo. In 1999 the murder ratethere reached 141per 100,000 people (com-pared with 37 per 100,000 in Baltimore,one of Americas more violent cities, lastyear). Diadema became so notorious thatpeople who lived there felt they had to lieabout their address in job interviews.

But since then the murder rate hasdropped steeply. Earlier this year, on a plotof land that was once a cemetery, a six-sto-

rey shopping mall opened in Diadema,complete with neoclassical ourishes andthe odd piece of what looks like marble, asecular monument to less violent times.The mall is still fairly empty, perhaps be-cause it was built so quickly that potentialshoppers are scared to go in case the rooffalls in. But many of the elements of thelower-middle-class Brazilian dream arehere: the jewellery on credit, the multi-screen cinema due to open soon, the air-conditioned atrium. It is a ne place to eat apo de queijo and re ect on what this spotwas like only a short decade ago.

7

Going for a bit of froth


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2

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ties, whereas children from poorer familiesoften have to pay to go to less good places.The BNDES transfers money from low-paid workers to the balance-sheets of Bra-zils large companies. It has supported JBS -Fribois transformation into the worldslargest producer of protein, which thecompany has accomplished through ac-quisitions in America. Yet the group re-mains privately owned: a bizarre appropri-ation of public resources that would causean outcry in other countries.

Brazilians also have a more Americanapproach to capitalism and free marketsthan they might appear to at rst sight.Many of their countrys success stories ofthe past 15 years, from the free- oating realand the autonomous central bank to theprivatisation of state-controlled rms thathave since ourished, are products of asimilar way of thinking about what eco-nomic arrangements work best. To hiscredit, President Lula has not reversedthese changes, as many feared he might.

The clash between a growing middleclass and a government that often seems tobe blocking its aspirations is creating arather American story about the deter-mined little guy being constantly pulledback by the dead hand of bureaucracy.Many of the younger businessmen and

bankers in Brazil have postgraduate quali-cations from American business schools.Quite a few hold views that would not beout of place at the American Enterprise In-stitute or other free-market think-tanks.

If Americas doubts about free marketsand Brazils con dence in them both con-tinue to grow, the two may shortly meet(see chart 7). Even President Lula now de-nounces protectionism, though many for-eign governments, noting Brazils still fairlyhigh import taxes, are unconvinced. Bra-zils imports and exports taken togetherwere equivalent to 22% of its GDP in 2007,compared with 23% for America. Aboveall, Brazil now seems con dent that a moreopen economy will not condemn it to arole as coee-maker to richer countries.

The future of the country of the futureYet if Brazil has at last discovered a formulafor releasing its wealth, it is also true thatmost of the countrys economic successesare clustered around the commodity sec-tor. Brazil has created no car or computercompanies with big sales abroad. Embraeris an isolated example of a big high-techexporter. The same can be said of the ser-vices sector. That is a pity for a country vi-

b i h i i di i

as Petrobrass deepwater drilling, do re-quire high levels of technical expertise. ButBrazils obstructive government seems tocon ne its businesses to competing inter-nationally only in sectors where naturaladvantages make them close to unbeat-able. Judged against its own past, Brazil isdoing astonishingly well. Judged against

its potential, it still fares poorly.Allowing for its size, Brazil spendsmuch less than the OECD average on re-search and development, and most of thatspending comes from the government: thepublic sector accounts for some 55% of in-vestment in technological innovation.South Korea, with a population a quarterthe size of Brazils, registers about 30 t imesas many patents. Brazil needs to do some-

thing about this: in order to live with thestrong currency that comes with success

under a free- oating exchange rate, it mustraise productivity.Like America, Brazil is so big and varied

that it often seems to contain at least twoseparate countries. One of these is a placewith ten land borders and no wars wherepeople speak a single language in com-pressed time zones; where there is no reli-gious con ict; and where three-quarters ofthe population turns out to vote, with elec-tion results announced the following day.This country has sophisticated economicpolicymaking and nancial markets, aswell as a growing collection of world-beat-ing companies. It runs on sushi and is usu-ally suntanned.

The other Brazil has a stubbornly highmurder rate and a violent police force.Many of its politicians see nothing wrongwith stealing public money or appointingrelatives to jobs within their private king-doms, and refuse to resign when foundout. It is a place of misery where 17% ofhomes do not have running water and toomany families l ive in home-made shacksby motorway bridges. A place wheremany people convicted of serious crimesgo unpunished, and those in prison liveout a brutalised existence. And a place of

environmental devastation that govern-ment is powerless to stop.Because this special report deals with

business and nance, it has concentratedon the rst place, but both Brazils are partof the great green elbow that sticks out intothe Atlantic. What makes the country soexciting at the moment is that, thanks to itsnewfound stability, Brazils better self nowhas a much greater chance of prevailing.

7

7The system of choice

Source: Pew Research Centre

Are people better off under free markets?% replying Yes

0 25 50 75

India

China

Britain

USA

Brazil

Germany

Japan

Russia

2002 2007

A special report on business and fi nance in Brazil

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