Author: Affonso Celso Pastore

Source: Valor Econômico, 08/10/2007

Despite the vigorous growth of gross fixed capital formation, which is exclusively the result of an increase in private investments, with very little contribution from the federal government's investments, we are very close to reaching full utilization of installed capacity in the industry. The graph below, constructed from data from the CNI survey, shows that since 2006 there has been a continuous reduction in idle capacity, which has already reached its previous peak. The growth in domestic demand has been driven by a reduction in the real interest rate; the increase in credit; by fiscal policy, through active income transfer, and by real increases in the minimum wage. The reduction in real interest rates and the appreciation of the real exchange rate, together with the improvement in country risk and abundant international liquidity, have boosted investments, but not at the same pace as demand has been growing. In addition to the absorption of idle capacity, part of the difference between supply and demand has been supplied by the increase in imports. With this, it will be possible to celebrate growth close to 5% in 2007, with inflation under control and within the target.

However, for accelerated economic growth to continue in 2008 without inflation, it will be necessary for the government to change its fiscal policy, and to do so in the opposite direction to that which has been defended by the new faction of spenders who installed themselves within the government. Everything indicates that exports will continue to grow, which makes it possible to continue expanding imports, particularly of capital goods, helping the gross formation of fixed capital. But that does not solve the problem entirely: there is no way to import labor, which is already scarce in some sectors, for example. Infrastructure bottlenecks are also not resolved with imports or speeches. They demand good projects, competence, clear rules and time to mature.

Thus, the moment is approaching when the Central Bank should interrupt the trajectory of falling interest rates. Whether this interruption will be followed by a resumption of the downward trajectory or a rise period is largely dependent on fiscal policy. The accelerated growth in public spending has been expanding demand. For example, spending on personnel and charges from the federal government, which until two years ago had been growing in real terms at 4% per year, is currently growing at 12% per year! There is no hope that the government will engage in a spending control policy. On the contrary, all indications are that it will continue to practice its version of a “management shock”, which is identical to the accelerated expansion of spending. Its propensity to spend is facilitated not only by the growth of GDP, which increases the collection, but also by the “cooperation” of the opposition parties, which are willing to approve the extension of the CPMF.

There are those who look at this picture and react cynically, arguing that this is not a problem, because in the end the government has been meeting the targets for the primary surplus and the public debt has been declining. But is the criterion of debt dynamics a good criterion for assessing the quality of fiscal policy?

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Investing in infrastructure without giving up social programs requires reducing waste and clear standards of efficiency in public spending
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Let us start with the example of the eighties and nineties. At that time, despite high public deficits, public debt grew very little. Two mechanisms prevented fiscal lack of control from generating unsustainable growth in public debt. The first was the abundant issue of currency, which charged society with an “inflationary tax” that fluctuated between 2% and 4% of GDP. That “tax” not provided for by the Constitution generated the equivalent of a primary surplus between 2% and 4% of GDP, which was not enough to prevent any growth in the debt / GDP ratio, but it was able to prevent this growth from being explosive. The second was the “heterodox” creation of asset taxes. In that inflationary chaos, the government had the power to arbitrarily pre-set the “monetary correction” for a future period, and frequently succumbed to the temptation to underestimate that correction, subsequently generating much higher inflation than announced. As a result, there was an unexpected depreciation of the real value of the debt issued with pre-fixed monetary restatement, which was equivalent to a tax on capital, which in the same way as the “inflationary tax” did not have to be provided for in the Constitution. The revenue from these two “taxes” explains the paradox of having a strongly expansionist fiscal policy, alongside public debt that did not show explosive growth. But all of this was only possible with increasing inflation, which hindered economic growth, and which generated an inequitable income distribution.

Inflation is currently under control, which prevents the large-scale use of the “inflation tax”, but we will not be free from inflation if the growth in spending is not contained. The increase in public spending and the tax burden raise the real interest rate and expose the Central Bank to criticism of the voluntarism of those who want to grow and spend at the same time. In one way or another, this conflict ends in more inflation and, consequently, less economic growth.

Poorer countries compel their governments to develop social programs, seeking to reduce poverty, which leads to a higher tax burden than in more developed countries. Cash transfers minimize the suffering of the poor, but do not guarantee the opening of employment opportunities and the increase in gains derived from the acceleration of growth. For this to happen, investments in infrastructure are necessary, without which the risks that limit private investments grow. The realization of these investments without abandoning social programs requires that another “management shock” be put in place, in which waste is reduced and clear standards of efficiency in public spending are pursued. It also imposes that regulatory risks are reduced, attracting private capital to carry out investments in infrastructure, instead of going backwards by creating new state-owned companies. More spending and more state-owned companies raise the political power of governments, but they are not ways to accelerate economic growth or to increase the well-being of society.

Affonso Celso Pastore and Maria Cristina Pinotti are economists and write monthly on Mondays.