Brazil is at an important juncture that could finally allow it to meet its full potential, possibly overtaking China as the Number Two economy of the world. The good news is that forces are beginning to move into alignment that could guide the direction of economic policy towards the sort of momentous reforms that must be undertaken for Brazil to fulfill its rightful destiny. The bad news is that most economists and their policy instincts are guided by models that are detached from reality.
The likely villain that can upend this tale of hope and optimism can be found within Mainstream economics, more specifically macroeconomic theory. Indeed, the greatest threats to long-term economic stability are the brainchildren of macroeconomists. On the one hand, Monetarists have provided justifications for an egregious violation of human nature, negative nominal interest rates. On the other hand, this has encouraged Keynesian economists to applaud the opportunity to lower the costs of funding fiscal deficits that have spawned a global debt bubble.
Getting better results for Brazil or any other reform-minded country requires a shift in focus from a macro orientation to micro-orientation. Evidence that this shift of focus offers best package and direction of reforms can be seen from the successful path taken by China and Chile. As it is, a comparison by most current measures indicates that Brazil’s economy is an underperformer relative to these two rivals.
While macroeconomic stability was an important element to move the economies of China and Chile forward, the most important changes were at the microeconomic level. Advancement in the economies of both countries came after a change in thinking about the true nature of sustained economic growth.
As it is, the study of macroeconomics does little to aid in understanding market processes & human action. Perhaps worse, macroeconomics has from the outset offered intellectual justification for expanding political power.
The recent gains of China and Chile would not have been possible without a significant reduction in the role of the State in their economies. It required that political actors understood they must embrace the forces of globalization rather than trying to shape those forces. By opening of their economies to the outside world and unleashing domestic private entrepreneurial initiatives, these countries moved from conditions of sustained misery to sustained growth.
Consider the problems arising from deficit spending that is about politicians satisfying demands of special-interest groups to secure their support at the ballot box while also attracting financial contributions to support electoral campaigns. Similarly, regulations or privileges (e.g., tax advantages, subsidies or restrictions on competition) tend to create distortions in economic decisions that might boost the performance of one sector at the expense of lower growth in other sectors.
These distortions tend to lead to a second round of interventions as injured parties issue demands to correct imbalances created by earlier interventions with more interventions. In turn, there is an endless cycle of distortions with interest-groups putting endless pressures on the State to act.
For its part, a focus on macroeconomics interferes with understanding the market process is by constructing untenable aggregates and promoting a misleading focus on price levels (e.g., consumer price indexes) rather than relative prices. For their part, relative prices are more relevant for most decisions about buying and selling whereas, in absence of acute problems caused by central-bank induced monetary disturbances, movements of price levels are background noise.
Macroeconomists are at comfortable imagining and discussing the “steady state” economy or general equilibrium. Such models are silent about the behavior of the constituent elements that are involved with the decision making that leads to any observed outcomes. Any model that does not explicitly include entrepreneurs and consumers to understand how firms or individuals interact is a pointless exercise that only provides some fleeting moments of intellectual stimulation.
One common mistake of macroeconomists is an insistence that capital formation is the basis of economic growth. Yet, neither capital accumulation, per se, nor technological advance will guarantee economic growth. Consider the numerous technological advances and the massive amounts of wealth held by the emperors of ancient China, but neither those technologies nor that capital led to shared improvements of living standards.
Another error derived from the underlying Keynesian logic of national income accounting is that consumption, being the largest component of the estimates of Gross Domestic Product (GDP), drives economic growth. This conclusion is drawn despite the clear sense of reality evident to an unschooled child that production must precede consumption.
It turns out that sustained economic growth depends upon a rich mixture of entrepreneurial initiatives plus technological advance plus capital formation (saving). As such, savings provide the fuel for growth and entrepreneurial initiatives are the engine of economic growth.
As for the "optimal" rate of investment, this is also a conceptual notion. A microeconomic perspective involves discovering how individual businesses develop expectations about future market performance and mix those with innovations to decide on investment strategy.
Since all this is influenced by interest rates, it is absolutely essential that central banks NOT manipulate interest rates, the single most important price for any modern economy. For example, artificially-low interest rates create distortions in the production structure and provide false signals that interfere with the coordination process that guides the planning of savers and investors.
In understanding the general relationship between saving rates and GDP, high saving rates do NOT always lead to higher GDP growth since this is a necessary, but not a sufficient condition. Savings must be channeled towards sustainable production through an effective system of financial intermediaries. Japan has a high savings rate but it is not enough because of a weak banking system. China is in a similar position with high savings rate, but China depends upon foreign capital as domestically-generated savings are misspent on SOEs.
A first step to achieve high private saving rates requires a permanent lowering of the overall tax burden (especially marginal tax rates) to will allow households and businesses to save more. This would increase disposable income so more can be saved as a natural outcome.
As Brazilian households and businesses gain greater control over their earning, they can spend and invest more so that more new jobs can be created. If these changes are permanent, there will be no need for monetary or fiscal policy that can only have temporary effects, if any at all.
One objection might be that cutting income or other taxes will reduce tax revenues. However, rising incomes from higher investments and spending will generate rising revenues over time.
In all events, keeping funds out of the hands of governments will NOT lower national savings rate, especially given the tendency to run deficits. Whatever funds governments collect tend to be used for consumption through transfers and subsidies that add nothing to the net stock of capital. But government access to more of the resources and wealth created by the private sector tend to inflict deadweight losses from inefficiency and corruption.
For Brazilians to expect higher and rising living standards, the economic policy mix must be towards increased production based on more investment by the private sector, where net gains in employment and national wealth occur. To have more private investment, there should be more savings derived from surplus production from earlier periods, leading to the formation of capital (i.e., machinery, tools, etc) and higher productivity to boost wages and living standards. It is only then that consumption can rise in a natural and sustainable manner.
Escuela de Negocios
Universidad Francisco Marroquín
Visiting-professor at Mackenzie Center for Economic Freedom
Funded by Mackpesquisa (Mackenzie Research Fund) resources