RaboResearch - Economic Research

Brazil’s economic model: In need of a revamp

Economic Report


The recent performance of the Brazilian economy has been disappointing. GDP grew by only 0.9% in 2012, after the already low 2.7% of 2011, and the economy is likely to have grown by only 2-2.5% in 2013. This stands in stark contrast to the 4.5% average growth of the period 2004-2010. In this Economic Report we conclude that consumption and commodity exports cannot continue to drive growth. To reinvigorate its economic model, Brazil needs to increase investment and productivity.

Brazil’s recent growth model

Until recently growth in Brazil rested on two pillars: booming external demand for commodities and rapid domestic consumption growth. Strong economic growth and industrialization in China resulted in a strong demand for food and other commodities.  Thanks to strong growth of both export volumes and prices, Brazil’s food exports grew from USD 16.1bn in 2001 to USD 78.4bn 2011 in nominal terms, while exports of ores and metals grew even from USD 4.9bn to USD 49.1bn over the same period (see also figure 1). Brazil was able to cater to the rising demand for food products by strongly increasing its agricultural production and productivity. According to the United States Department of Agriculture, total factor productivity grew by 2.55% a year in Brazil’s agricultural sector between 1985 and 2006.

However, while strong external demand thus contributed to growth, Brazil’s growth became increasingly domestic driven. In fact, in each year between 2006 and 2011, net external demand had a negative contribution to growth, as imports grew even faster than exports (see figure 2). Favorable terms of trade boosted gross fixed  investment, which grew from 15.9% of GDP in 2002-2005 to 18.3% of GDP in 2006-2011. The biggest contribution to growth, however, came from private consumption.

Consumption growth was driven by a number of factors. First, the Lula government (2003-2010) and its successor Rousseff’s sharply increased the minimum wage. As this minimum wage is widely used as a benchmark for wage setting, this resulted in a strong increase of the wage income and boosted consumption. Second, the government also boosted social spending. Third, partially thanks to the macroeconomic stabilization that took place in the late nineties and the first decade of the 21th century, access to credit improved. Consumers used this opportunity and credit to GDP grew rapidly.

All three factors resulted in a consumption boom. High consumption thereby also boosted the labor intensive services sector. This resulted in a strong fall of unemployment from 12.3% in 2003 to 5.5% in 2012. This increase in employment on its turn led to a further growth of consumption.

The end of a model?

The global financial crisis only resulted in a short interruption of high growth. While Brazilian GDP contracted by 0.3% in 2009, a vigorous recovery took place in 2010, when the economy grew by 7.5%, the highest level of growth in 25 years, thanks to fiscal, monetary and credit stimulus. However, as inflationary pressures started to increase, and inflation moved above the 2.5-6.5% target range in 2011, the central bank was forced to tighten its policy rate. Partially as a result, the economy rapidly lost momentum, as growth fell to 2.7% in 2011 and a meager 0.9% in 2012 and is estimated to have remained low in 2013 at 2-2.5%.  In particular investment took a strong hit in 2012. Despite a record 525 basis points cut in interest rates between the summer of 2011 and 2012,  gross fixed investment fell by 4%. Meanwhile, in 2013 consumption growth, which until recently continued to remain vigorous, has also weakened.

Figure 1: Brazil’s merchandise exports
Figure 1: Brazil’s merchandise exportsSource: World Bank
Figure 2: Growth drivers
Figure 2: Growth driversSource: EIU

Does this mark the end of the Brazilian growth model? The short answer seems yes, as the factors that boosted growth in the preceding decade are unlikely to drive growth as much in the coming years.  First, it seems unrealistic to assume commodity demand growth will be as vigorous  as it was in the past decade. While economic and population growth in the rest of the world may lead to continued growth in the demand for food, and Brazil is well equipped to benefit from this development thanks to its track record of high agricultural productivity growth and the relatively low use of existing agricultural land, this does not imply that agricultural prices will continue to rise. Meanwhile, demand for iron ore, Brazil’s single largest export product, may weaken as growth in China may become less metal-intensive. In fact, the price of iron has already fallen 27% between February 2011 and August 2013. Brazil’s oil sector is likely to grow and may be an exception.

The discovery of giant deep sea oil reserves in 2007 led to a lot of optimism about the future of the oil industry. Brazil was widely expected to become a major oil producer. However, the exploitation of the new oil fields will require an enormous amount of investment, as most of the new oil fields are located under a 2 km thick layer of salt, and it remains to be seen how fast Petrobras, Brazil’s state controlled oil major that has a leading role in the exploitation of the fields, will be able to boost energy production. In 2008, Petrobras stated it would boost oil production by 50 percent to almost 3.5m barrels a day in 2012.

However, production has only increased by 13 percent to 2.68m barrels a day in 2012. The rise of shale oil production may thereby make the (expensive) oil production in the deep sea fields less viable, although Brazil could also benefit in the longer run from the shale energy revolution as large shale energy reserves have been found in the country. Overall, while oil production is still likely to grow strongly in the medium term, current estimates forecast an increase of the Petrobras oil and gas production  to 4.2m barrels per day in 2020, the outlook for the near future is less benign than a few years ago. Furthermore, the growing importance of the oil sector may have negative effects on other parts of the economy, as we will explain.

Meanwhile, the primary domestic driver of growth, consumption growth, has also strongly slowed down. Consumer leverage is now relatively high. Although debt levels are still not very high by international standards, the very high interest rates Brazilians have to pay,  the average interest rate on consumer loans was 27.4% in 2012, result in a high debt burden, as the IMF also concluded recently (IMF, 2013). Although the government has tried to boost lending through attempts to reduce interest rates, it seems unlikely that credit growth can boost consumption as much as it did in the past years.

The room for consumption to grow is also limited anyway, as the economy is now operating at close to full capacity. Indeed, while the government has tried to boost growth in recent years by various stimulus programs, what is holding back growth now is not lack of demand, but supply problems. This is illustrated by the inflation rate, which has, despite the low level of economic growth, stayed close to or even above the upper bound of the 2.5-6.5% inflation target range, and the labor market, which is now extremely tight by Brazilian standard, as the unemployment fell to 5.5% in 2012 and many employers are complaining about labor scarcity (Manpower, 2013).

That supply has not been able to keep up with demand can also been seen if one looks at Brazil’s balance of payments; Brazil’s current account balance has deteriorated almost continuously since 2004. Until 2007, the country posted a current account surplus. Afterwards, this changed into a deficit, as domestic demand exceeded economic growth. At 2.4% of GDP, Brazil’s 2012 current account deficit was still not extremely large. Furthermore, the fact that sizeable foreign direct investments finance the deficit and Brazil’s large foreign reserves, which were equal to almost 15 months of imports, mitigate the balance of payments risks.

Figure 3: Current account & terms of trade
Figure 3: Current account & terms of tradeSource: EIU
Figure 4: Gross fixed investment
Figure 4: Gross fixed investmentSource: EIU

However, given the fact that the Brazilian economy is relatively closed, that terms of trade are already relatively favorable and that the Federal Reserve recently stated that it will start to taper its third quantitative easing program in January, which has already resulted in a less favorable external financial climate for emerging markets and that the current account deficit is estimated to have grown to approximately 3.5% of GDP in 2013, an even further widening of the current account deficit seems undesirable. 

The challenge: increasing investment and productivity

Given these supply problems, Brazil has to raise investment and increase the productivity of its economy. Both will not be easy. Investment is traditionally very low in Brazil. While the investment to GDP ratio grew in the boom years of the first decade of the 21st century, it stayed below 20% of GDP and fell back from 19.5% of GDP in 2010 to only 18.1% of GDP in 2012. By emerging market standards, Brazil thus has an extremely low level of investment (see figure 4). Investment is much higher in China and India, but also in the rest of Latin America, a region which has had a relatively low level of investment in the past decades, investment is much higher than in Brazil.

As the room to further widen the sizeable current account deficit is limited and a widening would increase balance of payments risks, increasing its investment has to be realized through an increase of savings. However, savings are also extremely low in Brazil. This is partially due to the government.  Government spending is very large by emerging market standards, but public investment is relatively small. Furthermore, Brazil’s relatively generous, primarily pay-as-you go, pension system, and the past episodes of hyperinflation, are also factors that may disincentive saving.

Meanwhile, the high real wage growth that was part of the Brazilian economic model has led to a strong deterioration of the competiveness of the Brazilian companies. In fact, Brazil has seen one of the fastest rises in unit labor costs in the past couple of years. This strong rise could be detrimental to the industrial sector in particular. If this leads to a deindustrialization of the economy, this may have negative consequences for productivity growth, as productivity growth tends to be much higher in the industrial sector than in the services sector. Brazil’s rise as a major oil producer may also lead to deindustrialization, as it is likely to lead to an increase of the exchange rate which will hurt the competitiveness of the industrial sector (Dutch disease).

Raising productivity is thereby likely to be tricky anyway. Brazil’s track record of realizing total factor productivity (TFP) growth is not very good. According to a recent study (Sosa, 2013), TFP growth contributed only 0.1% percentage points a year to growth in the period 2003-2012, in the preceding period (1990-2002), TFP growth even had a negative contribution of 1.6% percentage points a year to growth. While Brazil managed to achieve high TFP growth in the agricultural sector, TFP growth in the industrial sector and services sector was very low. Within the services sector there are thereby enormous differences in productivity between firms in Brazil.

The quantity and quality of the labor force will also determine Brazil’s future growth. In the past decade, Brazil has benefitted strongly from the strong growth of its labor force. According to the earlier mentioned IMF study, labor growth contributed 2.3 percentage points a year to growth in the period 1990-2002 and 1.9 percentage points a year in the period 2003-2012. However, while Brazil’s labor force will continue to grow in the near future, the rate of growth is set to continue to fall. According to the IMF, the working age population is growing now by about 1.2% per year, but this increase will slow, particularly after 2020. As a result, the potential growth rate of the economy will decline. One measure that could increase the supply of labor is pension reform. Right now, the average retirement age is very low (IMF, 2012). Working longer could increases the supply of labor. Meanwhile, the growth could also be boosted by raising the quality of its labor force. In the next economic report we will look at Brazil’s track record in this respect.


Brazil’s commodity and consumption based model needs to be adjusted. Brazil needs to raise investment, and savings, to deal with supply constraints. In the longer run, total factor productivity needs to increase to allow the economy to continue to grow. Furthermore, Brazil needs to increase the quality of its labor force. Increasing investment, productivity and the quality of the labor force is likely to be difficult, given Brazil’s weak track record. In the following Economic Report we will have a look at a number of structural issues. Dealing with these problems could open the door to faster growth.


  • IMF, Brazil: Technical Note on Consumer Credit Growth and Household Financial Stress, IMF Country Report No. 13/149, June 2013
  • IMF, Brazil: Selected Issues Paper, IMF Country Report No. 12/192, July 2012
  • Manpower, How to unleash Latin America’s greatest resource, 2012
  • Sebastián Sosa, Evridiki Tsounta, and Hye Sun Kim, Is the Growth Momentum in Latin America Sustainable?, IMF, 2013
  • United States Department of Agriculture, Policy, Technology and Efficiency of Brazilian Agriculture, Nicholas Rada and Constanza Valdes, July 2012

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