How corruption in Brazil has a cost on all of us
He was “standing in a sea of mud” as he had earlier lamented.
This was the man known as “The Father of the Poor”. He had fought big business and challenged the large landowners his entire political career, winning the hearts and minds of the people. Through his brand of populist politics, he brought social and economic change that helped modernise Brazil’s economy.
He founded state companies in oil (Petrobras), mining (Vale) and steel (Companhia Siderúrgica Nacional). He quadrupled the electorate and gave them the secret ballot. Women were enfranchised, extensive education reforms were introduced and social security laws were enacted.
But his time was up.
He grabbed a Colt pistol and shot himself through the heart.
More than sixty years after the tragic death of President Getúlio Vargas and Brazil still bleeds. Though progress has been made lifting millions out of extreme poverty, this resource-rich nation has been held back from emerging as the developed economy it should be today.
Earlier this year I was in Brazil and I asked a few people what they thought was the issue.
The reason was always the same: “Corrupção!”
It’s always been at the heart of Brazil’s problems. However, the sheer scale and level of corruption revealed in Brazil’s most recent political scandals were shocking.
Here’s what happened in brief.
Former President Dilma Rousseff is impeached in August 2016
It started when a $5.3 billion corruption scandal named “car wash” came to light. The executives of several construction companies formed a secret cartel to coordinate bids on Petrobras contracts. They then grossly overcharged Petrobras.
This is how it worked. Certain Petrobras employees received huge bribes along with help from politicians with influence on the board of Petrobras. As former President Dilma Rousseff was actually the chair of the board from 2003 to 2010, the chances are that she knew this was going on and it happen under her watch anyway. She was impeached by Congress on 31 August 2016 and was removed from office.
Under Dilma Rousseff inflation rose, so too did unemployment, national debt swelled, while Brazil’s currency took a pounding. Brazil entered the deepest recession in its history. So when Vice President Michel Temer was made President, there was a chance for change.
But this didn’t last.
President Michel Temer is then ensnared
Though deeply unpopular, he has tenaciously tried to push through reforms to help rebuild legitimacy for his party and the long-term survival of Brazil’s economy.
He has passed laws to limit Brazil’s budget spending and he has started the difficult process of tackling Brazil’s unaffordable pension system. He rose the minimum retirement age for men to 65 and for women to 62 from the low 50s before.
But then O Globo, Brazil’s largest news outlet, received a leaked recording. On it, President Michel Temer is heard giving orders to keep imprisoned politician Eduardo Cuhna – the architect behind President Dilma Rousseff’s impeachment – from spilling anymore details on the case.
The orders were heard being given to Joesley Baptista, the chairman of JBS – Brazil’s largest meat packer.
“You need to keep that up, OK?” Temer is heard saying.
It’s a shame – it really is. This latest crisis has surprised so few, but has once again upset so many.
So who cares? If you live on the other side of the world, why would it affect you?
The truth is that a lot of us are invested in Brazil even if we don’t realise it. For instance we may be exposed through our corporate pension plans that have probably got an allocation to emerging markets. We may be linked by our jobs or our own personal investments, if we work or invest in one of the many businesses in the West that generate revenue from emerging markets.
Therefore it should matter to you. It should matter to all of us. Corruption is holding back Brazil and it costs us as it chisels away potential investment performance we could be earning.
It prevent Brazil’s economy from functioning freely and here are three reasons why:
1. It creates artificially high prices and low quality
If you’re from Brazil or have lived there, you’ll be familiar with this problem. Bribes and favourable political connections that are commonplace in Brazil, lead to contracts being awarded and deals being made that leads to inefficient monopolies and oligopolies forming.
The Temer and Dilma scandals confirmed that this happened with brazen callousness. It proved these corrupt business practices have been common practice and supported by politics in Brazil for decades.
Lack of competition has meant higher prices for lower quality in Brazil because big businesses can get away with it. In Brazil, hefty import taxes applied by the government also act as an additional cushion to block foreign competition from delivering lower prices and higher quality.
The result is that normal Brazilian have no other choice but to accept what they get, while the wealthy elite can afford highly-inflation foreign imports. I actually wrote a post on this subject earlier this year and used the iPhone as an example.
2. It widens the gap between the rich and the poor
If the pre-World Cup riots were anything to go by, disparity of wealth is a major issue in Brazil. That’s not to say that huge progress has been made, lifting a huge proportion of the population out of extreme poverty. However, a lot Brazilians don’t earn a decent living wage.
The wealthy represent a minority in Brazil, but own the majority of assets. The great advantage of being an asset owner is that your wealth tends to compound over time making you even wealthier.
Those in debt, however, run the risk that their debt will compound the wrong way if they don’t pay it off. And, debt is always painful to pay off if you aren’t earning a lot. To put this into context, a savings account in Brazil will offer you between 0.5-0.7 percent a month. However, the interest rate for a credit card is north of 15 percent (Thanks Peter Meier for providing these numbers).
What is shocking is the ease of access to credit in Brazil. You can even split you grocery shopping into six monthly payments on a credit card, which is unheard of in the West. For many normal Brazilians, this easy access to finance is just too tempting even with extortionate interest rates.
3. It puts off long-term investment
Most Brazilians know about this already. It’s called Custo Brasil (“Brazil Cost”), which refers to the higher operational cost with doing business in Brazil. This is thanks to excessive regulation, poor transport infrastructure and services, and of course corruption. In short, it puts off investors.
Part of Custo Brasil comes from the tradition of political-patronage to big business in Brazil. It undermines the normal functioning of Brazil’s capital markets by artificially inflating the share price of companies that enjoy political favouritism. It also increases stock market volatility and reduces investor confidence in the equity market overall.
Furthermore, it undermines economic progress by funnelling investment away from where it’s needed most. For instance, take Brazil’s development bank (BNDES), which has over the past decade, invested heavily in trying to support the autonomous development of competitive corporations.
In the past seven years, it’s lent more to business than the US did in Europe during the Marshall Plan in GDP deflator terms. In fact, investment has ballooned in the past ten years.
However, its soft and subsidised loans are skewed to many already well-established industry leaders. This includes the President Temer scandal-linked JBS, Odebrecht, Petrobras, Embraer – the world’s third largest commercial jet builder – and even Ambev, the Brazilian arm of the world’s largest brewer, AB InBev.
Brazil has a bright future in terms of it demographics and it naturally resources. The long-term thesis for the nation remains intact. It will emerge one day as a developed economic powerhouse in South America. However, the longer corruption persists, the longer the journey will take.
Nevertheless, Brazil’s market is at least now pricing in the cost of corruption more fully with these recent scandals. The political status quo has also been challenged, which means there is a risk-premium to be earned if you’re patient. In other words, the country still offer fantastic investment opportunities, perhaps even more so than before.
