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This month marks the 30th anniversary of the birth of the Brazilian real, a major achievement that highlights both the promise and the limits of reform.
On the one hand, the creation of new currencies was successful. I remember visiting Rio de Janeiro in the early 1990s and experiencing hyperinflation. I tried to keep most of my money in U.S. dollars; if I happened to have some Brazilian currency (then called Cruzeiro Reals), I intended to spend it immediately. In 1990, Brazil’s inflation rate was 2,948%.
Fortunately, economists and other reformers came to the rescue and created an effective currency stabilization plan. Brazil first created a unit called the URV and changed contracts and prices to the new unit of account. Then, a new currency was introduced, the Real, which was equal in value to the URV and approximately equal to the U.S. dollar. This created the prospect of a new, more stable currency.
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A key part of the reforms was developing a credible fiscal stabilization plan. Brazil didn’t experience hyperinflation for no reason; rather, the newly printed money was used to pay for promised government spending. So, in order to make the numbers add up without hyperinflation, the Brazilian government cut some budgets, privatized some assets, transferred some functions to state and local governments, and made constitutional and legislative commitments to balance the budget.
It worked. In 1995, inflation fell to 66% and today it is around 4%. The textbook economic formula was used to fix hyperinflation with complete success. The adjustment led to a severe recession, but in this case, it is better to fix the problem first than to resort to a more painful solution later. Despite the recent weakness of the Brazilian currency, President Luiz Inácio Lula da Silva is trying to address the problem by tightening spending restrictions.
In Argentina, President Javier Milley is clear that he needs to follow a similar path. Brazil has shown that Latin American economies can introduce and sustain major reforms.
However, the ending to this story is not entirely happy. Brazil’s economic growth has been below 1% for many years, but has recently exceeded 2%. The country has abundant natural resources, a large number of talented people, some excellent companies and universities, and no natural geopolitical enemies. Even so, its economic growth performance is mediocre. Brazil should be able to achieve annual growth of 4% to 6%.
The reasons for this disappointing growth are varied and controversial. Possible culprits include corruption, excessive protectionism, an economy overly dependent on natural resources, an unreliable education system, and perhaps a loss of economic dynamism. In its golden years of the late 1960s and early 1970s, Brazil had very high growth rates, reaching 14% in 1973, and very good performance was possible.
No one, least of all me, is saying that Brazil today would be better off with a new round of hyperinflation. Yet it is also hard to deny that the limits of reform have become apparent. Even though reformers have largely got the script right, most of the characteristics of a country are hard to change in the short or even medium term.
Reforms often have a dramatic effect when an entire dysfunctional economic system is eliminated at once. Poland suffered for decades under communism, but since implementing market-oriented shock therapy in the early 1990s it has grown steadily and is approaching Western European living standards. China, Vietnam, and Estonia have also made radical changes, mostly for the better.
Unfortunately, the situation in Brazil (with some success) is more common. NAFTA solidified democracy in Mexico and helped develop manufacturing in the north of the country. But it didn’t make Mexico look like the Asian Tigers. New Zealand embarked on some fairly radical and mostly successful reforms in the 1980s, but the gap in living standards between New Zealand and the United States has not narrowed. New Zealand is a small country far from the rest of the world, and no policy changes can change that.
Don’t get me wrong: Brazil’s currency stability is cause for celebration. At the same time, Brazil’s economy is growing much slower than it should. Sometimes the best you can hope for from any reform is that it doesn’t make things worse. Sometimes — even often — that’s quite an achievement.
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