Opinion – Samuel Pessôa: 10% drop, how?

In the June 11th column, I showed that our great crisis, from the second quarter of 2014 to the fourth quarter of 2016, resulted in a permanent loss of 10% at the level of the economy.

This loss is distinct from that which occurred in the growth rate of potential output. That is, even considering that exogenous factors —such as the end of the commodity boom or the change in the rainfall regime—have reduced the growth potential of our economy, there was an additional loss of 10%. More details on the Ibre Blog.

On the Ibre Blog, reader Raul Santos, in a comment, asked a very pertinent question: “What would be the microeconomic basis for such a persistent effect resulting from misallocation”? I chose to answer you with this column.

My interpretation is that the permanent loss was the result of the high level of artificiality that prevailed in the economy due to the wrong economic policy since Lula’s second term.

In 2014, the unemployment rate was three percentage points below the natural rate. All this employment was allocated to activities that did not have a sufficiently high private profitability to pay for the work under the contract.

Investment in the period also had a high degree of artificiality. To put it better, the public and private sectors have for years generated credit for investments in activities that have matured poorly. Investment enters into GDP. As they matured poorly, they did not generate cash. At the end of the cycle, companies had debt but no production. Evidently, investment had to plummet, as a new investment cycle would have to be sustained by the return generated by the previous cycle.

In order to prevent investment from falling, given that the investment cycle had gone wrong, certain conditions would be essential: that there were profitable projects (that is, of good quality) ready to sustain a new growth cycle; that there were financial institutions, public and private, international and domestic, with the appetite and cash availability to finance them; and that the cost of capital of a new cycle of indebtedness, in a society that was already heavily indebted, that saves little and in which the cost of capital is historically one of the highest in the world, would not rise to stratospheric levels. Needless to say, these conditions were not given and that it was not within the reach of economic policy to build them.

To have a quantitative idea of ​​the situation at the time, the average investment rates in Dilma 1’s quadrennium was 22% of GDP. Petrobras alone accounted for just over two percentage points of this total. We had investments with Treasury resources, such as the MCMV program, among others, in addition to all the investment in the naval industry and in Grupo X, by Eike Batista, among many others that matured poorly. When the cost of capital to the Treasury soared, these programs had to be discontinued.

Other sectors affected by economic policy errors were sugar and alcohol and the entire automobile sector.

The first was because it ran out of cash to pay its debts due to the loss of profitability induced by the gasoline price policy conducted by Petrobras at the time; the automobile sector, due to the exhaustion of an aggressive policy of subsidized purchases of trucks and investment in new factories, with the expectation that the Brazilian market would quickly move towards a consumption of 5 million units/year of automobiles.

It makes perfect sense that 1/3 of everything that was invested during Dilma’s first term matured poorly and that, therefore, investment had to drop a lot.

I would say that these two factors —artifically low unemployment rate and bad investments— explain the microeconomic problem, that is, the misallocation of resources, which describe the permanent drop in Brazilian activity by 10% in the three-year period from 2014 to 2016.

It is theoretically possible that part of the permanent loss was caused by the fact that the economic policy after 2016 was very contractionary and generated a lack of aggregate demand. It is argued that the long unemployment would have caused hysteresis —permanent loss of productive capacity due to the loss of specific human capital. This argument does not seem relevant from a quantitative point of view, as the loss of specific human capital occurs in workers with higher levels of education. This is not the case with the workforce in Brazil.

Economic growth is not an act of will. Incentives and the entire institutional framework need to be well constructed so that an investment cycle does not become just debt and waste.