Opinion – Marcos Lisboa: Transition with the wrong foot

The transition to the new government began with the controversy over the dilemma between implementing campaign promises and balancing public accounts. The president-elect went public asking: “Why are people made to suffer to ensure such fiscal stability?”

The short answer is simple. Depending on the circumstances, people can suffer even more in the absence of “fiscal stability”. The full answer requires explaining the “depending on circumstances” weighting.

At the beginning of the last decade, the US and European countries faced recession and deflation, despite interest rates being close to zero. The expansion of public spending, in those circumstances, helped in the resumption of economic activity.

Currently, conditions are different. These same countries face high inflation, after the recovery of the economy after the first months of the pandemic.

Not everything was the fault of economic policy management. There is global inflation, caused in part by the problems arising from the lack of various equipment, in part by the impacts of the Ukrainian War on commodity prices.

In the case of the US, the Biden administration has its share of responsibility for the problem. He began his term with an impressive increase in public spending. Many economists have warned of the risks of such a policy in those circumstances.

Lawrence Summers, for example, pointed out, both in press columns and in more technical reports, that labor market data underestimated the strong expansion of the economy and the shortage of labor that put pressure on the wage-price spiral.

The result, he concluded, would be high and persistent inflation, the highest in four decades, which would require a sharp rise in interest rates to bring it under control. The cost of adjustment would be a possible, and harsh, recession. Bitter medicine, but better than the alternative.

His warnings were of little use. The Biden management and the US central bank, the Fed, believed that inflation would be temporary. These beliefs turned out to be wrong.

Our challenges are even greater than those of the US. The federal government budget for 2023 exceeds the spending ceiling, as Marcos Mendes and Paulo Hartung systematized in an article published in the newspaper O Estado de S. Paulo, much less if the additional promises made during the campaign are included.

The deficit in 2023 may fluctuate between 1.3% and 3.5% of GDP, depending on what is approved.

The transition team suggested passing a constitutional amendment to accommodate increased permanent spending. The announcement, however, left out the engineering of the proposal: how much more would be spent, which promises would be covered in the first year, which ones would be carried over to the following years, and how this expansion of expenditure would later be financed.

This proposal comes amid a very expensive federal government budget for an emerging country, captured by a plethora of interest groups. With each proposal to expand social spending, they seek to appropriate part of the resources, expanding subsidies for the private sector or making amendments possible by parliamentarians.

The Executive’s complacency with the capture of public resources by poorly conceived policies results in an expensive State, but ineffective in taking care of the population. We spend a lot, but we spend it badly, as the document “A post-pandemic economic agenda” sought to show.

With the resources we have, we should get much better results, for example, in student learning, when compared to what other emerging countries achieve. We should also lift more people out of extreme poverty.

As was the case in the US two years ago, the evidence indicates that the labor market is close to the neutral rate of unemployment, the one below which inflation is once again under pressure, as Samuel Pessôa has pointed out.

With current resources, it is possible to increase the effectiveness of social policy and balance public accounts. This agenda, however, requires addressing the benefits granted to interest groups and recognizing the need for a tidy brake.

On the other hand, accommodating pressures rather than facing dilemmas can be the gateway to a dynamic of rapidly worsening public debt. Politics is sovereign, but it must be aware of the consequences of its decisions. Ads that neglect the technique can result in harmful side effects.

The market is not a union with which a deal is negotiated. It is made up of many managers from the private sector, such as pension funds and companies, who assess, in a decentralized way, how to take care of the resources they manage.

These decisions are guided by what they hope will happen in the economy. If the scenario is of greater economic growth, these managers celebrate and increase investments.

On the other hand, if there is a risk of populist measures that result in the return of high inflation and an uncontrolled increase in public debt or in the tax burden, market interest rates rise and investment retracts, harming the generation of employment and income. The increase in the risk premium leads to currency devaluation, impoverishing the population.

Starting government sparingly allows for course corrections in the future. If, however, the option is to start with a high growth in mandatory spending, there is the risk of making an adjustment of the route unfeasible later on, compromising the rest of the mandate.

It is worth remembering what happened recently in the UK. Kwasi Kwarteng, finance minister in a conservative government, has proposed an apparently pro-market set of measures. They included exoneration of the richest, eliminating the rise in social security contributions, canceling the increase in corporate taxation and subsidizing the price of energy.

In the opinion of most analysts, the measures would be fiscally unsustainable. The result was a rise in market interest rates and currency devaluation. It was the end of the government of Prime Minister Liz Truss, which had barely begun.