A note on the political economy of the Brazilian economic development

Laudo M. Ogura1

Department of Economics, Grand Valley State University

Grand Rapids-MI, USA

Preliminary version (June 2016): Initial draft was written in 2005. The analysis was extended to
2015, but the literature review was not updated and it still not fully comprehensive. There are no
plans for future revisions or updates. This work is intended as an analytical review of the
literature. For further references, please consult the works cited in this paper.

Abstract

This note analyzes how political economy models may be useful to understand the Brazilian economic
development experience. The theories considered here include early political economy views about
development, democracy vs. dictatorship effects, political instability effects, and rent seeking and barriers
to technology adoption inefficiencies. The relevance of each model to explain the Brazilian economic
development is discussed.

1 Contact information: ogural@gvsu.edu. The author thanks Prof. Dr. Werner Baer, who taught the Economic of
Development and Growth graduate course in 2002, which served as the basis for this work. Errors and the many
omissions are the author’s responsibility.
 "Growth will simply not occur unless the existing economic organization is efficient. Individuals
must be lured by incentives to undertake the socially desirable activities."
(North and Thomas, 1973, p.2)

1. Introduction

This study focuses on political aspects of the economic development process. The main goal is to
review the relevant theoretical literature and to analyze how the main theories help explain the Brazilian
economic development experience.

Previous studies on political factors of Brazil’s economic development have been restricted to
specific models. The period analyzed here cover the republican years (1889-present).

Brazil has an interesting development history because the federal government had varying
degrees of discretion to change economic policies over the years. Since 1889, the economy developed
first based on agricultural production and export. Later, to reduce the dependence on agriculture exports,
governments started to protect and stimulate the national manufacturing industry. The alternation between
democratic and authoritarian regimes makes the study of the political economy of Brazil’s economic
development more interesting as it allows to relate the changes in economic policies and instability to
changes in political regimes.

The literature review is restricted to models that attempts to explain long term economic
development. Hence, models on political cycles (e.g., electoral and partisan cycles) are ignored. Persson
and Tabellini (2000) provide a comprehensive review of the political economy literature that includes the
effects of political changes on short term economic growth.

In the next section, we review the theoretical literature. In section 3, we analyze the relevance of
these theories in explaining the Brazilian economic development (1889-present). Section 4 offers
concluding remarks.

2. Political Economy and Economic Development

In this section, we cover the relevant literature on the political factors of economic development.

2.1. Early views

For Classical economists, free markets would yield efficient allocation of resources and the
exploitation of comparative advantages would bring economic development (Meier and Baldwin, 1957).
Thus, government had no other role than to assign or protect property rights (Smith, 1776).

The Classical view as well as Marx's (1952) view implied that democracy would eventually
hinder economic growth by letting the poor to demand distributive policies (e.g., heavy taxation on
capital). This would decrease profits and then economic growth. The issue of how democratic political
regimes affect growth is discussed later.

After the Great Depression of 1930s, government intervention in the economy started to be
advocated by many economists, justifying the rise of interventionist and authoritarian governments in low
developed countries (LDCs). The Keynesian theory of aggregate demand (Keynes, 1936) was used as an
argument for intervention, especially in times of recession. Schumpeter's analysis of economic
development (Meier and Baldwin, 1957) adds a strong argument for intervention in LDCs. His theory is
based on the need for innovations and capital markets to finance innovations, so that a strong government
may be helpful by satisfying these needs, especially in LDCs where the private sector is not capable of
doing so due to decentralized resources or high risks.

Hirschman's (1958) unbalanced growth model also can also be used to justify government
intervention. The model suggests that LDCs needed not only a big-push, as it was suggested by
Rosenstein-Roden (1943), but also resource concentration in certain industries due to the scarcity of
resources and the profit opportunities that excess capacity in some sectors would create. The role of the
government is to prevent shortage of public infrastructure. Under democracy, directing resources to invest
in infrastructure may be politically difficult except in times of shortage. Of course, authoritarian
governments can direct resources earlier to prevent shortage.

The advantages and disadvantages of centralized control of the economy is reviewed in the next
subsection.

2.2. Political regimes: democracy vs. dictatorship

One of the questions that economists have tried to answer is whether political democracy fosters
or hinders growth. Przeworski and Limongi (1993) survey the literature on this subject, concluding that
political regimes do not capture the relevant differences between policies that can stimulate or restrict
economic growth. We summarize here their analysis.

First of all, property rights are one of the preconditions for the development of markets. These
rights can be threatened by the state through taxation, expropriation, and confiscation, or by private
agents (for example, labor unions threatening capital returns and landless peasants threatening land
ownership; property crime, extortion, corruption, and similar illegal activities also increase the risks
associated with capital investment). Because democracy allows collective organization of individuals
(e.g., labor and peasants unions), it may negatively affect investment in new capital. Authoritarian
governments, on the other hand, cannot commit themselves to enforce property rights as they may
actually become a threat themselves through nationalization, taxation, regulation, or corruption.

Another way that democratic regimes can hinder growth is by allowing pressures for immediate
consumption, which reduces investment. Democracy offers the poor the power to demand redistribution
of income and wealth. As a result, investment in the economy is lowered because savings decrease2 or
because capital is highly taxed.3 Only authoritarian governments can be isolated from these pressures,
although dictators may have personal interests that are even more disruptive to investments. In the long
run, even authoritarian governments must somehow seek legitimacy, which can result in redistributive
policies.

Last, democracy can be vulnerable to pressures from interest groups, which are further discussed
in the next subsection.

Therefore, democracy may not allocate resources optimally to promote economic growth.
However, as Przeworski and Limongi (1993) point out, authoritarian rulers are often predatory: they are a
source greater inefficiencies because they benefit directly from taxation or from the extent of government
activities, leading to over-taxation and over-regulation.

Supporting the mixed implications from the theories, the empirical literature is inconclusive.
Hence, it is not the political regime that seems to matter for economic development, but the policies and
institutions supported by the political environment, which is determined by the interaction between
individual or group interests in society (to be analyzed next).

2.3. Interest groups and rent seeking

Agents who share common interests tend to organize to pressure the government for special
benefits (Olson, 1965, 1982).4 If the group is relatively small, its demands will probably disregard the
efficiency of the whole economy, seek only for benefits for the members (e.g., differential tariffs, price
support, tax loopholes, detrimental labor benefits, blocking of certain innovations, etc.). The resource
reallocation supported by lobbies may generate significant deadweight losses, in addition to the fact that
lobbying activities are itself wasteful as they compete for scarce public resources and property rights.

2 Poor people are assumed to have higher marginal propensity to consume.

3 High taxation on capital can be viewed as a threat to property rights. See Perotti (1993) and Persson and Tabellini
(1994) for some of the models of mechanisms by which income inequality lowers growth in democracies.
4 See, for example, Abramovitz (1983). More recent papers on the effect of interest groups on growth include
Tornell and Velasco (1992), Tornell (1995), Benhabib and Rustichini (1996), Lane and Tornell (1996), and
Svensson (1996).
 On the other hand, largest interest groups that could prevent inefficient allocations are unlikely to
organize collectively because of free-riding issues (individuals in the group have no incentive to be active,
since everybody gets the same benefit).

Olson also suggests that democratic societies will accumulate more special-interest organization
as time goes by (as an example, he points to the low growth rate of the UK economy in the twentieth
century). Evidence of the negative impact of interest group activities on growth can be found in Olson
(1982) and Choi (1983). However, other studies find little or no impact. The inconclusive evidence may
be due to the lack of valid proxies for the organization or strength of interest groups.

Individuals or groups can also create inefficiencies in the economy when they engage in rent
seeking activities (Krueger, 1973) or in government corruption (Rose-Ackerman, 1975). In this stream of
the literature, rent means the opportunity profit generated by government intervention. Examples of these
rents are the excess wages that public workers receive and the additional gains that firms get when
obtaining exclusive licenses (to import or produce certain goods, for example). Thus, rents are generated
when there is artificial excess demand caused by government intervention. To get these rents, individuals
or groups need to engage in rent seeking activities, for example, getting a higher degree diploma to be
able to apply for a government job, or lobbying government officials or politicians to get a license or
permit.

While rent seeking activities are usually wasteful, they may just be a response to government
interventions that have direct negative effects themselves. For instance, ceilings on interest rates lead to
credit rationing and regulated taxi fares result in increased waiting time.

Concluding, it is argued that rent seeking generates deadweight losses,5 which may result in
decreased economic growth. Krueger (1974) gives some empirical evidence to wasteful rents. A
theoretical analysis of the negative effects of rent seeking on growth can be found in Murphy, Shleifer
and Vishny (1993). In terms of empirical evidence, there are not many works likely due to the difficulty
to measure rents and its effects.

Corruption in governments implies similar problems as rent seeking activities. Schleifer and
Vishny (1993) and Tanzi and Davoodi (1997) develop models on how corruption can negatively affect
economic growth (for evidence, see Mauro, 1995).6

5 Not all rents are bad. Patents, for example, create rents that stimulate investments in research and development by
their seekers.
6 These models are originally not political economy theories of economic development. It is, however, taken into
consideration here because of their claims that monopoly rights are the main factor that hinders economic growth:
concessions of monopoly rights are granted in a political environment.
 The struggle among different interest groups may also generate political instability, which can be
negative to economic growth. This is reviewed in the next subsection. Subsequently, the focus turns to
how interest groups lead to monopoly rights that block technology adoption.

2.4. Political instability

There is a large literature on the effects of political instability on economic growth, which started
to develop in the 1980s. An extended survey cane be found in Alesina, Ozler, Roubini, and Swagel (1996)
or Persson and Tabellini (2000). The basic argument is that income inequality generates social tensions
that cause political instability, like social unrest, political violence, civil wars, or even government coups
and changes in the political regime. This instability affects investments and production by threatening
property rights, reducing the productivity of workers, or creating uncertainty on government policies and
reducing expected returns on investments. This is especially the case when there is the possibility of a
new government that may be prone to increase taxation or regulation on capital investments, inducing
lower investment, excessive consumption and capital flight (Alesina and Tabellini, 1989).

Gradstein (2002) argues that a democratic society is prone to have redistributive pressures
fostered by income inequality and unstable economic environment, which can lead to more discretionary
policies instead of stable rules. Discretion in policy making reduces private investments because it
increases the risks associated with future returns, thus lowering economic growth rates.

Other authors study the instability of inflation (Cukierman, Edwards and Tabellini, 1992) or of
balance of payments (Ozler and Tabellini, 1991), and the weakening of the government as a player in the
economy as it gets more vulnerable to lobbies and pressure groups (Murphy, Shleifer and Vishny, 1993).

Alesina, Ozler, Roubini, and Swagel (1996) offer evidence that political instability, measured as
propensity of government collapse, has negative effect on growth rates. On the other hand, a paper by
Campos and Nugent (2002) found that this evidence vanishes if controlled for Sub-Saharan African
countries. Omission of endogenously related variables like policy volatility or institutional factors might
be the cause of the inconclusive empirical evidence.

2.5. Differences in Total Factor Productivity (TFP) and monopoly rights

We come back to the issue of how interest groups can hinder growth. The following literature is
based on the work of Parent and Prescott (1994), who suggest that the large differences in per capita
income across countries is caused primarily by different degrees of knowledge that societies effectively
apply to their production. This heterogeneity arises because countries adopt different policies regarding
adoption of production technologies and work practices (Parente and Prescott, 2000, p. XVI).7 Examples
of barriers to technology adoption are the monopoly rights obtained by incumbents in some industries or
the resistance by labor unions in allowing the use of labor-saving technologies. The implications of this
theory are: 1) development miracles are consequence of the exploitation of a large stock of useable
knowledge when barriers to adoption fall (for example, South Korea greatly increased its TFP by
reducing the barriers after 1965); 2) poor economies do not need to create new ideas, but need only to
apply existing ones to their production (however, this requires the absence of barriers to adoption of new
knowledge); 3) governments of LDCs must stop protecting monopoly rights and promote greater
competition through privatization and/or free trade between regions and across countries.

3. Evidence from the Brazilian development experience8

Baer (2001) describes the pre-1930 political state in Brazil as non-interventionist, which was the
approach suggested by early economic theories. Landowners dominated the political scenario, but the
most economically influent groups were coffee growers, since Brazil was the major exporter of coffee at
that time. During this period, economic policies were highly directed to help the coffee sector. However,
Abreu (2000) argues that coffee growers and industrialists agreed to keep higher tariffs on imports. This
policy increased production cost of coffee,9 probably decreasing profits and exports. The higher
protective tariffs also decreased efficiency in the national production, but it helped build a productive
industrial capacity that was useful later during the 1930s world depression.

The 1930s represent a period of change in the political scenario, after the regime change.
However, there were no radical changes in economic policies. Coffee growers' interests were still
protected. But new sectors were listened by the new government, which needed a broader political
support to legitimate itself. As a consequence, the government adopted a growth-oriented policy putting
in course an industrialization process that continued until the 1970s (Baer, 2001, Abreu, 1990, Skidmore,
1957). Next, we analyze how the political scene affected the economic development of Brazil since the
1930s.

First of all, the state intervention in the economy and the rise of authoritarian regimes matches the

7 Grants or protection of monopoly rights result from political lobbies or corruption. The authors claim that their
theory explains the emergence of UK as the first economy to develop in Europe, the stagnation of China after the
fifteenth century, the current prosperity of US and Switzerland, and the growth miracle experiences of Southeast
Asian countries.
8 For a short review on the economic growth of Brazil, see Baer and Paiva (1997).
9 Brazil, which was the major producer of coffee, was able to partially compensate increased cost with higher
prices, but this must have led to a decrease in quantity demanded (Abreu, 2000).
new economic development models that emerged since the 1930s. Interventionism was characterized by
direct state investments or by stimulating private investments usually through fiscal and/or credit
incentives, and protection against imports. Also, development banks were created to foster capital
markets. These interventions are in accordance with Schumpeter's analysis of economic development,
which suggested the need to develop economic conditions for investment and innovation. State
investments in public infrastructure and heavy industries (e.g., mining, steel, and petrochemicals) opened
opportunities for private investments in new business (e.g., metals and plastic products; see Abreu, 1990).
Under authoritarian regime, directing resources to strategic investments was easier to pursue because
there was no need to negotiate the reallocation of resources. This reallocation was needed according to
Hirschman's model of unbalanced growth.

One negative effect of interventionism was the creation of economic rents, for instance, rents
from imports control and public concessions. Imports were kept under tight control by regulations and
tariffs, but the beneficiaries of rents were not only the national companies, but also the multinational
companies attracted by the government and the bureaucrats who had the power over import licenses (see
Abreu, 1990).10 Public concession (subsidized credits, fiscal incentives, public constructions, etc.) were
also under discretion of bureaucrats and politicians, then generating rents for them and for the winners of
concessions.

Besides rents, interventionism led to inefficient outcomes because the allocation of resources was
distorted. Rents and inefficiencies should have hindered economic growth, but there is a lack of studies
on whether this happened. Interventionism also allowed interest groups to protect themselves. For
instance, Shikida and Monasterio (2000) show that the existence of labor unions and industry unions
reduced growth rates at the state level in Brazil in 1970-1995.

Relating to the discussion about democracy vs. dictatorships, it can be argued that the
authoritarian regimes (1930-1945 and 1964-1984 periods) highly contributed to create a friendly
institutional framework to increase savings, to pursue public investments, to foster new industries, to
avoid popular pressures for redistribution, political instability, and to increase government revenues (see
Abreu, 1990, Baer, 2001, and Skidmore, 1957). However, the populist orientation of the first regime (in
the 1930s) led to measures that decreased efficiency, like over-regulation of labor markets.11 In the
second authoritarian regime, the advantages of an authoritarian regime clearly allowed a faster
stabilization and growth of the economy in the late 1960s and in the 1970s (see Figure 1 for per capita

10 Multinationals were attracted in sectors for what there was scarcity of capital and/or technology, like automobile
industry (Skidmore, 1957).
11 See Medeiros (2001). The new government also extended popular participation in elections, which increased the
vulnerability to pressures for redistribution.
real GDP growth rates since 1961). However, fiscal and external vulnerability remained due to an
inefficient tax system and high external debt accumulation, culminating in the economic crises of the late
1970s and early 1980s and the subsequent stagnation (see Abreu, 1990). For the post-1980 stagnation,
Martins (2001) argues that the excessive executive power inherited from the military regime led to
excessive use of discretionary policies, thus causing economic uncertainty and reducing private
investments. In defense of democracy as the alternative, Martins suggests that the relatively high
economic growth of the period between authoritarian regimes (1946-1963) was facilitated by stable
economic rules, since the Parliament had much more power. For the current democratic regime period
(which started in 1985), we can list several positive economic reforms adopted, like privatization and
trade liberalization reforms, price stabilization, restrictions on fiscal deficits,12 and the reform of the bank
system, including greater central bank independence (see Baer, 2001, for a review of this period). These
reforms were helpful in the 1990s and 2000s to gain greater economic stability and to increase social and
infrastructure investments. However, the lack of deeper reforms to reduce the role of the state in the
economy and to make private investment more attractive continued to allow excessive government
intervention in major industries (like infrastructure and oil extraction) and rent seeking by private
companies, politicians, and bureaucrats.

Political instability models may be helpful to understand certain period of the Brazilian economic
history, but while instability has been common, there were only few periods when relevant ruptures in
economic policies were likely.13 Most of the uncertainty came from excessive discretionary power that
allowed governments to change tax or regulatory rules at will. A problem in blaming political instability
for low investments is that instability usually derives from economic crisis: eventual decrease in
investments can be blamed on low economic perspectives rather than on uncertainties from social unrest
or policy changes. Chaffee (1998) points out that one positive feature of the post-1964 military regime
was that it did not represent a rupture to the development policy. The same can be said about the post-
1930 authoritarian regime, in relation to the defense of coffee production, which was still the most
important economic activity. More recently, due to slow down of the world economy since 2008, fiscal
capacity limitations have reduced the ability of the government to sustain infrastructure and social

12 The Fiscal Responsibility Law (signed in 2000), created criteria to punish bad fiscal management.
13 During the economic stagnation of early 1960s, one of the factors for the low incentive to invest was the political
instability caused by the uncertainty brought by the new elected government (Quadros-Goulart) in 1960 (Skidmore,
1957). President Quadros, who were a populist, resigned after few months in the government; Vice-President
Goulart, known for leftist preferences, were opposed by large sectors of society. Besides that period, concerns about
changes in the economic status quo were taken seriously only in the presidential election of 1989, when the leading
candidates were a liberal populist and a radical leftist. The concerns were justified especially because of the highly
deteriorated macroeconomic conditions at that time, which required strong measures from the new government (see
Chaffee, 1998). These periods of political instability can be related to Gradstein’s (2002) argument that democracy
can lead to more discretionary policies due to pressures from opposing interest groups.
spending. The resulting political instability and interventions (including discretionary spending to
stimulate the economy) have led to social unrest, loss of political support to the government, and threats
of increased taxation. This instability may have deepened the economic recession in 2015 as the
government was unable or unwilling to make any relevant policy change to avoid a greater loss of
political support.

Last, there is evidence that barriers to technology adoption slowed down economic growth in
Brazil. Studies of the impact of trade liberalization and privatization in the early 1990s show increased
efficiency in the industrial sector. Ferreira and Rossi (2001) and Moreira and Correa (1998) provide
evidence of increases in TFP and productivity per worker in industries after trade liberalization. Pinheiro
(1996) presents evidence of improvement in the performance of privatized enterprises. Baer (1994)
suggests that trade liberalization helped to enforce competition in privatized markets and then to
increased efficiency and productivity.

In conclusion, despite the fact that evidence listed above are not all rigorously tested, political
economy models seems to be helpful in understanding the underlying government policies that fostered or
hurt the Brazilian economy during the past century.

4. Concluding remarks

In this note, we reviewed the literature on the political economy of development and analyzed the
Brazilian economy case. Political economy models seem to help understanding both the fast economic
growth in Brazil in the 1970s and the emergence of inefficiencies that led to low growth in the 1980s and
1990s.

Institutional inefficiencies in the economy deserve a better analysis. An extension of this work
should look at the institutional changes that induced more efficient or inefficient allocation of resources
and the effects on economic growth in Brazil.
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Figure 1 – Brazil’s real GDP per capita growth

Source: World Bank (2016), using GDP per capita in millions of 2010 US dollars.