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30 September 2006
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Research in Brief
How Brazil can grow
Social and economic policies can help the country overcome entrenched
barriers to increased productivity.
Heinz-Peter Elstrodt, Jorge A. Fergie, and Martha A. Laboissière
2006 Number 2
The lackluster performance of Brazil's economy over the past decade, when
GDP per capita grew just 1.5 percent a year, has allowed the gap between
developed economies such as the United States and Brazil to widen and
provided an opportunity for fast-growing competitors such as China and India
to gain ground (Exhibit 1). A study finds that the root cause of Brazil's weak
growth is a relatively slow increase in labor productivity—the primary
determinant of a nation's GDP per capita. Brazil's labor productivity was 23
percent of the US level in 1995 and fell to 21 percent in 2004.
Your javascript is turned off. Javascript is required to view exhibits.
To encourage a public debate among Brazil's leaders on how to boost
economic development, we mapped the barriers to productivity growth in
eight sectors—agriculture, automotive, food retailing, government,
residential construction, retail banking, steel, and telecommunications—that
together make up 46 percent of the country's economy.1
We found that about a third of Brazil's productivity gap with the United
States is caused by two structural barriers. The first is the country's modest
per capita income, which makes consumers favor lower-priced products and
services. One illustration of the population's lower purchasing power: Brazil's
automotive industry primarily produces small, inexpensive cars and relies on
imports for higher-value-added vehicles. The second hurdle (labor is
relatively cheaper than capital) discourages the use of machinery that would
improve productivity. These structural limitations will fade if Brazil can
achieve strong, sustained economic growth. But first the government must
tackle the nonstructural barriers responsible for the remaining two-thirds of
the productivity gap. All of these problems can be resolved through social
and economic policies (Exhibit 2).
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The most important barrier—responsible for some 45 percent of the
nonstructural gap—is Brazil's huge informal economy, which represents
about 40 percent of the gross national income.2 By avoiding taxes, ignoring
quality and safety regulations, or infringing on copyrights, "gray-market"
companies gain cost advantages that allow them to compete successfully
against more efficient, law-abiding businesses. Honest companies lose profits
and market share, and thus make less money to invest in technology and
other productivity-enhancing measures.3
The second obstacle—macroeconomic instability—is reflected in the high
degree of uncertainty among Brazilian executives about future exchange and
interest rates and in the difficulties of forecasting demand for products and
services. Executives are left with little choice but to focus on short-term
financial management at the expense of growth and operating efficiency.
Instability also discourages long-term investment (to automate operations,
for instance), as companies and investors demand higher returns to
compensate for macroeconomic risks. The result is that Brazil's interest rates
are high—8 percent, compared with just 2.7 percent in the United States—
and the market for long-term debt is virtually nonexistent.
Regulations that limit productivity—such as labor and tax laws, price
controls, product regulations, trade barriers, and subsidies—are equally
problematic. Constraints on laying off workers (which add to employment
costs) and restrictions on hiring temporary workers prevent businesses from
adjusting their workforce to meet fluctuations in demand. Brazil's high sales
tax (around 30 percent on a new car, compared with 7 percent in the United
States) also hampers productivity growth, by reducing the demand for cars
and reinforcing the industry's focus on producing low-value-added vehicles,
for example.
Inefficient public services are another hindrance. One-quarter of the
population receives no secondary schooling; almost 12 percent of adults—
some 15 million people—cannot read or write.4 In the agricultural sector,
which employs some 20 percent of the workforce, this educational deficit
impedes the adoption and effective use of modern seeds, fertilizers,
pesticides, and planting techniques. Modern farms in Brazil do use such
techniques, but, even there, farm workers often lack the basic education
needed to apply them most effectively.
Finally, infrastructure limitations—including inadequate highways, ports,
railroads, and power generation and storage facilities—cause problems,
particularly in the agricultural sector. Up to 12 percent of all grain produced
in Brazil spoils before reaching ports or consumers, for instance.
The impact of these key barriers—informality, macroeconomic instability,
regulation, the provision of public services, and the country's infrastructure—
varies across sectors (Exhibit 3). Informality is the biggest obstacle to
productivity growth in labor-intensive domestic sectors, while macroeconomic
instability is the prevalent factor in capital-intensive export sectors.
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Our experience suggests that once a country has identified its productivity
barriers, it can tackle them through structural reforms and approaches
tailored to each sector.5 Brazil's government should establish conditions for
fair competition in domestic sectors and enhance international
competitiveness of the economy as a whole to benefit its export businesses.6
About the Authors
Heinz-Peter Elstrodt and Jorge Fergie are directors in McKinsey's São
Paulo office, and Martha Laboissière is a consultant at the McKinsey Global
Institute.
Notes
The study, "Brazilian economic program—Phase 1: Mapping barriers to
growth in the Brazilian economy," was conducted in 2005 by McKinsey's São
Paulo office in collaboration with the McKinsey Global Institute (MGI). The
project benefited from a previous McKinsey study on Brazilian productivity—
see Martin N. Baily, Heinz-Peter Elstrodt, William Bebb Jones Jr., William W.
Lewis, Vincent Palmade, Norbert Sack, and Eric Zitzewitz, "Will Brazil seize its
future?" The McKinsey Quarterly, 1998 Number 3, pp. 74–83—and from
similar MGI-sponsored studies in 16 countries. The methodology combines
detailed analysis of labor productivity in different industries with a set of
transverse analyses of the economy as a whole.
1
2
According to the World Bank.
Joe Capp, Heinz-Peter Elstrodt, and William B. Jones Jr., "Reining in Brazil's
informal economy," The McKinsey Quarterly, Web exclusive, January 2005.
3
Education Trends in Perspective: Analysis of the World Education Indicators,
Unesco Institute for Statistics and the Organisation for Economic Cooperation and Development, 2005.
4
Didem Dincer Baser, Diana Farrell, and David E. Meen, "Turkey's quest for
stable growth," The McKinsey Quarterly, 2003 special edition: Global
directions, pp. 74–86.
5
Phase 2 of the study will examine specific measures that the government
should take in these areas.
6
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