Brazil's Investment: A Maze in One's Own Navel

April 16, 2015

The recently deceased Uruguayan writer Eduardo Galeano once thanked journalism for forcing him to "stop contemplating his own navel." Last week, I wrote that investment in Brazil is sclerotic. Why? Perhaps because the country has been mesmerized by its own abdominal maze for far too long.

Consider the most common explanations for why Brazil's investment rate shows persistent apathy: Excessive taxes levied on businesses discourage fixed capital formation; poor infrastructure-including ongoing problems in the energy sector-increases production costs; high wages relative to worker productivity weigh on firms, hampering investment; an opaque business environment characterized by obsolete and excessive licensing requirements reduce firms' incentives to invest; an institutional environment marked by subsidized lending that favors certain firms over others misallocates scarce domestic savings; "state capitalism" and excessive government intervention crowd out the private sector. Evidently, all of these reasons have a role in explaining investment inertia. But, importantly, they are all homegrown.

Perhaps Brazil's sclerotic investment has something to do with its long-standing lack of openness.

A brief glance at other emerging economies reveals that this list of possible impediments to domestic investment is not exclusive to Brazil. Many of its emerging-market peers present the same problems-deficient infrastructure, for instance, is pervasive. Moreover, which emerging country does not suffer from an opaque business environment? Where in the emerging world could one say that the institutional environment is so superior to Brazil's that this alone would explain the differences in investment behavior? And what about "state capitalism"? China, a country that boasts one of the highest investment rates in the world, still cultivates many interventionist practices despite the reform efforts underway. The Brazilian tax burden is indeed anomalous, comparable to that of developed countries. But the order of magnitude is similar to that of Mexico's, the second largest economy in Latin America. While Chile, Colombia, and Peru, all have tax burdens of some 20 percent of GDP, in Brazil taxes account for about 36 percent of GDP; in Mexico they add up to about 30 percent. Meanwhile, according to the latest IMF projections, Brazil's investment rate of 19 percent of GDP is expected to fall in the medium term; Mexico's rate of 22 percent of GDP is expected to rise over the next five years.

If the oft-cited reasons used to explain the low level of investment in Brazil are not so different from conditions seen in other emerging countries, including in Latin America itself, what is missing from the discussion? Could it be something foreign to the country's navel, so to speak?

Here is a hypothesis: Perhaps Brazil's sclerotic investment has something to do with its long-standing lack of openness. It is no mystery that Brazil is one of the most closed economies in the world according to any metric that one chooses to gauge the degree of openness. It is no coincidence that this is also the most striking difference between Brazil and its emerging-market peers: Brazil is more closed than Mexico, Colombia, Peru, and Chile; all members of the Pacific Alliance, their growth rates are higher than Brazil's. Brazil is also less open than India, China, Turkey, and South Africa.

There is an extensive academic and empirical literature on the relationship between investment and openness (see, for example, the Peterson Institute's video on trade and investment). Several research papers show that the more open an economy is to international trade, the more foreign direct investment it receives. The more foreign direct investment it receives, the greater the availability of resources for domestic investment. Competition is also crucial: Economies that are more open induce greater competition between local and foreign firms, creating incentives for innovation and investment by domestic companies.

Unfortunately, Brazil is still fairly close-minded when it comes to these issues. Fears of losing market share and the old litany of "selling the country to foreigners" still dominate the national debate. It is time to stop navel gazing and take advantage of the unique opportunities that the current global debate on free trade agreements present.