Brazil’s path to inclusive growth

More than 25 years of democracy and political stability have allowed Brazil to make major strides in economic development, including cutting its official poverty rate by half. Yet the forces that provided much of the economy’s momentum during the past decade — an expanding labor force, credit-fueled consumption, and high commodity prices — are beginning to stall.

This recent slowdown has exposed the more fundamental issue of the country’s long-term weakness in income growth (exhibit). Although Brazil has become the world’s seventh-largest economy, it ranks 95th in the world for GDP per capita. Most households have experienced only modest income growth, while inefficiencies and extra layers of taxes and tariffs push the prices of many consumer goods beyond reach. Having successfully lifted millions out of extreme poverty, Brazil must now deliver on the promise of a middle-class life

Exhibit

Brazil has rapidly become the world’s seventh-largest economy, but individual wealth has failed to follow suit.

A new McKinsey Global Institute (MGI) report, Connecting Brazil to the world: A path to inclusive growth, argues that to raise incomes and living standards, the country must accelerate its productivity growth—and building new connections with the global economy could provide the opening to do just that. The blueprint Brazil has already established by successfully opening its agriculture sector and building the competitive aerospace firm Embraer demonstrates the value of harnessing global competition and supply chains. Deeper integration with global markets can offer greater rewards than ever before, and nations that do not participate in these expanding networks risk being left behind.

Becoming globally connected

Over the next two decades, Brazil needs to average 4.2 percent annual GDP growth to lift half of the still vulnerable population solidly into middle class. Using an assessment of how global networks influence economic growth,¹ we estimate that Brazil has an opportunity to add as much as 1.25 percentage points to its average annual GDP growth in the years ahead by deepening its ties to the rest of the world. In other words, global connectedness could get the country about a third of the way toward its goal of raising living standards.

Brazil today ranks only 43rd in the MGI Connectedness Index, and that indicates ample room for deeper engagement in all types of cross-border exchanges. While the country’s exports have grown since the turn of the century, they have become more concentrated in resources. From 2005 to 2012, commodities exports increased to $64 billion, from $11 billion—but over the same period, a trade surplus of $20 billion in manufactured goods evaporated and turned into a trade deficit of $45 billion.

As the commodities boom caused Brazil’s currency, the real, to appreciate sharply, the country’s goods have become even less cost competitive in global markets. Brazil’s exports are equivalent to 13 percent of GDP, far below the levels of India (24 percent) or Mexico (33 percent). To diversify exports, Brazil will need to compensate for this cost disadvantage by developing distinctive skills and capabilities, particularly in industries adjacent to commodities.

Brazil also has an opportunity to move up the value chain by exporting more sophisticated, skill-intensive products, but this calls for reconsidering its traditional approach to protecting local industries. In the heavily protected automotive industry, for example, high tariffs have encouraged foreign carmakers to create local jobs by establishing production within Brazil, but this hasn’t helped the country integrate into global value chains. Mexican auto plants now produce twice as many vehicles per worker as Brazilian ones, even though factories in Mexico produce a much higher share of midsize and large vehicles. This experience stands in sharp contrast to Brazil’s success in the aerospace and agriculture sectors, which have flourished since trade restrictions were lifted. One critical difference in these outcomes was an emphasis—before the government’s role was reduced—on building R&D muscle in the two sectors. That has paid off in higher productivity and exports.

Perhaps the most important opportunity to improve Brazil’s global competitiveness and increase trade lies in transportation and communications networks. Subsidies to all industries now total almost 6 percent of GDP, but Brazil’s investment in infrastructure averaged only 2.2 percent, well below the global average, between 2000 and 2011. The nation’s rail network is limited, and only 14 percent of its roads are paved. Lines of trucks waiting to load or unload cargo at Brazil’s ports can stretch for miles. Covering the vast expanse of the country is challenging, but it can harness its natural-resource wealth to invest in infrastructure, workforce skills, and other foundations for future growth.

As new markets open, Brazil has a crucial opportunity to weigh the state of its connections with the global economy. The country has traditionally focused on mitigating the risks of openness, but the inward-focused policies of the past probably won’t be sufficient to meet its goals for inclusive growth and higher living standards. Government and business leaders can increase Brazil’s dynamism only by harnessing the potential of global connections to increase productivity; by tapping into more of the world’s ideas, research, and best practices; by encouraging greater digital connectivity; and by increasing the flow of skilled workers and international students. The country needs a new catalyst for growth that can deliver broad-based prosperity to the vast majority of its citizens—and that catalyst could be found beyond its borders.

About the authors: Heinz-Peter Elstrodt is a director in McKinsey’s São Paulo office; James Manyika is a director with the McKinsey Global Institute, where Jaana Remes is a partner; Patricia Ellen is a principal in the Rio de Janeiro office, where Cesar Martins is a consultant.

Source: McKinsey&Company