Rajan on Brazil

University of Chicago professor and ex-chief economist of the World Bank did an interview with Brazilian magazine Veja, published online today. Rajan has distinguished himself by being one of the first to clearly foresee the economic crisis brewing in the United States, back in 2005. He also published the book Fault Lines, which is the book that most aggressively attempts to push the crisis back to an ultimate cause, starting with flattening wages and increasing consumer and housing credit in the 1970s. In the Veja interview, he argues that the panics we are seeing now are the tip of the iceberg, with perhaps a full blown crisis still to come. He also weighs in on Brazil's position. It's nice to hear from him on the subject given his eminence and track record in getting the economy right. But he doesn't provide much that we aren't hearing elsewhere. Among the major takeaways:

Brazil has a currency problem (no secret to anyone here) caused by a reliance on commodities and the vast amount of foreign investment flooding in. Brazil's real is twice as expensive compared to the dollar these days as it was back around 2003, making it ever harder to be competitive in exports. In recent years, Brazil has seen a growing budget deficit due to cheap imports and tough times for exporters. The solution has been to try to limit the flow of capital from abroad, but it is clearly not working. The banking authorities cannot effectively fight the rise of the currency and inflation at the same time.

He alludes to credit threats, and though doesn't get into it much, he makes one very crucial point: once the credit ball starts rolling, it becomes very hard for politicians to stop it once it gets ugly. [quick background: Brazil's position regarding consumer credit is debatable; Brazilians tend to say it is contained and far below US crisis levels compared to the size of the GDP; others have noted that the important metric is not the absolute size of consumer debts, but the cost of servicing them relative to income for much of the population (which comes to something like 25% of income for many people).]

Brazil needs to invest more in infrastructure (again, this is no secret to anyone that has paid attention to Brazil of late). There are severe bottlenecks on roads and ports that increase costs and hurt competitivity. Brazil is required to invest in infrastructure (roads, trains, etc) for the World Cup and Olympic Games, but Rajan sees the effort as insufficient to solve Brazil's problem and make it more competitive. [As a side note, recent corruption scandals have shown that the people responsible for trying to modernize Brazil for the big events are incredibly corrupt. Ministers are being fired right and left, especially the Minister of Transportation, who spent large portions of the budget enriching his family and friends, and then requested more money from the Federal Government to cover the shortfalls his corruption produced.]

Finally, he produces some words of wisdom I hadn't seen before: Brazil needs to get out of this mess not through clever tactics like manipulating exchange rates, but by actually modernizing its manufacturing sector and becoming effective, like Canada and Australia did in the past when their currencies were made uncompetitive by large capital inflows. Not a short term project, and in my view, probably not one that the Federal Government can manage politically due to corruption, a bad education system, and a host of other problems.