brazil under cardoso || fiscal squeeze and social policy during the cardoso administration...

Fiscal Squeeze and Social Policy during the Cardoso Administration (1995-2002)Author(s): Matías VernengoSource: Latin American Perspectives, Vol. 34, No. 5, Brazil under Cardoso (Sep., 2007), pp. 81-91Published by: Sage Publications, Inc.Stable URL: http://www.jstor.org/stable/27648045 .

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Fiscal Squeeze and Social Policy during the Cardoso Administration (1995-2002)

by Mat?as Vernengo

Conventional wisdom associates the two lost decades of economic stagnation in Brazil to macroeconomic imbalances and excessive budgetary deficits. Contrary to conventional

wisdom, the fiscal crisis of the state in Brazil was the result of the liberalization strategy that started in 1989 and was accelerated and complemented during the Cardoso adminis tration (1995-2002). The fiscal crisis of the state resulted from the financial liberalization

of the 1990s and the increasing burden of interest payments on public debt. The interest

burden, in turn, meant that fiscal spending on social policy was squeezed, a result that is common in liberalization experiences in the periphery. The amount of social spending

was insufficient during the Cardoso administration, and problems were not restricted to

inefficient spending.

Keywords: Fiscal policy, Development, Latin America

Conventional wisdom associates the two lost decades of economic stagna tion in the developing world that started, particularly in Latin America, after the Mexican debt crisis of August 1982 to macroeconomic imbalances and excessive budgetary deficits. Fiscal deficits, in turn, are seen as part of the failed

attempts at industrialization led by the developmental state during the import substitution-industrialization period. These views led to a revision of develop

ment strategies and were incorporated into the structural adjustment programs

sponsored by the International Monetary Fund (IMF) and the World Bank. This

negative view of the role of the state in development culminated in the case of Brazil with Fernando Henrique Cardoso's famous obituary for the Vargas era.

The idea that a fiscal crisis of the state was central to an understanding of the limitations to economic development that emerged in 1970s was in fact also raised by progressive writers. James O'Connor (1973) argued that capitalist states tend to increase spending to stimulate economic growth but decline to

increase taxes in order to preserve their political legitimacy. Valpy Fitzgerald (1978) argued that in Latin America the tax increases needed to finance public spending were borne by the working class and that inadequate tax revenues

tended to destabilize the economies of the region and limited the viability of

dependent capitalist development in the area.1 This paper suggests that, contrary to conventional wisdom and progressive

criticism of the role of the state in economic development, the fiscal crisis of the state in Brazil was the result of the liberalization strategy that started in 1989,

Mat?as Vernengo is an assistant professor at the University of Utah, Salt Lake City. He thanks

Alcino Ferreira C?mara Neto and Jos? Antonio Pereira de Souza for several discussions on the

topic of this paper, and Alfredo Saad-Filho for comments to an earlier version.

LATIN AMERICAN PERSPECTIVES, Issue 156, Vol. 34 No. 5, September 2007 81-91 DOI: 10.1177/0094582X07306243 ? 2007 Latin American Perspectives

81



82 LATIN AMERICAN PERSPECTIVES

intensified during the Collor (1990-1992) administration, and was accelerated and complemented during the Cardoso administration (1995-2002). In this

view, the fiscal crisis of the state resulted from the financial liberalization of

the 1990s and the increasing burden of interest payments on public debt. The interest burden, in turn, meant that fiscal spending on social policy was

squeezed, a result that is common in liberalization experiences in the periphery (Grunberg, 1998; Toye, 2000). This suggests that the idea that the main problem

with social policies in Brazil is the lack of targeting, as usually noted by the World Bank and emphasized by several writers (e.g., Schwartzman, 2000; Barros and Carvalho, 2004), is fundamentally incorrect. The amount of social

spending has been insufficient during the Cardoso administration, and problems are not restricted to inefficient spending.

The paper is divided into three sections. The first revisits the notion of the

fiscal crisis of the state. It is shown that the crisis of the state both in the center

and in the periphery of the capitalist system is associated with rising financial costs and that this argument is valid for Brazil. In particular, since the Cardoso

administration was instrumental in promoting financial liberalization, the fiscal crisis intensified in this period. The second section shows the resulting fiscal

squeeze of social spending. It is shown that improvements in certain social indi

cators during the Cardoso era?often used as a defense of his social policies? have deeper historical roots. The last section provides some reflections on

alternatives to the current fiscal crisis.

THE FISCAL CRISIS OF THE STATE REVISITED

The rise of the "tax state" is tied up with industrialization and the unprece dented rate of growth of per capita income experienced in the past 200 years, for

the most part in the Western world.2 Some writers claim that the Keynesian revolution (which occurred at a time when the tax state was consolidated), while

arguably saving capitalism from itself by helping to reduce unemployment, had

unexpected consequences that may now unravel the tax state. This section shows that the risk of the fall of the tax state is related to rising financial costs

rather than excessive social spending. The rise of the tax state and the rise of modern capitalism are part of the same

process. The expansion of markets and the development of long-distance trade in the eighteenth century created new sources of revenue. Indirect taxes such as

customs and excise taxes were initially the main source of state revenue. Only in the late nineteenth century and more clearly in the twentieth did direct taxes on income and to a lesser extent on wealth become relevant. Tax revenues

remained relatively low, averaging 10 percent by the late nineteenth century in

the main developed countries.

The process of industrialization and urbanization, with the rise of an urban

working class, led to a whole new set of demands for social spending that could be satisfied only by increasing taxation. Slowly throughout the nineteenth

century the Night Watchman state?the minimal liberal state?evolved into a

more active participant in the economy. By the late nineteenth century, with the rise of socialism and the labor movement in Western Europe, social concerns

became an essential part of policy preoccupations. Starting with Bismarck in

Germany, a limited system of welfare developed.



Vernengo / FISCAL SQUEEZE AND SOCIAL POLICY 83

Balanced budgets were seen as essential not just to keep the debts at sustain able levels but also to avoid excessive burdens on the poor, who paid the most taxes. With the depression and the advent of Keynesian economics the role of the state changed significantly. Income tax and social security contributions became the main source of revenue, and the role of indirect taxes diminished. A

progressive income tax?once advocated by Marx and Engels (1959 [1948]: 28) as a radical measure?became standard in the Western world. The tax state had

gone from its modest origins, when public borrowing was a substitute for taxing the privileged and indirect taxes, essentially on the poor, were the main source

of revenue, to a progressive system of taxation in which the bulk of contributions came from direct taxes on the upper class.3 In sum, the rise of the tax state can

be seen as a struggle over who would carry the burden of taxation?a battle, one

should add, that was progressively, if slowly, won by the underdogs. By the late 1970s tax revenues in the developed countries ranged from slightly

less than 30 percent to more than 60 percent of the gross domestic product (GDP), and some writers foresaw the downfall of the tax state. According to O'Connor

(1973), a structural gap developed at the heart of the tax state. The ability to raise taxes was limited, but the social demands were virtually unlimited, hence a fiscal crisis was inevitable. The tax state?along with capitalism itself, for Marxist

writers?carries the seeds of its own destruction.

Further, the impressive increase in the cross-border flows of trade and capital that came to be called "globalization" is seen by many writers as having dealt the last blow to the bloated welfare state and led eventually to the demise of the tax state. But, like the proverbial rumors of the death of Mark Twain, rumors

of the death of the tax state may be exaggerated. In fact, there is no clear evidence of the death (a severe reduction of the size) of the tax state, at least in macro

economic terms.

If one looks at the amount of government expenses and revenues in the past two decades, one notes that the rate of growth vis-?-vis that of the previous century stagnated, but the amount remains large by historical standards

(Tanzi and Schuknecht, 2000). During the twentieth century, the average share of government spending among Organization for Economic Cooperation and

Development (OECD) countries increased from around 10 percent to around 50 percent of GDP. Despite all the rhetoric on the demise of the tax state, global ization and the conservative revolution have been able not to //shrink,/ the state but only to stabilize its rate of growth.

This is not to say that there are no problems for the tax state. The main

problem, which is usually associated with a fiscal crisis of the tax state, is the accumulation of debt during the past 30 years. Table 1 shows the increasing burden of debt in developed countries. While most economists and politicians are concerned about the debt, either because it promotes unfair intergenera tional transfers or because it slows the pace of capital accumulation, progres sive writers have focused on the burden of interest rates. In this view, the

problem of debt accumulation results less from the increase in social spending than from the combination of high rates of interest and low rates of growth in the past 30 years.

Pasinetti (1997: 168) argues that the growth of debt is not caused by Keynesian profligacy and that the vulnerability of fiscal accounts "usually attributed to the high size reached by the debt ... is in fact due to the high




TABLE 1

Debt and Interest Burdens (% of GDP)

Debt Burden Interest Burden

1970 1980 1997 1970 1980 1995

Canada 51.9 44 93.8 1.2 2.5 4.3

France 53.1 30.9 64.6 0.5 1.5 3.2

Germany 18.4 31.1 65 0.4 1 2.5

Italy 41.7 58.7 121.7 1.8 5.4 11.1

Japan 12.1 51.2 87.1 0.4 2.4 3

UK 81.8 54 60.3 2.7 4.7 3.7

USA 45.4 37 61.5 1.3 2.3 3.2

Source: Tanzi and Schuknecht (2000).

level reached by interest rates." The causes of high interest rates and low rates

of growth are highly complex and related to the demise of the accumulation

regime that was in place during the so-called Golden Age of capitalism (Glyn et al., 1990). However, Pasinetti (1997) argues convincingly that a revenge of the

rentier?the reverse of Keynes's euthanasia of the rentier, that is, the pressure from those that depend on rents, particularly financial rents, to increase their share of the pie by raising the real rate of interest?resulting from income

distribution conflict is at the heart of the process.4 Interest payments as a share of total GDP?which represent the burden of

interest payments associated with government debt servicing?have increased

(Table 1), crowding out social spending. It was the Bretton Woods period, in

which capital controls were widespread and interest rates were set with a view to generating full employment, that allowed government social spending to

increase without leading to explosive increase in government debt. Pasinetti

suggests that the accumulation of debt is the result of the increase in interest rates that ultimately results from a more open international financial environ

ment globally. If we look at the Brazilian experience, we note that the accumulation of

domestic public debt accelerated only in the 1990s, simultaneously with the

liberalization of the capital account of the balance of payments. Figure 1 shows that the debt-to-GDP ratio was relatively low at the beginning of the Cardoso administration and has increased ever since. The initial levels of public debt are, in fact, relatively low by international standards. Further, Figure 2 shows that the increase in debt is not the result of primary deficits, which exclude interest

payments related to debt servicing but include social spending. In fact, only in two years in the 1990s did the government run primary deficits, and their

magnitude in both years was smaller than 1 percent of GDP. Debt is accumulating because the size of interest payments has been around 4 percent of GDP. This can be seen in Figure 2, where the difference between the primary surpluses and the operational deficits corresponds to real interest payments.

Real interest payments have been maintained at high levels in order to

maintain inflation under control. Fiscal policy has been reduced to the setting of a primary target, usually by agreement with the IMF, with the overriding objective of controlling prices. Despite the maintenance of primary surpluses,




.I i i i I i i i I i i i I i i i I i i i I i i i I i i

91 92 93 94 95 96 97 98 99 00 01 02 03

Figure 1. Public Debt in Domestic Currency (% of GDP) (http://www.ipeadata.gov.br/).

Figure 2. Fiscal Deficits (% of GDP), Operational (above) and Primary (below) (http://www .ipeadata.gov.br/).




TABLE 2

Income Distribution and Poverty

1990 1993 1995 1997 1998 1999 2001 2002

Gini 0.61 0.58 0.57 0.57 0.56 0.58 0.60 0.59

TheilT 0.78 0.77 0.73 0.74 0.74 0.72 0.73 0.71

Poverty 42.0 43.0 35.1 34.0 33.4 35.3 35.1 31.3

Source: http://ipeadata.gov.br/ipeaweb.dll.

which force the central government to constraint social spending, public debt has exploded. The only reason is the high interest rate levels imposed by the Central Bank. High interest rates, in turn, are the result of anti-inflationary policies in a globalized environment. High interest rates also imply that the

government is transferring a sizable share of the GDP to the owners of bonds

(i.e., banks, corporations, and wealthy individuals). The high-interest-rate

policy is the Brazilian version of Pasinetti's revenge of the rentier and the main

explanation of the fiscal crisis of the state.

FISCAL SQUEEZE AND SOCIAL POLICY

The increase in the debt-to-GDP ratio during the Cardoso administration went hand in hand with the increase of interest rates and the interest burden? the share of government spending devoted to debt servicing. One would

expect this fiscal crisis to have had negative consequences for social policies and led to the squeezing of social spending. However, conventional wisdom on social policies during the Cardoso administration is that poverty was reduced and social indicators usually improved while income inequality declined

slightly at the beginning but remained at high levels (Schwartzman, 2000). Table 2 shows poverty and income distribution indicators for the 1990s. In

fact, looking at the Gini or Theil T coefficients, one can notice a slight improve ment. The limited improvement according to these measures provides no con

siderable reduction of inequality, which remains among the highest in the world. At the same time, poverty fell considerably, from 42 to around 31 per cent of the population. Some writers associate the reduction of almost 25 per cent in poverty rates to the 1994 stabilization plan (Amadeo and Neri, 1999), even though more than half of the reduction took place before the Real Plan. The

implication of these improvements in inequality and poverty, some would argue, is that the Cardoso administration was doing something right. However, that conclusion may be deceiving.

Two factors must be emphasized about the evolution of income distribution in the past decade. First, the improvement in income distribution as measured

by Gini and Theil coefficients was relatively small and short-lived; progress in

the base of the distribution is insufficient to improve the Gini coefficient, which is driven by the behavior of the middle quintiles (Rocha, 2000: 3). Second, it is not clear that income distribution did in fact improve during the 1990s when we look at alternative measures. For instance, the proportion of total income represented by wages was 45.4 percent in 1990 and only 35.6 percent in 2003 (see Table 3). The flip side of the reduction in the proportion of wages




TABLE 3

Functional Income Distribution (% of GDP)

Year Operational Surplus Wages

1990 32.5 45.4

1991 38.5 41.6

1992 38.0 43.5

1993 35.4 45.1

1994 38.4 40.1

1995 40.3 38.3

1996 40.0 38.5

1997 42.8 37.5

1998 41.6 38.9

1999 40.5 38.1

2000 40.6 37.9

2001 40.0 37.0

2002 41.9 36.1

2003 42.9 35.6

Source: http://ipeadata.gov.br/ipeaweb.dll.

is the increase in the net operational surplus (interest, profits, rents, etc.) from 32.5 to almost 43 percent in the same period.

The reduction in the proportion of wages indicates that the process of liber alization and the increase in unemployment dramatically reduced the bargaining power of workers (Vernengo, 2004). Furthermore, the maintenance of high rates

of interest as part of the exchange-rate-based stabilization program allowed an

increase in the remuneration of capital despite the increasing competition from abroad. These results show a considerable worsening in income distribution, in contrast with the picture presented by the Gini coefficient. Part of the expla nation for this apparent ambiguity is that both the Gini and the Theil index are

calculated on the basis of wage income. Hence, the relative small reduction in

inequality in the 1990s reflects a reduction in overall wage inequality, while the

proportion of total income represented by wages has been compressed. Also, it must be emphasized, real wages in the 1990s were lower than in the 1980s and in the import-substitution period (Vernengo, 2004). In other words, the high interest-rate policy that led to the fiscal crisis of the state is also responsible for a considerable worsening of income distribution in a country that already had one of the most unequal distributions of income in the developing world.

A second type of question is about the relation between income distribution and poverty. Reduced inequality as measured by the Gini coefficient has had

negligible effects on poverty reduction. In fact, Rocha (2000:6) shows that poverty also fell considerably after the short-lived period of stability during the Cruzado Plan in the mid-1980s, a period in which income distribution was deteriorating. One may conclude that price stability was the main explanatory variable in

poverty reduction. Poverty rates, however, have been falling since the 1970s,

according to Rocha (2000). Therefore, sources other than price stability are also

important for poverty reduction. Amadeo and Neri (1999) argue that the increases in the minimum wage in

the poststabilization period (i.e., after 1994) were sufficient to reduce poverty in the urban areas substantially In other words, the increase of the minimum

wage in an environment of price stability proved to be an important factor in




TABLE 4

Social Indicators

Year Life Expectancy Illiteracy Rate Infant Mortality Fertility Rate

1940 43 56 158 6.1 1950 46 50 138 6.2 1960 52 40 118 6.3 1970 54 30 117 5.5

1980 60 25 88 4.4 1990 65 19 50 2.7

1996 67 17 41 2.1 1998 68 14 36 NA

Sources: IBGE (1990) and Schwartzman (2000).

the reduction of poverty. The argument, however, is not completely convincing when looked at from a long-range perspective, since real minimum wages were constant in the 1970s and falling in the 1980s while poverty was falling throughout the period. Therefore, a higher real minimum wage is only part of the explanation.

The question remains, then, what the main force behind poverty reduction is. Output growth is the obvious candidate, but it cannot explain all poverty reduction, since poverty also fell in the first part of the 1980s, a period in which the economy stagnated as a result of the debt crisis. In retrospect, the most

likely explanation is that the reduction of poverty was a consequence of the

process of industrialization and the consequent migration from rural to urban areas. All in all, cities provide greater access to electricity, treated water, medical

care, and public schools.5 In other words, urbanization, the extension of social benefits to rural workers, and the relative decline of the cost of food rather than a reduction of inequality are the most likely driving forces of reduced

poverty in Brazil (Rocha, 2003).6

Finally, it has become commonplace to argue that, despite the external

fragility and unemployment, the social agenda advanced during the reform

years. The main problem was associated not with low levels of social spending but with the management of public funds in the social sphere (Schwartzman, 2000). Several social indicators, such as life expectancy, illiteracy, infant mortality, and fertility rates did improve in the 1990s, suggesting to some that criticism of the reforms may have been exaggerated (see Table 4). However, it is evident that all these social indicators were improving before the reforms, going back at least to the 1940s. This seems to indicate that the market-friendly reforms had a limited, if any, role in the improvement of social conditions. The real cause, much as in the case of poverty reduction, seems to be the process of urban ization and the benefits associated with urban dwelling. The implication is that alternative macroeconomic policies, which put a lesser burden on social spending,

may in fact accelerate social progress, which is still sorely needed in the Brazilian case. Furthermore, the widely accepted notion that the Cardoso administration

was successful in defining and implementing social policy but its economic outcomes were disappointing must be revised. Clearly, income distribution worsened and much of the improvement in social indicators is not directly related to the Cardoso administration.




More important, it is hard to believe that social indicators would not have

improved if a larger share of government spending had been diverted from interest payments to social programs. Social programs are fragmented in their

coverage and incomplete in their scope, and a comprehensive and universal welfare system was never properly developed. Further, as noted by Lessa et al.

(1997), the extension of the social safety net implicit in the 1988 Constitution never made it into the budgets implemented by several administrations. In

fact, in 2002 the Cardoso administration's spending on social programs (excluding social security payments) corresponded to 73.9 percent of its expenses on debt

servicing (Pochmann, 2003: 5). Total social spending as a share of GDP in 1998 was 12.2 percent, around half of what was spent in OECD countries in the same year (6). Over the whole Cardoso period (1995-2002) federal public debt increased from around R$66 billion to slightly more than R$363 billion, and close to R$109 billion went to interest payments.

The suggestion that social spending is high and not properly targeted to the poor?which ultimately informs the critiques, from both left and right, of the

welfare state in the developed world?is clearly out of place. It seems, on the

contrary, that the "financialization" of government expenditures has led to wors

ening income distribution and, by limiting the ability of the state to increase social spending, limited the ability of the state to reduce social inequalities. In the past, income inequality went hand in hand with high rates of growth and the extension of consumption to relatively large proportions of the population. During the Cardoso administration a new pattern of income concentration has

emerged, one that is inimical to growth and depends exclusively on financial transfers to the wealthy.

CONCLUDING REMARKS

The idea that a bloated state?the result of the expansion of Keynesian policies in the center and import-substitution-industrialization strategies of development in the periphery?hinders economic growth and has a limited effect on social indicators was common sense for writers on the left and right of the political spectrum during the 1990s. However, the evidence suggests that the idea that a fiscal crisis of the state resulted from overspending on social programs is incorrect. In Brazil this view translated during the Cardoso administration into the notion that better management and more targeting of social spending rather than increased spending would be necessary to improve social conditions. Increased spending was seen as synonymous with fiscal irresponsibility and

incompatible with macroeconomic stability. However, when one looks at the historical record of domestic public debt

accumulation it is clear that it did not increase to unsustainable levels during the import-substitution-industrialization period and effectively decreased dur

ing the 1980s. In fact, since the debt crisis primary surpluses have been achieved in almost every year by successive administrations. Debt increased

considerably in the 1990s, and arguably the fiscal crisis of the state resulted from financial liberalization and the increasing burden of interest payments on

public debt. The fiscal crisis of the state had at least two important effects. On the one hand, by limiting the ability of the developmental state to invest,




particularly in infrastructure, it had a negative effect on growth (C?mara and

Vernengo, 2004-5). On the other hand, the interest burden meant that fiscal

spending on social policy was squeezed and maintained at relatively low levels. This suggests that the idea that the main problem with social policies in Brazil is the lack of targeting is fundamentally incorrect. The amount of social spend ing was insufficient. Further, by increasing financial transfers to the owners of

public debt bonds, the Cardoso administration considerably worsened income

distribution when measured properly by functional income distribution cate

gories. The worsening of income distribution in a country with one of the worst

records in the world is a serious indictment of Cardoso's social policies. The fact that some social indicators continued to improve slightly during the 1990s is most likely unrelated to patterns of spending during the Cardoso era.

Reviving the ability of the state to spend on social programs and on investment

projects would require drastically reducing interest rates. This would be possi ble only by reducing the risk of capital flight. Capital controls, used in Brazil until the early 1990s and by several developing countries afterwards (e.g., Chile, China, India), seem unavoidable if a more effective role for the state in reducing social inequalities is intended.

NOTES

1. A similar view on the fiscal crisis of the Brazilian state is developed by Bresser Pereira (1991). 2. On the tax state, see Schumpeter (1954 [1918]). The tax state should not be confused with

the welfare state. The tax state is one in which taxation has replaced income from state property as the main source of revenue. The welfare state is one in which the state assumes the formal

responsibility for the well-being of all its members. Although welfare states are all tax states, the

reverse is not necessarily true.

3. Furthermore, Keynesian policies made fiscal deficits not a permanent feature of the economy but a functional instrument for reducing unemployment in periods of crisis. Keynesian policies became popular in the periphery during the period of import-substitution industrialization in the

aftermath of World War II.

4. Shaikh (2003) and Lindert (2004) show that social spending and the welfare state had no

negative effect on economic growth. 5. The official poverty line is based on a consumption basket that includes basic needs rather

then the more simplistic measures used by the World Bank (see Rocha, 2003). 6. Around half (51 percent) of the poor were in rural areas in the 1970s and close to half of the

population lived in rural areas. By 2002 only 14 percent of the poor were in rural areas and close

to 90 percent of the population lived in urban areas.

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