BRAZIL Stabilzation Shock

...Private investment was expected to resume as price stability reduced uncertainty and the profitability of speculation on the financial market...

...It is doubtful that Tancredo, an economic conservative, would have taken such unorthodox measures...

...The Cruzado Plan was a prerequisite-not a substitute-for a more comprehensive development program, including structural reforms...

...Even within the dominant PMDB, debate over the plan was almost nonexistent...

...Policy-makers and union leaders were slow to recognize the extent of income redistribution...

...Business Week was calling Brazil "the Third World's success story...

...others less lucky were sacked by angry crowds...

...ceived as betrayal...

...Following a series of ad hoc austerity measures in 1980 and 1981, an acute balance of payments crisis forced Brazil to go to the International Monetary Fund (IMF) in late 1982...

...Gesner Oliveira Filho, a researcher at the Sdo Paulo Centro Brasileiro de Analise e Planejamento (CEBRAP), is currently a graduate student in economics at the University of California, Berkeley...

...The cruzeiro was devalued by 30% in February 1983...

...A new "inflation proof"' currency, the cruzado, sliced three zeroes from nominal prices in cruzeiros, the old currency...

...As GNP fell, so did import demand...

...Now that the newly elected Congress has taken office, the illegitimacy of the legislature can't be used as an excuse to rule by decree...

...An important populist leader, Vargas has often been compared to Juan Domingo Per6n in Argentina and .Azaro CArdenas in Mexico...

...While the plan provided an opportunity for more fundamental reform, it succumbed to inherent weaknesses and implementation dictated by the electoral calendar...

...Promising automatic wage increases if inflation hit 20% made it critical to keep official inflation below that rate...

...wages were often not in line with food price increases...

...The Democratic Alliance was crumbling as progressive sectors of the PMDB began to publicly distance themselves from the Sarney government...

...A Product of the 1980s Launched in February 1986 amidst looming economic crisis and political floundering, the Cruzado Plan was a product of the turmoil of the 1980s...

...McDonald's was closed down for illegal price hikes...

...The criticism implies that the transfer of 5% of GNP in debt service is unimportant and that the maintenance of these payments remains the only criterion for good domestic policy...

...While prices can ultimately be forced down in a recession, the consequence is economic hari-kiri...

...People wore buttons declaring themselves Sarney's "price inspectors," and crowds armed with price lists patrolled supermarkets, calling in the police to report unfair increases...

...This was done at the expense--often consciously--of the incoming legislature's resources...

...Support for Sarney has since plummeted, as the post-election measures-which amounted to a dismantling of price controls-were per*A devaluation makes imports more expensive and exports more profitable as the producer receives more domestic currency per dollar of exports...

...Important economic and political space won in early 1986 has been lost...

...Unlike the "Miracle" (1968-1973) before it, the growth in the Cruzado's wake was not generated on the backs of the working class...

...Nevertheless, it was an important and innovative approach to price stabilization in a country plagued by rampant inflation and unemployment...

...The legitimacy of the government and the subsequent success of any economic program will depend on a change in content, as well as in form...

...Furthermore, little was done to bring business and labor organizations in on the plan's implementation or revision...

...Rather than lose his newly won support, Sarney held off on significant adjustments until after the November elections, ignoring growing economic danger signals...

...Based on the IMF view that a trade deficit results from a country living beyond its means, a standard program of restrictive monetary and fiscal policy was attempted to cut back demand...

...Not surprisingly, these policies proved successful in restoring positive trade balances...

...In Brazil, the Plan's economic architects became celebrities overnight...

...From 1980-1983, per capita income fell by 11...

...Despite the short-run economic boom, private investment did not respond...

...was commonly known, had a reputation for conciliation and was expected to use that authority to both negotiate better terms from Brazil's foreign creditors and implement social reforms...

...The current impasse cannot all be blamed on the debt...

...Meanwhile, strike activity continued throughout this period, partly taking advantage of low unemployment...

...There is still no policy for reviving and financing investment, either public or private...

...Therefore, the freeze was politically and economically unsustainable and, unless corrected, shortages were inevitable...

...As long-time Finance Minister under the military government Delfim Neto remarked, he's seen that movie before...

...He appeared indecisive in the face of a worsening economic situation, refusing to implement promised reforms...

...So, prices raised in July and November were removed from the index...

...when demand was further increased and reshaped by the freeze, industry could not satisfy the increase...

...Although the private sector had lost confidence in the plan by summer,** the PMDB's November electoral landslide indicated continued support for the government...

...Ex-president of the military's Democratic Social Party (PDS), he had been appointed vice-president as a political compromise...

...Rather than working through political parties, Congress or other institutions, Sarney legislated the plan by decree, appealing directly to "the people...

...What happens next in Brazil depends on its success in negotiating with foreign creditors and on the political impact of those talks at home...

...The blanket price freeze had severe repercussions on the structure of relative prices...

...In essence, the Cruzado was an emergency plan to curb acute inflation and to provide space for complementary development plans and more structural reforms...

...I 4freeze of prices, wages and exchange rates and fiscal restraint...

...But the IMF package, combined with a global recession, threw Brazil into the worst depression of its history...

...Today, with inflation at an annual rate of 700%, no one is predicting "Swiss" inflation in Brazil any longer.* Most of the president's original economic team have left government, and economic policy is in disarray...

...The July package, which raised prices with a tax on items such as automobiles, gasoline and alcohol, only fostered fear of further hikes...

...When the newly elected Congress, which doubles as a Constituent Assembly, convened in Brasilia on February 1, Sarney made a grand entrance through the garage to avoid demonstrators out front-a sign of the extent to which he had staked his Helen Shapiro is completing an economics dissertation on state-led industrialization in Brazil...

...Had the Cruzado been implemented as originally conceived, the outcome might have been quite different...

...But the plan's redistributive impact on income and the commitment to maintain growth rates required an accelerated rate of investment for which no provisions were made...

...Then-governor of Rio de Janeiro Leonel Brizola initially criticized the plan, predicting a drop in real wages...

...Acceptable to both sides of the political spectrum, Tancredo, as he *A leader in the revolution of 1930, Var- gas served as president of Brazil from 1930-1945 and 1950-1954...

...This is not to deny the enormous constraints imposed on the New Republic...

...Literally, only a handful of technocrats were involved in the details...

...In May the first series of shortages struck and rapidly multiplied...

...The wide consensus on economic policy has vanished...

...Rio favela I Y'Market imbalances were also magnified by the boost in demand...

...The dramatic turn of events in 1985 was also a factor: president-elect Tancredo Neves' unexpected death and the succession of his runningmate, Sarney, shifted the political landscape...

...His long political career, originating with Getulio Vargas,* had not been compromised under the military regime...

...But the freeze caught some prices in the high phase of the indexation cycle, others in the low phase...

...Inflation, after falling slightly in 1981, soon leaped to over 200% in 1983 and 1984 and to over 400% in early 1986...

...After taking office, Sarney's political position weakened further...

...Even as demand is cut today, costs and prices still reflect past inflation...

...And Sarney, who had loyally served in all the previous military governments, became a popular hero...

...It not only generated unrealistic expectations, but gave policy-makers a vested interest in maintaining the charade...

...Domestic private investment plummetted...

...Named for the new currency, the plan's promise of price stability and economic growth at first seemed to be fulfilled as growth rates topped 8% and inflation fell from an annual rate of 400% to less than 20...

...Domestic credit was restricted and real interest rates soared...

...And, if inflation hit the 20% ceiling, automatic wage adjustments were guaranteed...

...This "inflationary memory" helps explain why IMF recessionary policies are ineffective in combatting inflation...

...Brazil's foreign exchange reserves dwindled...

...Had the impending freeze been announced, merchants would have raised prices, leading to further inflation...

...The recent declaration of a moratorium on debt payment was no more than a desperate measure to face the depletion of foreign exchange reserves and to gather a minimum, albeit fragile, base of domestic support...

...His announcement on Brazilian television marked the formal death notice for the year-old Cruzado Plan...

...Finally, a set of labor-related measures was added to make the Cruzado politically palatable...

...This lack of participation and negotiation not only undermined confidence that the government would abide by its own rules, but also meant that these groups bore no formal responsibility for the plan's success...

...After years of neglect under authoritarian rule, social needs and political demands must be addressed with limited economic resources...

...Imports--especially food-were needed to make up for the shortfall...

...In the public mind, the Cruzado Plan became the equivalent of a long-run price freeze...

...their books, despite daunting titles such as Zero Inflation and The Heterodox Shock, hit- the best-seller list...

...The middle class bought groceries at higher prices in the same stores where the poor waited in line...

...Meanwhile, fiscal policy was in disarray...

...It was an unorthodox, daring attempt by a weak president to gain much-needed legitimacy and a political base...

...In the plan's first three months, retail sales jumped by 25...

...Measures taken in July and November 1986 to transfer resources to the state and slow demand proved insufficient on both counts...

...A consumer boom ensued, fed by wage increases, income redistribution and, after a few months, the expectation that the freeze wouldn't hold...

...Meanwhile, in response to devaluation and the sluggish market at home, exports soared, topping imports by $6 billion in 1983 and by $12 billion in 1984 and 1985 and allowing Brazil to service its foreign debt without fresh loans...

...Mission: Zero Inflation In contrast to IMF austerity packages, the plan tried to address the inertial component of inflation through a MARCH/APRIL 1987 0 . :3 P *Switzerland is known for its very low inflation rates...

...policy errors were made, and mistakes will have to be corrected...

...And, with only a few exceptions, official indexation schemes were abolished...

...This audacious plan was a last-ditch effort to win credibility by a weak president, and as such, reflected the fragility of the transition to civilian government after 20 years of military rule...

...Little was done to control government spending, and the deficit grew...

...Accusing cattle-ranchers of hoarding, the government confiscated fattened cattle...

...For example, wages changed every six months, other prices every three...

...Although not elected directly, he had broad popular support...

...The real public deficit-deemed the major catalyst to inflation-was drastically reduced by 1984...

...Playing with economic indices and awaiting elections before making major policy changes is too reminiscent of the military's practice...

...Economic growth tightened labor markets, leading to further wage increases and expanded employment...

...Suppliers, holding out for higher prices, started stockpiling commodities, and consumers sped up purchases, transforming speculative shortages into real ones...

...Like the Austral Plan in Argentina, the Cruzado was based on the idea that inflation in this context is essentially "inertial...

...Indeed, the plan's creators insisted that redistribution was not an explicit goal...

...Such obvious manipulation further eroded public confidence...

...In Brazil, contracts and prices were revised at staggered intervals...

...Anticipating a devaluation by August, exporters began to delay sales as importers stepped up purchases.* Warehousing potential exports and increasing imports caused the trade surplus to disappear...

...Problems soon emerged, however...

...Shortages did not merely arise from stockpiling, however...

...As shortages became pervasive, people began to act on the assumption that the freeze wouldn't hold, making things worse...

...But the need for surprise led to absolute centralization of the economic decision-making process...

...Sarney, however, was a different story...

...The country had already been operating at close to full industrial capacity before the Cruzado...

...Moreover, the plan's surprise element worked against the democratization process...

...A particularly vicious circle developed in the foreign exchange market...

...The minimum wage was raised by 15%, all workers received an 8% bonus and an unemployment insurance program was created for the first time...

...Since the mid-1960s in Brazil, this has been formalized and exacerbated through indexation, or the periodic adjustment of contracts to correct for past inflation...

...Beef and other foodstuffs disappeared from the shelves...

...In theory, once the system's "inflationary memory" had faded away, conventional economic policy tools would become more effective...

...Indeed, he masterminded those schemes...

...From Euphoria to Impasse The announcement of the Cruzado Plan was greeted with enthusiasm...

...Skyrocketing inflation in the face of economic contraction led many Brazilian economists in search of alternative theory and policy...

...The conversion table for wages and other contracts in cruzeiros was constructed according to their real average value of the preceeding six-month period...

...The demise of the plan reflects the fragility of Brazil's two year-old democratic transition...

...Made in Brazil" Because oil prices and interest rates have been low, and Brazil's 19831985 trade surpluses enormous, the international financial community has labelled the recent crisis as strictly "Made in Brazil...

...President Jose iarney political fortune on the success of the Cruzado Plan...

...He lacked Tancredo's legitimacy and the clear support of the centrist Democratic Alliance-composed of the Party of the Brazilian Democratic Movement (PMDB) and the Liberal Front Party (PFL)-which had brought them to power...

...Public spending soared, partially reflecting the eagerness of federal, state and local officials to maximize political gains...

...The domestic consumption boom also weighed on the balance of payments, since many exporters began to sell their products at home...

...What Went Wrong Predicting zero inflation verged on demagogy...

...Although the impact on real wages is still unclear, those at the bottom of the income scale do seem to have benefitted, MARCH/APRIL 1987 compensating for losses suffered in the early 1980s...

...The government refused to realign prices, or to deal with the consequences of not doing so...

...For example, if inflation rises 100% during a contract period, nominal wages will rise to cover the increase, automatically perpertuating past inflation into the future...

...Growth had resumed, yet inflation was speeding up...