Brazil x Mexico: Bad but Some Good

Brazil and Mexico, the two largest economies in Latin America, are forever sites of great potential and some disappointment. In sociology, we used to speak of arrested development.   The fact is that while both countries get pumped every few years or so by the international press, they also seem to never quite take off.

We might blame the current administrations. In Mexico, Enrique Pena Nieto is now half way through his six-year term and usually expectations are lowered as the tenure in office shrinks. At the outset, there was great hope for reforms in education, violence reduction and lessening the impact of the drug cartels, plus a major effort at reforming and renewing investments in the energy sector. The assassination of the 40 plus students in Guerrero state, the tragic-comic escape of Chapo Guzman, the ongoing deaths of journalists and the economic stutter have all sapped presidential legitimacy. And, as with Brazil, there has to be the waif of scandal and corruption at the highest levels.

Brazil faces a similar litany of maladies. The corruption scandal at Petrobras drained perhaps $3 billion directly from the company’s income but more importantly the repercussions have come close to shutting down major economic players. The presidents of leading construction companies – Andrade Guttieriez and Odebrecht – are imprisoned. Many other companies are forbidden from bidding on public contracts. As the wheels of justice turn exceedingly slowly in Brazil, it’s virtually impossible to predict when there might be legal resolution and relief from scandal fatigue. All of this comes with the collapse of commodity prices, increased inflation, rising unemployment, street protests calling for impeachment, lack of water in Sao Paulo and no entertainment until the Olympics a year from now. Brazil also faces a two-year recession, a first in its history.

So is there anything good that can come out of the current situation? In Mexico, the government seems more determined to pursue the opening of the energy sector and this should bring in foreign investment and could possibly have a positive effect in shaking up PEMEX. While still dependent upon oil, Mexico has also successfully promoted the automobile assembly industry and has surpassed Brazil in the production of vehicles thanks partially to its proximity to the US but also to the 40-plus free trade agreements Mexico has in place. The rising cost structure in China has also helped Mexico become a bit more competitive in manufacturing and logistics. If Brazil continues to stagnate and remain over dependent on basic commodities, it is likely that the Mexican economy will outstrip Brazil’s.

One good thing about Brazil’s strong economic contraction is that it may have the unexpected side effect of strengthening the country’s institutions. The threat of Dilma’s impeachment seems to have receded. Municipal elections are coming up and the millions of people who have demonstrated in the streets have done so peacefully. There is no guarantee that the current set of mostly self-serving and bought off congressmen will be soon replaced, but each election offers the opportunity to learn and participate. The complexity of Brazilian society, the demands of the population and the relative sophistication of its productive structure are all ahead of the political class and the governing bodies. Dilma announced belatedly cutting 10 of the 40 plus cabinet positions, which in principle might eliminate some expense. Those in civil society find this laughable, as they know the whole bureaucracy could be halved with no loss of functionality.   Still, Brazilians have a strong state driven heritage, which is only slowly being called into account.

Another positive effect is the salutary debate on the type of economic model that Brazil desires. Brazil is a capitalist society tied to a broken down state capitalist system. The country is being forced to decide on its economic model.

Both Mexico and Brazil move by lurching, stumbling and repeating mistakes. Still, they are both too integrated and too sophisticated not to be part of a global political and economic system.   They may not be leaders but both are significant regional players that can use the free flow of information, people and goods to offer their population a bit more than token opportunities. This will depend on the demands and articulations in civil society as much as it will rely upon the slow change to effective governance.

Brazil – Three Possible Scenarios to 2018

There are at least three possible economic and political scenarios for Brazil in the remainder of 2015 and to the end of 2016.

The best case scenario involves slow but progressive economic recovery due to the nature of the business cycle. The economy after shrinking for over a year and a half will hit bottom and there will be recovery. At the same time, President Dilma, Lula and allies find a modicum of political support in Congress and in state and municipal administrations that shore up legitimacy not because Dilma is beloved but because the alternative of impeachment or resignation is much worse. The corruption investigations will proceed on course and reach ever deeper into without touching Lula, Dilma or PSDB cacicques such as FHC, Alckmin, Aecio or Serra. To date, these politicians and power brokers are all “blindados” (protected with “armor”) In this case, Dilma makes it to 2018 and her legacy is that she presided over Brazil’s most extensive house cleaning with prison terms for the wealthy and powerful, just not the most powerful public figures. At the same time, Dilma continues to support to Joaquim Levy over the Manteguista remnants from the previous administration and the economy maintains (barely) its investment grade status and inflation and interest rates while at historic highs for the 21st century remain under a semblance of control.

The worst case involves an institutional crisis where Dilma is either impeached or resigns. The danger here is rupturing respect for the legitimacy of the presidency. Everyone knows at this point that Dilma does not match up to the pre-electoral image of super manager and Lula’s rightful successor as the deliverer of growth, education, infrastructure and security. Obviously, the proof in the pudding shows her failure to deliver on all fronts. Without leadership (Dilma’s weakness), economic stagnation continues. The problem for those who want impeachment is that there is hardly anyone better who can legitimately replace the President. Michel Temer is the VP but he will lack support in Congress and from the population as any changes will be resisted by one sector or another. There is no national salvation plan.   Incompetence is not an impeachable offense and the votes of 53 million plus cannot be recast or forgotten. The electoral calendar and the Constitution deserve respect. Brazil survived the lost decade of the 80’s and it can survive the lost eight years of Dilma. Political rupture will almost certainly be accompanied by further economic trauma and Brazil will lose its investment grade rating. Interest rates and inflation could easily double. It is not a pretty picture for a country that should be doing better but as is popular to say today: “It is what it is.”   Fatalismo take hold.

The third possibility is to simply muddle through. Impeachment will be on the table but will not have sufficient Congressional or popular support to actually occur. The economy will decline because of the lack of productive investment on the one hand and due to over taxation on the other. Institutions will be shaken but will not fail. Respect for politicians of all stripes will further decline but Brazilians will actively mobilize in the streets and on the web seeking a better resolution in 2018. The corruption investigation may will ultimately result perhaps not in pizza but rather minor hand slaps for the construction companies. The prosecutors will feel frustrated but will nevertheless have set an example for the future and Brazilians will think about cleaning up even if they don’t. The presidential election of 2018 will arrive and once again the same politicians of the past will be up for the vote.

Eventually, Brazil needs to define what kind of society it wants. The general outline for the democratic process is in place. The problem however remains in the organization of the means of production and the distribution of rewards therefrom.

Brazil’s historic and ingrained inequality of opportunity disqualifies liberal capitalism for major sectors of society. State capitalism and its dependency on centralized planning and control have lost support and legitimacy because of all the corruption and waste. Cleaning up the economic model with so many entrenched interests is a challenge and long term project which will also require cleaning out politicians. This probably won’t happen.

Doing Business in Brazil-With a Strong Dollar??? Just one variable.

While nearly all of the world’s largest 500 companies are in Brazil, it’s well known that Brazil’s business environment is exceedingly complex.

Large corporations can do business in Brazil in part because they can afford to hire those knowledgeable on the intricacies (both legal and otherwise) of doing business in Brazil.

At the other end of the spectrum, small foreign companies often express an interest in the Brazilian market but are soon put off by the costs of overcoming the myriad bureaucratic and cultural difficulties.

Between the multinationals and the small companies, there is a large segment of mid size companies. What about them? Certainly, they have interest and the need for expanding their markets and sales but still they are usually at a loss as to how and where to start. Moreover, companies that were attracted to Brazil by positive reports in business and financial publications five or more years ago are now put off by reports showing the economy has soured.

Brazil’s size, its hosting mega-events such as world cup soccer and the Olympics, its international reputation for beautiful women, carnaval, music and sexy charm, make the country an exotic attraction. But how does this actually transform into business, particularly for mid-sized company?

At first glance, some companies are tempted to push into the market. The Internet is the typical starting place for companies that want to explore and certainly there is a lot of information available, too much in fact. Even the experienced can easily get lost and bogged down. So basically, the slog is too long and too hard given the perception and the availability of friendlier markets elsewhere. Thus, pushing into the Brazilian market is probably the wrong tactic.

On the other hand, some mid size companies feel a need or are pulled to be in Brazil.   Companies or individuals are open and ready for their product. UBER and Netflix, while not exactly midsized, have essentially been pulled in due to the size and the “open space” in the market. Midsized companies that see demand for their products through international inquiries and demands indicating “critical mass” should consider making the investment. However, all companies need to go into the market with eyes wide open and with triple the preparation required for markets with better functioning institutions and less corruption.

There is a lot of chatter now that Brazilian companies are attractive because of the recession and the strong dollar. However, in considering a green field investment, an acquisition or a joint venture, the foreign entity needs to recognize that Brazil only works for companies that are in for the long term. The rest is pure speculation and foreign speculators will almost always be at a tremendous disadvantage in dealing with well-informed locals.   A favorable exchange rate can be an illusion. A foreign company putting money in will also have to look at taking funds out and in this case the exchange is working in reverse.

Aside from the need to hedge on foreign exchange, all companies must also face the complexities of the labor system, the many rules and regulations for set up and operation, an ever changing and burdensome tax structure plus the possibility of ever present government audits by a myriad of agencies, not just the tax authorities. Speaking of taxes, Brazil’s tax burden is basically equivalent to that of the Scandinavian countries but without the same return in services such as infrastructure, education, health and security. So the country is a challenge.   Better valuations may prove attractive but represent only one aspect of the entry and on-going operating cost.

Nevertheless, Brazil has tremendous opportunities in many fields including traditional industries. The market is there, the middle class has expanded with a desire for all things new, the economy is large and dynamic and profit margins can be very high once a company is established. However, profits will only come after hard work and a big down payment of “skin in the game” and by the time they are realized, the exchange rate could certainly be different. So again, Brazil is a long term play.