Embracing Lula's pragmatic legacy

We’ve seen this before. A new president prepares to take office in Brazil, and market-watchers wonder if she’s about to drive the country to the left. When the outgoing President Luiz Inácio Lula da Silva was first elected in 2002, some feared he and his Workers Party would demonise the private sector, make life harder for foreign investors, and compete with Venezuela’s Hugo Chávez to become Latin America’s leading populist firebrand.

Yet, the image of Lula as a fist-shaking ideologue never made sense. He earned his man-of-the-people reputation as a tough labour negotiator, a maker of deals, not of speeches. Despite the populist rhetoric of earlier failed runs for the presidency, Lula has largely kept the promises he made during the 2002 campaign to pursue market-friendly policies.

He has certainly increased state influence in some sectors, and the pace of government spending has accelerated. But Lula’s legacy will come from the consensus he has constructed across Brazil’s left in favour of policies that encourage private-sector growth, attract foreign investment, and force government to keep inflation in check. That’s a huge contribution to his country’s future.

Pro-market approach

The clearest sign of Lula’s success is that on Jan 1, he will pass the presidency to his former chief of staff, Dilma Rousseff. Now there are fears that the new president will prove more activist than her predecessor and will stunt the country’s growth with heavier-handed state interference in the next stage of Brazil’s development. To be sure, the state will play a larger role in some sectors, and Dilma is unlikely to roll back the pace of spending as much as many economists would like. But as with Lula eight years ago, they underestimate her pragmatism, the realism of her advisers, and the potential for a genuinely market-friendly approach.

Dilma and many within her inner circle credit Lula with helping Brazil weather the financial crisis with far less damage than we’ve seen in Europe or the United States. Dilma and her primary economic adviser, Luciano Coutinho, played a role in that success, and they’re unlikely to change their minds on this issue.

That’s why Dilma will move forward with plans begun under Lula to move the state deeper into some key sectors. That trend will be most obvious in the oil sector, as the government works to maximise its control of the country’s vast offshore oil fields. Dilma intends to replace the current concessions framework for offshore exploration and production with production-sharing agreements that make Petrobras, the state-owned oil company, sole operator with a minimum 30 per cent stake in all projects.

The new government will also advance plans to increase state control of mining with the creation of a regulatory agency, and tax changes. An activist industrial policy spearheaded by the National Development Bank will not be rolled back, and Dilma will probably increase the state’s influence in the utilities and telecommunications sectors, as well. New restrictions on foreign land-ownership will make headlines.

In addition, Dilma will struggle to slow the recent growth of government spending despite the wishes of her advisers. Austerity is a tougher sell when times are good, particularly for public officials who know that belt-tightening always incurs a large political cost.

But like Lula eight years ago, Dilma and her team will pleasantly surprise investors in several important ways. The successes of the Lula presidency have given leaders of the Workers Party — including Dilma — a deeper appreciation for the rewards that come with market-friendly policies.

We don’t expect labour or pension reform, but Dilma is likely to push for tax reform. Her government is also likely to take on a range of modest reforms to encourage greater private-sector investment in large infrastructure projects. With the World Cup (2014) and Olympic Games (2016) coming to Rio de Janeiro, Dilma’s team is well aware that private investment in highways, ports and new commercial real estate has never been more important.

The moral of this story is that Brazil has become an increasingly complex emerging market. Its politics have evolved far beyond caricatures of left and right, and the country now enjoys the beginnings of a deepening prosperity and self-confidence. The challenges ahead are formidable, and economic success often leads to choices which aren’t always ideal. But the new policy signals suggest that Brazil’s next generation of leaders may be more up to the task than many pundits expect.