IBRD • IDA THE BRAZIL OF THE FUTURE TOWARDS PRODUCTIVITY, INCLUSION, AND SUSTAINABILITY © 2023 The World Bank Group 1818 H Street NW, Washington, DC 20433. Telephone: 202-473-1000; Internet: www. worldbank.org This work is a product of the staff of The World Bank Group with external contributions. “The World Bank Group” refers to the legally separate organizations of the International Bank for Reconstruction and Development (IBRD), the International Development Association (IDA), the International Finance Corporation (IFC), and the Multilateral Investment Guarantee Agency (MIGA). The World Bank Group does not guarantee the accuracy, reliability or completeness of the content included in this work, or the conclusions or judgments described herein, and accepts no responsibility or liability for any omissions or errors (including, without limitation, typographical errors and technical errors) in the content whatsoever or for reliance thereon. 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Acknowledgements: This report was prepared by a team led by Marek Hanusch (Lead Economist and Program Leader), Gabriel Zaourak and Matteo Morgandi (Senior Economists) under the overall guidance of Johannes Zutt and Paloma Anos Casero (Country Directors), Doerte Doemeland, Jorge Araujo and Pablo Gottret (Practice Managers), Shireen Mahdi, Rafael Muñoz Moreno (Lead Country Economists) and Pablo Acosta (Program Leader). The team included Cornelius Fleischhaker, Fabiano Silvio Colbano, Gabriel Lara Ibarra, Mathieu Cloutier, Maria Gabriela Farfan Betran, Andre Loureiro, Leandro Costa, Edson Correia Araujo, José Signoret  (Senior Economists), Asta Zviniene (Senior Social Protection Specialist), Alberto Coelho Gomes Costa (Senior Social Development Specialist), Ana Maria Munoz Boudet (Senior Social Scientist), Kjetil Hansen and Daniel Ortega Nieto (Senior Public Sector Specialists), Gabriel Sensenbrenner (Senior Financial Sector Specialist), Etienne Raffi Kechichian (Senior Financial Sector Economist), Rishabh Sinha, and Rafael Amaral Ornelas (Economists), Marta Arretche, Eduardo Mello, Joaquim Bento de Souza Ferreira Filho, João Marcelo Borges, Arthur Bouchardet, Claudia Mayara Tufani, Luis Diego Rojas Alvarado, Raphael Pinto Fernandes, Breno Salomon Reis, and Simon Jonas Neugebauer (Consultants). Peer reviewers of the concept note were Sebastian Eckardt (Practice Manager), Philip Schellekens (Senior Economic Advisor) and Philip Keefer (Principal Economic Advisor, Inter-American Development Bank). Peer reviewers at the decision meeting were Sebastian Eckardt (Practice Manager), Omar Arias (Lead Economist), and Marcos José Mendes (Associate Researcher, Insper). Aart Kraay (Deputy Chief Economist and Director of Development Policy), Elena Ianchovichina (Deputy Regional Chief Economist), Ekaterina Vostroknutova (Lead Economist), Sophie Naudeau (Operations Manager), Luis Alberto Andres (Sector Leader), and Renato Nardello (Program Leader) provided helpful comments during the preparation process. Background papers were provided by Darlene Damm, Fernando Veloso, Gabriel Zaourak, João Marcelo Borges, Breno Salomon Reis, Faruk Miguel Liriano, Gabriel Sensenbrenner, Alexander Vostroknutov, Pedro Fandiño, Marta Arretche, Marek Hanusch Ioannis Kospentaris, Martijn J. Burger, Martijn Hendriks, Elena I. Ianchovichina, Daniel Bonatto Seco, Gabriella Gontijo, Ignacio García, Isabella Lins, Javier Bundio, Vinicius Buso, Galileu Kim, Eduardo Mello, Daniel Ortega, Kjetil Hansen, Theo Ribas Palomo, Bruno K. Komatsu, and Naercio Menezes-Filho. This report drew on the parallel preparation of other World Bank reports, including: Brazil Human Capital Review; Brazil Poverty and Equity Assessment; Brazil Country Climate and Development Report; Brazil Infrastructure Assessment; Brazil Social Protection 2040; Brazil Health Sector 2040; A Balancing Act for Brazil’s Amazonian States: An Economic Memorandum. Flavia Nahmias da Silva Gomes, Adriane Landwehr (Program Assistants) and Priscilla Nunes Cardoso De Sa (Team Assistant) provided outstanding administrative support. The team is grateful for insightful comments from and discussions with Elaine Marcial (McKenzie Institute Brasília), Matias Spektor (FGV), Erik Kimbrough (Chapman University), and José Álvaro Moisés (USP). Contents Introduction: Envisioning Brazil in 2042 2 1. Overcoming the legacy of exclusion and preparing for megatrends 5 Many Brazils: overcoming inequality and benefiting from diversity 5 Preparing for megatrends 7 Embracing technological change 7 Tackling climate change 8 Adapting to demographic change 10 2. Promoting inclusive, sustainable growth 12 Raising productivity to boost sustainable growth 12 Preparing Brazil’s education system for closing the gap between skills and jobs 15 Strengthening the relevance and sustainability of social protection systems for future challenges 18 Ensuring adequate access to infrastructure services 20 Reshaping today’s limited fiscal policy space in line with long term priorities 21 Fiscal sustainability could also be enhanced by reforming the tax system 24 3. Building an inclusive social contract 26 4. Four alternative futures for Brazil 28 References 35 Introduction: I n 2022, Brazil celebrated its 200th anniversary. What will Brazil celebrate at its 220th anniversary, in 2042? Following the recent elections there is Envisioning a window of opportunity for reforms that will shape Brazil’s development over the next decades. “The Brazil Brazil of the Future: Towards Productivity, Inclusion, and Sustainability” takes a long-term perspective on Brazil’s development, exploring how prudent in 2042 actions today can generate opportunities for a more prosperous, inclusive, and sustainable society over the next 20 years. The report aims to stimulate public debate about a virtuous cycle for 2042, illustrated by four alternative future scenarios. Brazil has come a long way. The return of Brazilian democracy in the late 1980s allowed for broadening social opportunities. In the 1990s, Brazil started transitioning toward more flexible and inclusive markets through liberalization, while strengthening macroeconomic stability through the Real Plan. In the 2000s, Brazil benefited from the commodity price supercycle. Economic and social progress accelerated—including a buoyant economy, falling wage inequality, further expansions of social protection, and a significant progress in preserving the Amazon rainforest, 60 percent of which is in Brazil. Between 2001 and 2013, nearly 25 million Brazilians escaped poverty and Brazil’s formal employment peaked. Brazil became one of the world’s 10 largest economies and a major global food supplier. Yet, in the past decade Brazil experienced two recessions, one linked to the end of the commodity boom and one to the Covid-19 pandemic. Gains in poverty reduction were eroding while deforestation was on the rise again. Brazil’s current social contract has come under strain, undermining Brazil’s potential. Social contracts are defined as “dynamic agreements between state and society on their mutual roles and responsibilities”, and they determine what each group contributes to and receives from the state.1 When the social contract is strained, the room for reforms is limited as there is 1  World Bank 2021 no agreement on what citizens are willing to contribute economy uses fewer resources. In the case of Brazil 3 and what they expect to receive in return. Indicators this implies less deforestation, the country’s leading T HE BR AZIL OF T HE F U T U R E of social cohesion are low in Brazil, falling significantly contribution to climate change. Less deforestation, in from the “golden years” in the 2000s. In recent years turn, is a critical foundation for Brazil to safeguard its political polarization has reached new heights while economy which critically depends on the ecosystem trust remains very low by global standards. Yet trust services provided by the country’s forests, especially is critical for future planning: Those trusting public the Amazon rainforest. institutions (the government or the judiciary) have more of a long-term planning horizon.2 Overly discounting Today’s decisions will shape Brazil’s path to 2042- the future is a poor foundation for investments, both at and can help to create this virtuous cycle. Figure 1 the individual and broader society level. A strong social depicts the report’s conceptual framework to restore contract is critical to build a better future. Brazil’s virtuous cycle of productivity, inclusion, and sustainability. Brazil’s recent performance is marked For Brazil to succeed in building on the achievement by low growth, high inequality, and environmental of the past and tackle the challenges of the future, degradation. Brazil’s present is shaped by the it needs to enter a virtuous cycle of productivity, country’s historic legacy (generating “many Brazils”) inclusion, and sustainability. There are still and it will be altered by megatrends that will majorly many distortions in Brazil’s economy undermining shape the future for Brazilians; these include climate productivity in many areas, including the closedness change, technological change, and demographics. To to trade, an inefficient tax system, gaps in education, create a virtuous cycle and build a prosperous future, and eroding resource governance. These undermine bending the arc of history while turning megatrends the country’s economic potential. Unlocking economic into opportunities, Brazilians will need to make potential will generate aspirations, the desire to plan proactive choices. With a stronger social contract at and the propensity to save and to invest to acquire the core, society needs to embrace reforms to promote the necessary skills for the future. Better education, social and economic inclusion, savings, investment, especially for the underserved poor, will both promote human capital, productivity and sustainability. These economic growth while improving access to better jobs. areas form part of a mutually reinforcing ecosystem Opening markets will provide new opportunities for that will promote economic growth and jobs, foster smaller firms and lower prices for all. There is a virtuous environmental sustainability, and generate the public cycle between productivity and inclusion. And this resources underpinning the role of the state in providing cycle also includes sustainability. A more productive critical public services.   Figure 1. A virtuous cycle for a prosperous, inclusive, and sustainable Brazil Human capital, savings / investment, productivity Economic growth and jobs Megatrends: Social & Historical legacy • Climate change economic Environmental sustainability & “Many Brazils” • 4IR inclusion • Aging Public resources Social contract Source: World Bank. 2  Vostroknutov, A. 2021. 4 How to create a virtuous cycle? History and all. A more inclusive social contract can facilitate megatrends will determine the future unless Brazilians critical reforms. By reforming public education and T HE BR AZIL OF T HE F U T U R E make deliberate choices to change the path of history providing Brazil’s children access to more and better and seize opportunities from megatrends while education, the gains of technological change could be minimizing the risks. Preparing for megatrends implies shared widely. Social protection reforms could lead to embracing technological change, tackling climate better protection of those in need at much lower fiscal change, and adapting to demographic change. To costs. A more efficient and progressive tax system could further promote inclusive, sustainable growth, there help raise the needed revenues to invest more in Brazil’s are at least six critical areas for reform: (i) raising future, while reducing inequality. Changing labor taxes productivity in the private sector to boost growth could help reduce current incentives for employers to in an environmentally sustainable way; (ii) preparing rely on more precarious forms of employment. Natural Brazil’s education system for closing the gap between resources, such as forests, could become a sustainable skills and jobs; (iii) strengthening the relevance and foundation of prosperity and Brazil could once again sustainability of social protection systems for future become a leader in fighting climate change. All this challenges; (iv) reshaping today’s limited fiscal policy would sustainably generate economic growth and space in line with long term priorities; (v) improving the revenue needed to finance progress in a fiscally access to infrastructure services; and (vi) building a sustainable way. Brazil could become a major exporter more equitable and efficient tax system. Reforms can of green commodities and manufactured goods, only be undertaken if they are sufficiently supported benefiting from the high demand for green production by Brazilian society. This requires strengthening across the world. Its innovative green-energy matrix Brazil’s social contract to provide the required trust together with low land-use emissions would make it that the reforms will benefit everyone over the long highly productive and competitive on international term. markets. And Brazilians would become active players and innovators in international business and global With the right reforms Brazil can become an supply chains, opening new possibilities for growth economic powerhouse that offers opportunities for across the economy. 1. Overcoming the legacy of exclusion and preparing for megatrends Many Brazils: overcoming high throughout the 20th century by global standards. inequality and benefiting from Inequality increased during the military regime, began diversity declining roughly a few years after the democratic transition, yet stalled in recent years (Figure 3). there Today, many Brazils coexist. At one extreme is an are two main explanations for Brazil’s high historic upper class predominantly white, largely formalized, inequality: first, its institutions were intentionally built well educated, urban, and Southern or Southeastern. in colonial times to extract income and wealth from At the other are those in the bottom 30 percent, slaves and the poor, and, notwithstanding considerable predominantly of color, informal or in subsistence improvements, still promote various forms of agriculture, uneducated, poor, rural, and Northern or exclusion.3 Second, political and economic elites were Northeastern. Brazil also has a substantial urban middle successful in maintaining throughout the century and upper middle class, which is more heterogenous restrictive political participation to preserve extractive racially, more often formally employed but seldom institutions, unlike other western democracies after highly educated. Children are over-represented among World War II.4 Yet diversity need not mean division: families in poverty and the lower middle class, while the it can be an asset that can unlock talents promoting elderly among the richest (Table 1). development. And a less divided, more inclusive society will be more successful in shaping a common path Despite progress, Brazil remains among the world’s benefiting everyone. most unequal countries. Currently, the many Brazils are a source of inequality. For example, white Brazilians Promoting inclusion will be a critical overarching enjoy much better employment than Brazilians of color theme for Brazil’s path to 2042. This will require social (Figure 2). Brazil’s Gini coefficient of inequality, and consensus for policy action—including in how Brazil will the share of income to the top 1 percent, remained decide to prepare for the megatrends. 3  Acemoglu and Robinson 2012; Engerman and Sokoloff 2005. 4  Piketty and Saez 2014; Souza 2016; Scheidel 2017; 6   Table 1. “Many Brazils” at a glance Poor Vulnerable Upper T HE BR AZIL OF T HE F U T U R E Rich Population (bottom middle class middle (top 10%) 30%) (30%–59%) (60%–89%) Race White (% adults) 24.7 37.3 52 69.8 Number of adults 18+ 2.39 2.34 2.21 2.02 Number of children 0–17 1.91 1.07 0.61 0.52 Family composition Number of elderly 65+ 0.12 0.29 0.33 0.33 Dependency ratio 1.01 0.67 0.48 0.44 South/Southeast (%) 36 57 71 73 Location North/Northeast (%) 59 35 20 18 Adults out of labor force (%) 38 25 18 16 Labor market Adults unemployed (%) 27 11 5 3 inclusion and social Adults working formally (%) 11 35 55 63 protection Working informally (%) 70 44 29 22 Tertiary education, among age 25+(%) 2 6 18 58 Human capital Secondary education, among age 25+(%) 27 35 40 29 Income Total household income (per capita BRL) 276 736 1,561 5,848 Note: Income percentiles obtained from SEDLAC data. Formal refers to workers with carteira assinada, or 4ilitary/servidor estatutario, or employer/self-employed who report contributing to previdencia. Education among individuals 25+. Source: World Bank staff based on PNAD Continua 2020.   Figure 2. Labor status of whites (left) and Brazilians of color (right), according to per capita income deciles in 2019 Brazilian whites (million) Brazilians of color (million) 30 30 20 20 10 10 0 0 Poor Vulnerable Upper Rich Poor Vulnerable Upper Rich (bottom Middle Class Middle Class (top 10%) (bottom Middle Class Middle Class (top 10%) 30%) (30%-59%) (60%-89%) 30%) (30%-59%) (60%-89%) Formal Self Employed (TA) Firm owner (SIMPLES) Microentrepreneur (MEI) Public Employee Informal Formal Private Employee (CLT) Unemployed Out of labor force* Note: Occupational status of adults age 18–64 and not enrolled in school. Brazilians of color identify as “pardos” or “pretos”. Source: World Bank, based on BraSIM 2019 microsimulation tool.   Figure 3. Income Gini for Brazil, France, and the United States, 1900–2018 7 T HE BR AZIL OF T HE F U T U R E 0.7 30 0.6 25 Gini Brazil I 0.5 Gini Brazil II 20 Top 1% share Gini USA 0.4 Gini 15 Gini France 0.3 Brasil 1% share 10 USA 1% share 0.2 France 1% share 0.1 5 0 0 1900 1913 1917 1921 1925 1929 1933 1937 1941 1945 1949 1953 1957 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 2013 2017 Source: Fandiño et al. (2022), using on data from: Gini (left axis): Brazil I (IPEA 2020; World Bank 2020); Brazil II (Bertola et al. 2012); United States (Milanovic 2013; World Bank 2020); France (Morrisson and Snyder 2000; World Bank 2020). Top 1 percent share (right axis): (average share held by the richest 1 percent in 1930–1935, 1970–1975, and 2010–2015) (Souza 2016; WID 2020). Preparing for megatrends of things (IoT) and biology, developing autonomous vehicles, 3D printing, advanced robotics, distributed Megatrends raise the cost of inaction and create ledger technologies (such as blockchain), new—often opportunities. Technological progress, climate more resource-efficient—materials (such as synthetic change, and population ageing are among the global meat), and artificial intelligence/data science. and national megatrends, which will also shape Brazil’s future. Whether domestic or external, megatrends tend The many Brazils are reflected in different rates to be inescapable; all societies will need to confront of technology adoption across households and them. Policy reforms will be critical to help individuals, firms. Only about 0.1 percent of Brazilians have not firms and institutions adapt to them and, ideally, thrive experienced the second industrial revolution, but 23 because of them. percent have yet to experience the third industrial revolution. Adoption of Industry 4.0 technology is Embracing technological change generally low in Brazil, at about 4 percent compared with about 20 percent based on international benchmarks.6 Global technological change has been profound, Recent evidence for the state of Ceará (a poor state) and the Fourth Industrial Revolution is the latest points to a technological divide across companies: in wave of global technological disruption. The world addition to the low adoption of technology for the third has gone through three revolutions, starting with the and fourth industrial revolutions, there are large gaps agricultural revolution and followed by the industrial across firms, with smaller firms lagging.7 revolution and the digital revolution, each of which fundamentally altered societies and economies.5 At the Technological change could accelerate welfare gains turn of the 21st century, a Fourth Industrial Revolution if digital access becomes universal, and regulations commenced that is distinguishable from the digital prevents abuse of market power. For consumers, this revolution, which by 2000 had reached a point of could result in digital leveling, as there would be many sophistication and integration that was profoundly digital substitutes for more expensive real goods and affecting society and the economy. Technologies under services. However, some recent digital advances bring Industry 4.0 include the intersection of the internet considerable risks, including mental health issues and 5  Schwab 2017. 6  Albrieu et al. 2019. 7  Cirera et al. 2021. 8 political control—even threats to democracy itself. Embracing technological change can be an For firms, recent technological change increases opportunity. Embracing technology can help Brazil T HE BR AZIL OF T HE F U T U R E competition by creating better ways of competing become more affluent—and it can help Brazil prepare and spurring innovation and productivity. In contrast, for other megatrends, such as tackling climate change when digital firms experience near-zero marginal cost, (for example, by adopting less resource-intensive that can stifle competition, resulting in multinational technologies) or adapting to demographic change (for monopolies or oligopolies with very limited oversight example, by supporting elderly care). What is critical is from national authorities. Ensuring that technology that all Brazilians, poor and rich, firms and individuals, benefits society remains the role of governments, so will be prepared to seize these opportunities. regulation, domestic and transnational, will assume an ever more important role. Brazil has taken initial steps Tackling climate change to deal with some of these issues by establishing the Central Data Governance Committee in 2019. Other Climate change is expected to increase the risk and concerns include market concentration, for instance intensity of water scarcity and drought across Brazil, when incumbents control other firms’ access to requiring significant adaptation.9 The main exception technologies that directly affect their revenue stream is the South-Central area, from São Paulo to the South and competitive competencies.8 (Brazil’s primary agricultural zone), which is expected to experience increased precipitation. This, together Technological change will also alter the way in with changes in seasonal rainfall patterns (including which firms source and use labor locally, enhancing the greater frequency of intense precipitation events), opportunities for skilled workers but also carrying is expected to translate into higher incidence and significant risks for workers’ protection. An increase intensity of flash flooding. Climate change requires in the share of tradable service jobs (related to Brazil to take various adaptation measures, from services that can be sold abroad) as a result of new more climate resilient infrastructure to more climate- technologies will enable firms to source skills from attuned social protection systems. Given Brazil’s the rest of the world if they are not locally available. infrastructure gap, the additional cost associated with The internet and artificial intelligence are already adaptation is relatively small (about 0.8 percent per enabling the outsourcing of an increasing range of year between now and 2030). tasks required in the service sector, where most new jobs will be created. For Brazilian workers, there will be The impacts from climate change on households’ more opportunities to tap into global trade-in services, welfare are expected to be broad and inequitable. but also a greater risk of displacement by technology. About 3 out of 10 individuals live in either high Data has shown a steep decline in the number of jobs socioeconomic vulnerability or high environmental with routine and manual tasks in Brazil (those most vulnerability.10 About 19 percent of the population at risk of displacement by technology) and an upward reside in municipalities that are considered to be at high trend in the growth of non-routine analytical type environmental risk exclusively, while about 8 percent of of jobs. Furthermore, it can be anticipated that the the population are in municipalities considered to be in number of stable and dependent jobs may continue high socioeconomic vulnerability – though not at high to decrease, as firms can outsource a greater number environmental vulnerability. The urban poor, especially of functions via platforms. A rise in self-employment residents of informal settlements, are particularly and freelancers as a share of total formal employment vulnerable to disasters. There is evidence correlating has already been occurring in Brazil in the past decade, low levels of income (or, broadly speaking, social and driven high differentials in labor costs in favor of the economic vulnerability) and occupation of disaster- self-employed. These changes are challenging the prone areas (and, in turn, vulnerability to hazards). reach of labor regulations and part of social insurance, Informal settlements in Brazil are often located on low- designed last century for an industrial, salary work- lying, flood-prone land or on steep slopes, and consist based work economy. of structures that are easily damaged during floods and landslides. These areas oftentimes overlap with those 8  Damm 2022; World Bank 2021. 9  World Bank 2023 10  World Bank 2023. with high exposure to hazards in coastal zones. A total Except for its high deforestation rates, Brazil is 9 of 15.4 million people live in coastal zones at less than already a very green country, which could become a T HE BR AZIL OF T HE F U T U R E 10 meters above sea level, of which 86 percent are in major boon for its future development. With energy urban and quasi-urban areas, including Rio de Janeiro, and industry only the third and fourth largest gross Salvador, Fortaleza, and Recife. Brazil’s well-developed emitters in Brazil, its emissions profile differs from that social protection systems are a solid foundation to of developed countries, with a significant percentage strengthen household’s resilience to climate shocks— of renewables, including hydropower: Brazil has one but they could be further attuned to more specifically of the world’s most decarbonized energy sectors, attuned to natural disasters. with renewables accounting for over 45 percent of the Brazilian energy matrix and over 80 percent of Agriculture and power are the sectors most its power matrix,11 compared with world averages of vulnerable to climate change. Hydropower accounts approximately 15 percent and 27 percent, respectively.12 for about 63 percent of the Brazilian power sector. But the penetration of higher carbon-intensity fuels has More frequent and intense droughts thus threaten been increasing. Brazil can, however, consolidate and the national power supply, especially since Brazil’s further advance its decarbonization achievements at hydro stations are relatively old (55 years on average) low cost while also generating significant opportunities and maintenance has in some cases been lagging for green exports of wind turbines, electric vehicle considerably, further increasing the vulnerability to batteries, and green hydrogen—and of climate action climate change. This vulnerability has been tempting minerals. That would also lower Brazil’s potential costs policymakers to invest in additional thermal capacity, from global decarbonization efforts. If Brazil manages which in turn contributes to global warming, even to reduce deforestation and simultaneously build though there are green power alternatives, such on its green asset base (including green power and as wind and solar. Agriculture, one of Brazil’s main sustainable forest use), it can expect a considerable drivers of economic growth, is also expected to be hit, relative increase in its competitiveness in global trading though there is considerable variability across Brazil’s systems--which can be further enhanced through landmass of continental dimensions. Especially if investments in productivity across all sectors. markets and policy succeed in enabling farmers to adapt to changing conditions, promoting climate- Effective carbon pricing and sectoral interventions smart agriculture, overall impacts on agricultural could help Brazil to further seize opportunities from production across Brazil may be limited. global decarbonization.13 Legislation to establish a carbon market is currently under review in Congress. The “arc of deforestation” advances deeper into An Emissions Trading System or a carbon tax would the highly sensitive Amazon biome, risks of tipping be a critical pillar to support Brazilian decarbonization points could change precipitation patterns and hurt and strengthen its edge in green markets. However, the agricultural producers across Latin America. Effective main source of emissions in Brazil is related to land use deforestation control, especially in the Amazon (but change (notably deforestation) and agriculture, sectors also elsewhere, like the Cerrado biome) is critical for in which traditional carbon pricing practices are not Brazil’s future. Various policy measures are required easily applied. These sectors could be incorporated into for this, including the full implementation of the Forest a national compliance market through carbon offsets. Code, the designation of vast undesignated areas (often In addition, sectoral interventions will be needed: subject to land grabbing), effective law enforcement especially interventions to curb deforestation, most of (much deforestation is illegal), subsidy reform, and which is illegal. This includes effective land and forest sustainable trade. At the same time, Brazil has governance, a review of agricultural subsidies and the enormous potential in raising conservation financing rural land tax, and value chain monitoring. A policy in carbon markets, linked to the effective reduction mix including productivity, effective carbon pricing in deforestation. This can generate resources for a and sectoral interventions, such as effective forest growth model anchored in ecosystem preservation and governance would help Brazil reach net zero emissions inclusive development. by 2050 (Figure 4). 11  Ministério de Minas e Energia 2022. 12  IEA 2021. 13  World Bank 2023. 10   Figure 4. A mix of higher productivity, effective carbon pricing, and sectoral interventions could reduce Brazil’s net emissions to zero by 2050 T HE BR AZIL OF T HE F U T U R E 2500 Bunker Fuels* Production of Fuels Greenhouse Gas Emissions (Mt CO2e) 2000 Other energy use Transportation 1500 Waste Land-use change and forestry Removals (Land-use in agriculture) 1000 Removals (secondary vegetation) Fugitive emissions 500 Power Buildings Industrial processes 0 Agriculture Removals (A/Reforestation & forest restoration -500 Removals (Protected areas & indigenous lands Net GHG Emissions -1000 *Banker fuels excluded from net emissions 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040 2042 2044 2046 2048 Source: World Bank 2023. 2050 Adapting to demographic change Higher care burdens on working age adults could stifle labor force participation and will sustain internal Brazil is getting old. The share of young people in migration towards Southern states. Dependency Brazil is projected to decline rapidly over the next ratios (defined as the ratio of family members not of decades, with implications for labor markets, pensions, working age, per working age adult), disproportionately education, health and inequality. While 52 percent of affect Brazil’s poor households today who tend to have the Brazilian population was between 0 and 19 years more children. In the future, the elderly are projected to old in 1950, this share fell to 28 percent in 2020 and make up a greater share of dependents. In 2042, the is expected to reach 22 percent in 2042 (Figure 5). In dependency ratio in Brazil is expected to be around 53 absolute terms, this will represent a 13 percent decline percent but could be as high as 69 percent if years of in the number of young people over the next 20 years. schooling rise. States in the South and Southeast, in line with their development processes and incomes, Brazil is on a path to become old before becoming rich. are expected to experience higher dependency ratios, An older society faces multiple challenges. Jobs that thus internal migration flows will continue to follow job are typically done by younger workers will be harder opportunities. to fill and require more immigration or automation. In addition, in countries with growing retired populations, Brazil will need to adapt to its aging population. typically savings (and thus investments) tend to High income economies with ageing populations do fall, with negative impacts on economic growth. not necessarily experience a slowdown in growth, Demographic ageing will put pressure on public if they increase automation. This requires both an resources and could further tilt the political economy adequately educated workforce and investments. in favor of policies that support present consumption, Increasing the supply of early childhood development slow-down productivity growth and depress savings. and lifelong learning programs is already part of the The school-age population, in contrast, will decline, policy agenda, but going forward, the elderly will need though not necessarily the number of students. This more, efficiently designed, social care services. Brazil demographic change presents important opportunities will need to embrace migration, from the rest of the for expenditure reallocation within the education sector world and within the country. Reforms require a social to close critical coverage gaps. contract that can support the required investments and that welcomes newcomers.   Figure 5. Brazil’s population pyramid, 1991–2042 11 T HE BR AZIL OF T HE F U T U R E 1991 2010 80+ 80+ Male 75−79 Female Male 75−79 Female 70−74 70−74 65−69 65−69 60−64 60−64 55−59 55−59 50−54 50−54 45−49 45−49 40−44 40−44 35−39 35−39 30−34 30−34 25−29 25−29 20−24 20−24 15−19 15−19 10−14 10−14 05−09 05−09 00−04 00−04 −10 −5 0 5 10 −10 −5 0 5 10 Population in million Population in million 2020 2040 80+ 80+ Male 75−79 Female Male 75−79 Female 70−74 70−74 65−69 65−69 60−64 60−64 55−59 55−59 50−54 50−54 45−49 45−49 40−44 40−44 35−39 35−39 30−34 30−34 25−29 25−29 20−24 20−24 15−19 15−19 10−14 10−14 05−09 05−09 00−04 00−04 −10 −5 0 5 10 −10 −5 0 5 10 Population in million Population in million Source: Census and IBGE. 2. Promoting inclusive, sustainable growth Raising productivity to boost A productivity-focused model would be more sustainable growth sustainable. First, productivity becomes increasingly important as countries develop and the gains from Brazilian economic growth has been slow and accumulating factors—labor, capital, and land—are environmentally unsustainable. During the now small relative to potential gains from productivity. commodity supercycle, poverty and wage inequality Second, accumulating the factor land is synonymous declined as the number of jobs and social transfers with frontier expansion in the “Arc of Deforestation”. A increased, but income inequality, which also accounts productivity-based growth model would also reduce for capital income, seems to have stagnated. Once pressure on Brazil’s precious natural forests, including commodity supercycle came to an end, Brazil became the Amazon rainforest.15 A similar argument applies to poorer (Figure 14). other forms of extractive development, including oil and gas, which is particularly relevant in a decarbonizing There are limits to Brazil’s growth model based on world. Raising productivity across the economy will factor accumulation. Labor accumulation has been a result in more economically and environmentally major source of growth in Brazil (Figure 15).14 However, sustainable development. the demographic dividends are nearly exhausted, and Brazil is now one of the fastest ageing societies. The Brazil has much to gain from a more productivity- accumulation of capital has been hindered by low focused growth model combined with institutions savings, in addition to high discount rates, which are that foster inclusion and sustainability.16 Achieving a common in middle-income countries with substantial more inclusive society can also improve Brazil’s paltry levels of poverty and exclusion. With limited potential savings and investment rates, helping the economy from labor and capital accumulation, Brazil needs build its stock of capital. It could also raise labor to strive for higher productivity, which can increase force participation, a source of both higher and more output from existing factors and multiply the gains inclusive growth, as women would benefit. And Brazil’s from new accumulation. One path to higher aggregate current model of factor accumulation is running out productivity is to reallocate resources from low- of steam since its ageing population can provide little productivity to high-productivity sectors. Another economic stimulus going forward. For longer-term requires greater innovation. growth, Brazil needs to shift its focus to productivity, 14  Dutz 2018. 15  World Bank 2022b. 16  World Bank 2022b.   Figure 6. Gross national income per capita   Figure 7. Labor adjusted for education has 13 (1990-2022) – declining with two recent been a driver of recent economic growth, but T HE BR AZIL OF T HE F U T U R E recessions, PPP, 2017 international $ productivity stagnates 18000 5.0 16000 4.0 14000 3.0 12000 2.0 10000 1.0 8000 0.0 6000 -1.0 4000 2000 -2.0 0 -3.0 1997-2005 2006-2011 2012-2019 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 Capital Labor Human Capital TFP GDP Growth Source: World Bank. Source: World Bank. World Bank 2022. Note: Figure shows decomposition of GDP growth in selected periods by its factors (human capital, labor, capital, and total factor productivity. especially in currently lagging non-commodity sectors, Amazon, the “arc of deforestation” where forest to move up the value chain and lower the costs of governance is weak17 Agricultural productivity gains domestic products and services while gaining global at the national level (especially if also combined with market share. This could make Brazil both greener and more effective land and forest governance) are less more inclusive. likely to give rise to the Jevons effect and may increase the global food supply without increasing deforestation Raising productivity in agriculture and mining will in Brazil. Taking market share from less competitive increase income and welfare, but the associated commodity producers in other parts of the world could impacts on environmental sustainability are also reduce pressure on global ecosystems. ambiguous. Higher productivity in agriculture and mining, Brazil’s current growth sectors, will not Raising productivity in urban sectors would boost necessarily reduce environmental costs. In theory, welfare and reduce many environmental costs, at higher productivity also means more efficiency, so less least on average. Brazil’s strong commodities sector resource use. This tends to be positive at a global scale. makes it more difficult for industrial or traded services However, this may not be the case Brazil. If demand is sectors to take off, because of “Dutch disease” in the elastic, higher productivity means more consumption case of minerals and “Brazilian disease” in the case of the good (the Jevons effect), which may lead to more of agriculture.18 Essentially, high productivity in these pressure on natural resources. Since Brazilian mineral sectors appreciates the exchange rate, making it more markets are international, demand is elastic. For oil difficult for industrial sectors to compete in global exports, higher oil productivity would thus also mean markets—in addition to myriad domestic constraints higher oil exports, potentially contributing to higher linked to Brazil’s history with import substitution. global damage from greenhouse gas (GHG) emissions Since 1996, labor productivity gains have been highest (even if the oil is not used in Brazil), depending on in agriculture and mining. At various times over whether Brazil takes market share from existing that period, manufacturing has either stagnated or producers or grows the global supply of oil. For similar contracted. Nontraded services, like finance and real reasons, the Jevons effect can also arise in agriculture, estate, have had modest productivity gains, but they and the risk is higher in the nine states of the Legal seem to have been unable to provide the economic uplift 17  Hanusch 2023. 18  Ferreira Filho and Hanusch 2022. 14 of traditionally traded sectors like manufacturing. This of tax regimes, with rates that vary according to region may be due in part to high distortions in the financial and sector, the proliferation of special regimes and the T HE BR AZIL OF T HE F U T U R E sector, particularly to high rates of earmarked credit, constant changes in legislation lead firms to spend a which has had limited impacts on the productivity of lot of time and money on tax planning. The complexity the economy.19 Higher productivity in urban sectors, of Brazil’s tax system hinders productive allocation of like manufacturing and many services, should be able firm’s resources and results in high compliance cost. to counter Dutch disease and Brazilian disease20 and As an illustration, Brazilian taxpayers spend four recalibrate the competitiveness of Brazil’s economy, times as much time to comply with tax obligations while diversifying it further into urban sectors. Higher as the average of Latin American countries and eight gains in manufacturing across Brazil could also reduce times as much as OECD average.22 Moreover, the GHG emissions in net terms.21 system imposes a high amount of judicial uncertainty and conflict on taxpayers and extensive public and There are at least five critical reform areas to private resources are spent in judicial disputes. Current enhance productivity. Education and infrastructure resources under tax litigation may reach one third of are among the first. As discussed earlier, low human Brazil’s GDP.23 capital is perhaps Brazil’s biggest constraint, as a source of inequality—it is also a major drag on productivity. The taxation of goods and some services is extremely Similarly, Brazil’s chronic infrastructure underspending inefficient in Brazil.24 The majority of indirect taxes is undermines inclusion (through poor access to basic levied on turnover, following a cumulative regime that services) and productivity (by generating economic imposes higher effective rates on firms that are in the costs) simultaneously. Brazil needs to invest more and final stages of the production chain. Moreover, even better. taxes that are legally non-cumulative may become cumulative in practice because of weak institutional Greater openness to trade is a third priority. Brazil designs. One of the most important sources of revenue remains one of the most closed economies in the world. for Brazilian states is the ICMS. The ICMS rules state Trade agreements can support the gradual opening of that only inputs that are physically incorporated into the economy, lowering prices for firms and consumer, the final products give right to tax credits. Hence, taxes plugging gaps and inefficiencies in domestic value on inputs like telecommunication services or publicity chains, and putting competitive pressures on poorly do not generate credit and become cumulative in performing firms. Ratifying the EU-Mercosul trade the tax structure. In addition, many companies face agreement is one immediate possibility for progress bureaucratic difficulties when claiming for tax credits, on this. The agreement foresees greater access to which can take years to be reimbursed. In some cases, EU markets for Mercosul countries, including Brazil, firms simply give up their credits.25 The cumulative especially for agricultural commodities. In exchange, structure creates an artificial incentive for vertical Mercosul countries will reduce selected tariffs and integration and market segmentation, undermining nontariff measures on imports of EU manufactures. competition and diversification. Modelling points to large economic gains—which could be further enhanced if Brazil unilaterally lower nontariff Replacing existing indirect taxes with a single measures. The evidence suggests that such reforms though federally shared value added tax would can be consistent both with higher productivity-led present a vast improvement. The new tax should be growth and lower emissions. non-cumulative, with a broad tax base that includes intangible goods and financial services. Refunds for Reforming the intricate corporate and indirect tax tax credits should be provided timely and without need system is a fourth urgent priority—for productivity for judicial recourse. Moreover, proliferation tax rates reasons in addition to equity reasons. The vast number should be limited, avoiding exemptions and special 19  Dutz 2018. 20  Ferreira-Filho, J. B. and Hanusch, Marek 2022. 21  Hanusch 2023. 22  World Bank, 2018. 23  Appy, 2017. 24  There are five taxes of such kind: three federal taxes (PIS, Cofins and IPI), one state tax (ICMS) and one municipal tax (ISS). Each of them is subject to different regimes and a variety of tax rates, depending on sector and location. 25  Appy, 2017. regimes that create distortions and impose compliance importers, exporters, and other foreign trade agents to 15 costs. Finally, the tax should follow the destination fill out all their forms in one place. But other reforms T HE BR AZIL OF T HE F U T U R E principle, eliminating incentives for tax competition are still needed to stimulate competition between firms (guerra fiscal) between states. This would result in a and ease the adoption of technology, such as removing firmer revenue base for states as well as ending the local content requirements. The new bankruptcy law practice of firms’ decisions on allocation of investment for small and medium-size firms that still awaits and production being driven by tax planning rather than implementation could improve the reallocation of productivity concerns.26 A reform proposal broadly capital and thus boost productivity. along these lines was approved by the lower house of congress in July 2023, raising hope of tax reform finally Because the innovation levers are influenced by becoming a reality after decades of failed attempts.27 government capabilities, reforms to raise public sector productivity should also be a priority. The A fifth priority is fostering innovation. Brazil needs agenda of public sector reform should focus on policies to support equitable and sustainable growth transparency and accountability, as well as revisions and to boost productivity through innovation. These to business support policies and the establishment of policies can be placed in categories that complement regular evaluation procedures. The government can the levers of innovation: institutions that stimulate also facilitate business innovation. By the end of 2021, competition between firms and lower barriers to it had reduced the backlog of pending patents by 77 technological transfer, efficient allocation of resources percent.30 While this is a notable accomplishment, to markets, removal of distortions in the financial additional measures are needed to raise innovation market, and high skilled workforce and well managed levels in private organizations, such as fostering firms. With these levers in order, Brazilian firms will be university research (not reducing university funding able to successfully adopt and adapt more advanced for discretionary expenditure). Policies are needed to technologies and management methods from other attract and retain foreign direct investment (FDI) in countries and produce frontier technology. However, sectors other than agriculture and minerals, particularly all of these policies are essential, as they reinforce in key service sectors that are enablers for the rest of one another. For example, it is unlikely that firms will the economy. Reducing restrictions on FDI in modern be well managed if the workforce is not skilled, or that services can enhance inflows of technology and capital the financial market will be well regulated without into modern services like ICT, finance, and business institutions that stimulate competition. services. These services are not only exportable, but are also intermediate inputs into manufacturing and Some innovation levers depend on the approval of agriculture. reforms that still need to be fully developed. Studies have revealed the need for comprehensive tax reform Preparing Brazil’s education that simplifies and unifies tax rules across jurisdictions system for closing the gap and reduces the scope of ineffective special tax between skills and jobs regimes.28 For example, the effect of Simples Nacional on formalization has been demonstrated to be modest, Education is a key source of equity and inclusion. and its rules for tax exemptions perversely motivate Educational attainment also saw marked improvements firms to remain small and less productive.29 Such during the last two decades, but gaps in quality, and policies inhibit the efficient allocation of resources discrepancies in outcomes by region, sex and race to markets. Similarly, reforms that lower tariffs for remain glaring. The World Bank Human Capital Index capital and intermediate goods and reduce the costs of (HCI) is a synthetic indicator to measure the potential trade are necessary to foster technological transfers. productivity of a child when reaching adult age, New regulations were recently implemented in this depending on years of schooling, learning outcomes direction, including a new foreign trade administration, and health conditions. Brazil’s overall HCI improved and an electronic one stop shop solution allows from 0.53 in 2007 to 0.55 in 2019 (Figure 9), most 26  Gobetti and Orair, 2016. 27  The proposal approved by the lower house is PEC 45/2019, which was under consideration in the Senate at time of writing (September 2023). 28  Veloso 2021; World Bank 2018. 29  Firpo and Portella 2021; Piza 2018; Veloso 2021. 30  Foreign Office Presentation 2022. 16   Figure 8. Changes in task content of   Figure 9. Brazil Human Capital Index and its occupations, 2012-2020, by education constituents, 2007–2019 T HE BR AZIL OF T HE F U T U R E 0.05 1.00 11.20 0.95 11.00 0.04 Difference in task index value 0.90 10.80 0.03 0.85 10.60 0.02 0.80 10.40 0.01 0.75 10.20 0.70 10.00 0 0.65 9.80 (0.01) 0.60 9.60 (0.02) 0.55 9.40 (0.03) 0.50 9.20 Non- Non- Routine Routine Non- 2007 2009 2011 2013 2015 2017 2019 routine routine cognitive manual routine analytical interpersonal manual Human Capital Index (LHS) Health Index (LHS) Harmonized Learning Outcome (LHS) Below Secondary Secondary Tertiary Survival Index (LHS) Expected Years of School (RHS) Source: World Bank. Source: World Bank 2021. remarkably in total years of schooling.31 For instance, been declining over the last decade (Figure 8). While between 2000 and 2019, net enrollment rates jumped presenting new opportunities for skilled Brazilian from 66 percent to 94 percent in preschool (5–6 workers, technological change underscores the year-olds) and more than doubled in upper secondary importance of developing the human capital of workers school. However, Brazil’s HCI value remains below who will be displaced by automation, including adults the average for all upper middle-income countries in already out of school. Absent a massive reskilling, the Latin America, and disparities around race and region potential for mismatch is high, with resulting growth are stark. Boys of color, in particular, fall increasingly in inequality and more limited productivity gains from behind due to high school dropouts, lower learning, technology itself as needed workers become scarcer.32 and shorter life expectancy (a reflection of exposure to violence). COVID-19 further reversed HCI gains, by as The types of jobs that will soon become more prevalent much as 10 years according to World Bank estimates, require multidimensional skills, including cognitive, especially in the poorer North and Northeast. The socioemotional, and technical competencies. quality of education rose more slowly than enrollment, Workers will have to perform increasingly creative or particularly in upper secondary education. For analytical tasks in the services sector and the industrial instance, nearly all children in Brazil graduate without sector. Problem solving, critical and analytical thinking, proficiency in math. Education remains a key reform use of basic software and media tools are some of the area for Brazil. skills these jobs require. The largest skills shortages in Brazil are in services, health, and information and The destruction of jobs with routine tasks, and the rise communications technology (ICT) sectors, according in occupations requiring cognitive and interpersonal to a recent OECD survey.33 LinkedIn (a job matching skills will result in an increasing mismatch between platform) data, show that web development, digital labor demand and supply. Occupations with a higher marketing, and advertising are among the most content of routine and manual tasks have already requested skills by employers.34 31  The index score ranges from zero to one, and measures the productivity as a future worker of a child born today (relative to the benchmark of full health and complete secondary education). It can be decomposed into three main dimensions: survival, education, and health. World Bank 2022. 32  Acemoglu and Restrepo 2019. 33  OECD 2018. 34  Amaral et al. 2018. The development of these higher-order cognitive The projected decline in the number of children 17 skills depends on workers’ possessing foundational entering basic education, coupled with the current T HE BR AZIL OF T HE F U T U R E cognitive skills, such as literacy and numeracy, and education financing formula, opens a window of socioemotional competences in order to learn on opportunity for Brazil to accelerate investments the job. For many emerging professions in knowledge in its future workforce at all levels. Expenditure economies, the ability to acquire, synthetize, and simulations for the next two decades shows that apply new knowledge critically to reach business the current spending formula will allow for a gradual objectives is key, because many business-relevant increase in investments per pupil, still relatively low, skills have to be learned on the job and from others.35 without reaching higher aggregate spending levels. Employers emphasize the importance of basic writing Resources, however, will need to be reallocated and and communication skills across occupations.36 The better invested, to yield results. These include the demand for social skills is also on the rise, for similar reform of teaching career paths, a faster expansion reasons.37 Thus how students learn will be as important of extended school days, which now cover only 11 as what they learn. Early childhood education is critical percent in primary grades, and less than 12 percent to enable children to develop the skills required to thrive in upper secondary. The available resources should be in this type of education system. This shift implies sufficient to close gaps in early childhood education a pedagogical revolution in schools and teaching and accommodate higher participation in secondary approaches. education, but only provided governments roll out appropriate interventions to increase enrollment. Technical and vocational education and training Finally, savings from shrinking children cohorts could remains a little-pursued path in Brazil. Studies show be also used to provide financial support for higher a statistically significant positive wage premium of 9.7 education, and post-secondary adult training. percent on average for students completing technical school at the upper secondary level, compared with Governance reforms underpin any improvement students attending traditional high school and then of much needed cost-efficiency in Brazil’s basic entering the labor market.38 Yet, only 10 percent of education. The Northeasterm state of Ceará has upper secondary students are enrolled in technical become a role model for aligning schooling with learning and Vocational education and training courses, four by leveraging financial incentives to improve learning times less than the average in OECD countries. The low in both municipal and state schools, using a mix of uptake is due to a combination of limited information cooperation and competition.40 And the Southeastern and, especially, undersupply. state of São Paulo gave school principals management tools and training to apply a problem-driven approach Access to universities is still limited and highly to education’s challenges.41 The capacity building dependent on family income. Currently, of young improved school approval ratings and reduced people ages 18–24, almost 7 in 10 in the top income repetition rates, particularly in schools with more decile are enrolled in higher education, compared with low-income students.42 Concrete governance reforms 1 in 10 in the bottom 30 percent and less than 1 in 5 include one or more of the following elements: among the vulnerable middle class.39 Hence, most adults enrolled in formal learning in Brazil are still • Improving the accountability of school systems, pursuing an undergraduate or graduate university teachers, and principals to learning outcomes, degree up to their late 40s. Financial restrictions and and reward schools, principals, and teachers for long requirements to graduate explain such protracted performance. university careers. • Selecting principals based on technical and ability criteria. 35  World Economic Forum 2021. 36  Markow and Sederberg 2020. 37  Hansen et al. 2021, p. 869. 38  Almeida et al. 2015. 39  Based on PNAD C, 2019. 40  Loureiro et al. 2020; Petterini and Irffi 2013. 41  Andrews, Pritchett and Woolcock 2017. 42  Reis 2021. 18 • Driving school management to improve learning education programs is to quickly train workers in outcomes. order to improve their odds in the labor market,44 for T HE BR AZIL OF T HE F U T U R E • Reforming teacher training (pre- and in-service) to example, by easing occupation transitions. In Brazil, make it more practical and evidence-based. participation in formal short training is just 2 percent of working age adults. Such rates will need to increase (in Brazil’s upper secondary education reform and the OECD countries, as many as 40 percent of the adults, new national core curriculum for basic education including 20 percent of low-skilled workers, attend are opportunities for incorporating missing cross- some form of education or training every year).45 In the cutting skills. In the coming years, it will be key for future, as the demand for skill diversifies, such programs Brazil to support stages to implement the recently will be crucial to filling small skill gaps in the education approved new curricula for primary and secondary of workers. Despite their potential, many adult learning education. These greatly increased the flexibility for programs fail to generate expected results because students to pursue more market focused disciplines they are poorly designed and implemented, not least and offers space for schools to develop innovative because they fail to accommodate changes in how the programs and courses focused on socioemotional brain learns at later stages of life.46 skills, technical skills, and digital skills. Finally, Brazilian youth, especially from more In the case of higher education, both financing and disadvantaged backgrounds, will need education governance reforms are essential to allow the sector counselling and career guidance, supported by to grow while raising quality. Diversifying funding more open education data. More than half of sources, including means testing for tuition fees and young people in an ad hoc survey in Brazil reported scholarships, can make the Brazilian higher education underestimating by half the returns from completing system more equitable and improve quality. While secondary education and, to a smaller degree, public funding will remain vital, expansion of access higher education.47 Schools remain the best place for and quality will be difficult for universities while relying providing active counselling of students for the next on government support alone. At the same time, steps in their education, while employment services performance-based financing formulas that take into can develop specific services to support out-of-school account graduation rates and labor market outcomes youth in vocational decisions. These programs require could improve efficiency of the system and the value federal support for methods, capacity building, and for students. Such financing reforms should occur readily absorbed information. while granting public universities more autonomy in managing human and financial resources while Strengthening the relevance and increasing accountability is key for improving efficiency. sustainability of social protection Funding based on number of graduates rather than on systems for future challenges enrollment is common in financing formulas around the world. Additional mechanisms will be needed to The social protection system can also further ensure learning quality, so that universities focus on promote inclusion. In the last quarter of the 20th improving teaching methodologies and approaches. century Brazil created the foundations for today’s Professors’ career progression could also be linked to welfare state, marked by universal access to healthcare research output and teaching quality, to better align and pensions, but also persistent fragmentation. public and private incentives.43 Brazil historically made access to social protection depend on participation in formal employment. The Short-cycle higher education programs are a 1988 Constitution partially reversed this and included promising means of improving efficiency and many “outsiders” through the institution of universal widening access to skills attained postsecondary healthcare and social pensions.48 Since 2003, the formal education, especially for time-constrained creation of the subnational Social Assistance Network adults. The main objective of short-cycle higher and the Single Registry allowed to roll out large scale 43  World Bank 2006. 44  Ferreyra et al. 2021. 45  OECD 2019. 46  World Bank 2019. 47  Almeida and Packard 2018. 48  Arretche 2018.   Figure 10. Social insurance, labor market, and   Figure 11. Distribution of population, by age 19 social assistance expenditure throughout the groups and income quintiles T HE BR AZIL OF T HE F U T U R E lifecycle in Brazil (2019) 100% 3% 700000 100% 8% 14% 83% 90% 17% 17% 90% 600000 80% 80% 500000 70% 70% 56% 60% 60% 62% 400000 62% 70% 70% 50% 50% 300000 40% 40% 200000 30% 30% 12% 41% 20% 20% 100000 5% 30% 1% 10% 10% 21% 16% 13% 0 0% 0% Not age specific Child Adult Elderly Q1 Q2 Q3 Q4 Q5 Social Insurance Social Assistance % of Total 0-17 18-63 64 or more Labor Market Total Source: The World Bank using expenditure data from Portal da Source: PNADC 2019. Transparência, 2019. Note: Programs are classified according to main target-age groups. Bolsa Família is classified as SA-child, SUAS and housing policies are classified as SA-all, Salário Família is LM-child. social assistance, the Bolsa Familia program, and of incidence, the federal conditional cash transfer Bolsa helped reduce poverty. Social protection was also Familia remains the most pro-poor in a constellation critical for mitigating the economic effects of Covid-19, of benefits. The past government increased Bolsa especially through Auxílio Emergencial. In rolling out Familia’s impact in alleviating poverty by raising its this program, Brazil developed key innovations to value, though its design will need improvement to enroll affected individuals and pay benefits quickly and ensure horizontal equity across families of different remotely. However, this new layer of noncontributory size50. Formal sector pensions, disproportionally social entitlements was created alongside legacy benefit households in upper income quintiles even programs for formal workers and pensioners, to avoid though they are subsidized to differing degrees (Figure political confrontation. A similar mechanism was used 11). Thus, taken all together, Brazil’s tax-benefit system to create the unified health system, which led to public, is only mildly redistributive. Moreover, few social free, and universal healthcare, while maintaining protection programs are promoting human capital previous fiscal arrangements with private insurance and opportunity: active labor market programs such plans, thus allowing upper-middle classes to opt-out as skills development programs and intermediation with a subsidy.49 Since inception, the system has faced services receive only a minimal share of spending and budget constraints. Brazil has been a pioneer in its largely serve formal workers. social protection system—it can build on this track record for further progress. The changing nature of work, demography and climate change further challenges the relevance Despite their breadth, Brazil’s overall social and effectiveness of current instruments to cope protection expenditures are only mildly redistributive with short-term shocks. The transformation of with limited and intergenerational fairness. Four- work relationships due to technology, outsourcing, fifths of the country’s social protection expenditures and distortive taxation is likely increase the share of are allocated to programs that mainly target the formal workers who are self-employed; these will be at elderly (Figure 10), as in many OECD countries. In terms greater risk of income and earnings volatility, as well as 49  Menicucci 2007. 50  World Bank and UNDP 2023. 20 displacement by technology or abuse of market power better services. by platforms. New sources of risk unaddressed by (v) Strengthen integrated policies to deliver early T HE BR AZIL OF T HE F U T U R E current social protection instruments include climate childhood development programs in coordination shocks and longevity in poor health. With an eye to with social assistance offices the future, Brazil can reconcile its social protection and labor market systems through design features To strengthen the impact of the social protection that promote equity, opportunity, and resilience. system in reducing poverty, Brazil could consider: To meet the challenges of the future, Brazil’s social protection and labor system will need to enhance its (vi) Consolidating transfers for working families (Bolsa traditional income support by adding design features Familia and wage subsidies for formal workers), that promote economic opportunity for and foster the into a universal child benefit combined with an resilience of Brazilians at all different stages of the additional means tested allowance for low income lifecycle. households; this would also help reduce exclusion errors without additional leakage; and Several reforms could bring the social protection (vii) Building the capacity of the Reference Centers for system closer to this vision, without increasing Social Assistance (CRAS) to deliver quality social fiscal costs.51 Brazil already has many of the programs services, such as case management, with the aid of needed to achieve this vision, but rebalancing and digital solutions for routine activities. reforms are still needed. This chapter as well as the companion report on social protection (World Bank To be able to finance these ambitious changes, it and UNDP 2023), advance a number of detailed, will be necessary to increase the efficiency and complementary and incremental reform proposals, equity of overall social spending. First, this will that could help Brazil improve in equity, resilience and require further parametric reforms to restore pensions’ opportunity: medium-term sustainability, as well as continuing to restructure subnational pensions for civil servants, and To increase the resilience of the future workforce unemployment insurance design. Additional reforms and households, this report proposes: to better adapt to the changing nature of work include: (i) coordinating explicitly non-contributory pensions (i) The consolidation of different unemployment with the design of the contributory minimum pension, programs in a single unemployment insurance that so that all types of workers are better incentivized includes an individual saving component and risk to contribute and every year of contribution counts; pooling insurance component; (ii) adding technological innovations and consolidate (ii) The introduction of new financial instruments that registries in the social protection delivery system, incentivize savings and can help manage income based on lessons learned from the experience of volatility for workers in the informal sector and the implementing the emergency cash programs during self-employed; and the pandemic. Finally, (iii) reducing differentials in (iii) New features and financing mechanism in Bolsa contributions and taxes paid on earnings across Familia, that can increase its rapid deployment different legal forms of working, whether dependent or after climate-induced disasters self-employed.52 To increase opportunities for employment and Ensuring adequate access to human capital, the social protection system could infrastructure services (iv) Develop new labor market policies to support There are still considerable needs to provide all workers in job-to-job transitions or first labor Brazilians with adequate access to public services. market entrants, including via innovative contracts Over the past years, access to basic services with private and nonprofit providers and digital incrementally expanded, but at different pace in providers. Reforms in cash benefits mentioned different sectors. For instance, by 2019 access to above would provide the fiscal space to invest in electricity was nearly universal in Brazil (Figure 12): this 51  Fietz et al. 2021. 52  These reforms are discussed in detail a companion report to this publication “Social Protection for the Future Brazil” (World Bank and UNDP 2023). resulted from years of investments in poorer regions   Figure 12. Access to basic services (% families), 21 and targeted social tariffs, through the Luz para Todos Brazil, 1978-2019 T HE BR AZIL OF T HE F U T U R E program launched in 2003. In contrast, access to water remains far from universal, and an even greater gap 100% exists in access to sewages, with the resulting health impacts. Policy-specific production and maintenance 95% costs, as well as overlapping competences across 90% government levels, help explain why progress on coverage of basic services varied so widely. Ensuring 85% adequate access to public services for all is an urgent priority. 80% 75% Brazil invests too little in infrastructure, limiting progress in guaranteeing minimum access to 70% basic services and limiting productivity growth. Poor Vulnerable Upper Middle Rich (bottom Middle Class Class (top 10%) Infrastructure spending fell dramatically over the 30%) (30%-59%) (60%-89%) years, from about 4.8 percent of GDP in the 1980s, Toilet Trash Collection Electricity to just over 2 percent in the 2010s, and to only 1.6 Internet Water Connection percent in 2020. Brazilian public investment is no longer sufficient to replace depreciating capital, let Source: Palomo et al (2020). Elaboration based on PNADs data from 1978 to 2013 and PNADC for 2018 and 2019. alone expand the infrastructure stock. The gap to meet the Sustainable Development Goals measures about 3.7 percent per year, up to 2030. There is a need of another 0.8 percent up to 2030 (or 1.2 percent up Reshaping today’s limited fiscal to 2050) for adequate spending on climate mitigation policy space in line with long term and adaptation.53 The largest needs for investments priorities are in the transport sector. Over the next 20 years Brazil could benefit from reprioritizing its budget As the social obligations of the Brazilian state to better support infrastructure. A comprehensive increased, public spending grew, but revenues did infrastructure governance strategy could underlie not keep up and became ever more regressive. The a stronger emphasis on infrastructure spending, increase in the size of the public sector over the last supported both by public and private investment.54 three decades is largely due to the growth in the number of local public employees, largely explained Brazil has one of the strongest public-private by their increasing role as providers of social services. investment frameworks among Latin American Moreover, several social policies enacted to protect the countries that could prove a major boon as Brazil poor, as well as generous pension entitlements, were steps up its infrastructure priorities. Progress not accompanied by sufficient financing strategies, was recently made on updating Brazil’s public leading to a growing fiscal gap. In fact, taxation infrastructure management system55 but there are became more regressive in the democratic period: still significant gaps especially at the subnational level, and revenue was hollowed out by exemptions and with high variance in quality across Brazil’s states and deductions. Horizontal inequality between taxpayers municipalities. This will require significant investments with similar incomes is the norm, benefitting mostly in capacity building to support infrastructure planning high and medium earning self-employed and capital and implementation at the subnational level. owners. Brazil will need to create the space to fund its 53  World Bank, 2022b. 54  World Bank, 2022b. 55  A major overhaul of Brazil’s infrastructure planning and governance was triggered by Decree 10526/2020 (World Bank 2022a), triggering the institutionalization of the Integrated Long-Term Infrastructure Plan, the updating of federal plans for transport, energy, water resources, urban mobility, and telecommunications. Progress was made on research and development in a more harmonized and transparency way. The new governance model instituted by the Interministerial Infrastructure Planning Committee (CIP-INFRA 2021) promotes the appraisal and prioritization of large-scale projects with upstream levels of planning based on socioeconomic cost-benefit analyses. Significant strides have also been also achieved in the dissemination of standardized methods aligned with international best practices for project preparation (Five Case Model Guidance), ex ante appraisals (CBA Guide), and ex post evaluations. 22 development priorities while making the budget more   Figure 13. Public debt is high, implying limited progressive in order to strengthen its social contract. fiscal buffers T HE BR AZIL OF T HE F U T U R E (% of GDP, net terms) Future governments will need to rebuild the fiscal space to propel Brazil’s future. Public debt levels are 70 high (Figure 13) and fiscal space is further constrained 60 by elevated budget rigidities concentrated on pension payments, wage bill, and mandatory minimum 50 constitutional spending on public health and education. 40 Since public debt is higher than in other emerging markets, Brazil is spending a large share of its budget 30 on interest payments. So, only a small fraction of 20 the budget is discretionary, limiting the provision of tangible public services to the poorest Brazilians. 10 0 A credible fiscal framework is fundamental to ensure 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 E fiscal sustainability. There is no trade-off between fiscal sustainability and other priorities, such as productivity, inclusion, or environmental sustainability. Source: World Bank. Rather, fiscal sustainability is a necessary condition to meet other priorities. In 2017 Brazil adopted the Medium-Term Expenditure Framework would generate ‘teto de gastos’, which limited primary spending an overall stronger fiscal framework for Brazil. growth to inflation. This rule constrained investment spending, which was being crowded out by expanding A large portion of future spending will be dictated mandatory current expenditures – especially on by budget rigidities, which allocate most spending payroll and pensions. It was also overly rigid in a world to education, health and pensions. Federal rules of intensifying shocks, such as the Covid-19 pandemic constrain subnational borrowing, and states’ debt or climate shocks, and calamity exceptions to respond is low in most cases. States and municipalities face to shocks increasingly undermined its credibility. A structural deficits in their public pension systems new fiscal rule adopted in 2023 is more flexible and and have the main responsibilities to provide public balanced, combining primary balance targets – which services on health, education, and security. However, can be achieved by raising revenue as well as reducing the space for structural reforms has been limited expenditures - with limits to primary expenditure by a social contract that tends to favor stability of growth. If implemented appropriately this fiscal rule existing entitlements. Thus, fiscal structural reforms will provide an anchor to stabilize public debt, while are critical to recreate the fiscal space to implement allowing for increased public investment. public programs that are in the public interest and will enable Brazil to shape its future. At the same time, the Despite the adoption of the new fiscal rules, sectoral reforms discussed in this report are critical to Brazil’s fiscal and budgetary framework remains improve the quality of expenditures. fragmented. The framework of spending and primary balance rules coexist with a ‘golden rule’ Education expenditures are expected to continue which, in principle, limits federal borrowing to the increasing despite declining student numbers. equivalent of capital expenses. Furthermore, Brazil Following its demographic pattern, the number has a Fiscal Sustainability Law that lays out general of students in Brazil, like many other advanced principles of good budgeting. Finally, Brazil has only economies56, has been falling in the last 15 years, except an incipient Medium-Term Expenditure Framework. for early childhood and higher education. Despite Consolidating the fiscal anchor, the golden rule, the these changes, this report projects that spending on Fiscal Sustainability Law, and strengthening the education will continue to increase and remain the 56  Investment in education is expected to fall from 4.4 to 3.9 percent of GDP in France, 3.5 to 3.1 percent in Italy and 5.5 to 5.1 percent in Belgium (EPC/EC 2021). These computations assumed a fixed age-spending profile for the EU population and projected how aggregate spending will change with population ageing. So, they focused almost exclusively on the demographic effect. key driver explaining Brazil’s expenditure trajectory a convergence to 1 percent annual excess cost growth, 23 in the next two decades, due to constitutional public health spending as a share of GDP would still fall. T HE BR AZIL OF T HE F U T U R E minimum rules. Earmarked spending rules – binding mostly for states and municipalities - have helped to Pension programs remain extremely fragmented increase investment in education57; however, revenue in Brazil, and are the primary source of fiscal earmarks are highly procyclical, forcing governments vulnerability for subnational governments. The to increase education spending in times of economic pension reform of 2019 was a key step towards a expansion, without planning or a focus on results.58 more sustainable pension system. Gradual increases They also imply a strong budget rigidity, hampering in effective retirement ages mostly affect the higher any possible downward adjustment in spending, even income population which tends to retire especially with demographic changes.59 Given these constraints, early due to their higher contribution frequency. it will be essential that education expenditures can be However, teachers, uniformed personnel, rural workers, allocated strategically across levels, and thus provide and some other public sector workers, still retain the opportunity to close existing gaps at pre-primary options to retire earlier (very early by international and upper secondary levels, and with a focus on standards). The pension reform stabilized the deficit improving quality of spending. until the end of 2030s, however, due to demographic change, further adjustments will be necessary beyond For public health spending, fiscal projections indicate this time (Figure 14 and Figure 15). Of immediate a 1 percentage point increase as a share of GDP until concern is the growing deficits in many subnational 2042. Government spending on health services is civil servants’ pension systems, which are expected to expected to grow from 3.9 to 4.9 percent of GDP. As worsen in at least ten states and crowd out the use of health spending tends to gain space with increases in public revenues for social services, infrastructure and income, the projected increase in GDP is responsible for to invest in the younger generations. The complexity more than half of the projected increase in public health of reforming existing entitlements even in a context of expenditure, while changes in population structure very constrained fiscal resources are a good example explain about one quarter. Brazilian fiscal rules also of the political economy of the “Many Brazils”, and the influence the results, ensuring growing allocations. importance of building a shared vision to invest in the In real terms, resources directed to public health are country’s future. projected to grow by expansion of 75 and 56 percent in real per capita terms. Converting by purchasing power A package of interventions in addition to benefit parity, projection results show that health spending reforms will be needed for achieving lasting solutions per capita in Brazil will reach almost $1,000 by 2042. to pension sustainability. At the subnational level, in addition to reducing outstanding privileges for Still, health spending is projected to remain upcoming cohorts, several policies can reduce spending insufficient given the profile of healthcare users in across the more than 2000 subnational pension 2042, unless the efficiency of spending improves systems: these include better human resource policies dramatically. Argentina and Chile currently spend for civil servants, more effective asset management, more on health per capita than Brazil is projected to investing in information systems that tackle errors, 20 years from now. With efficiency gains, Brazil could overlaps and inefficiencies. In addition, while reforming improve health outcomes by 9 percentage points benefits may be at times politically prohibitive, other using the same amount of funding. Alternatively, it measures to claw back unjustified subsidies include could offer the same level of services using 34 percent increasing levels of contributions, as well as reforms less resources. If Brazil gradually increased efficiency, to the personal income tax, which today continues reaching the efficiency frontier in 2042, public health to offer regressive exemptions on pensions incomes. spending as a share of GDP would fall approximately Beyond benefit parameters, in the medium-term 0.6 percentage points, despite population ageing, pension sustainability depends also on achieving a reaching 3.2 percent at the end of the period. The more regular and substantial density of contributions efficiency gains are so significant that, even assuming in the population; thus, the aim of increasing formal 57  The constitution stipulates that states and municipalities spend at least 25 percent of their revenues from taxes and transfers on education, while the federal government was required to spend at least 18 percent. 58  Loureiro et al. 2020. 59  The Brazilian constitution also stipulates minimum levels of public spending on healthcare. 24   Figure 14. Projected revenues, expenditures,   Figure 15. Simulated deficit of the RGPS and deficits of RGPS private sector pension private sector pension system up to 2080 T HE BR AZIL OF T HE F U T U R E system up to 2080 according to economic growth scenario 20% 0% 15% -2% 10% -4% 5% -6% 0% -8% -5% -10% -10% -12% -15% -14% 2019 2024 2029 2034 2039 2044 2049 2054 2059 2064 2069 2074 2079 2019 2024 2029 2034 2039 2044 2049 2054 2059 2064 2069 2074 2079 PAYG Total Revenue PAYG Current Balance PAYG Total Expenditure PAYG Current Balance with 1% higher growth PAYG Current Balance Source: World Bank simulations based on the PROST tool, using Source: World Bank. Figure shows two scenarios for the RGPS administrative data from INSS. pension fund deficit, one with baseline growth assumptions and one with 1 additional percentage point of economic growth. Based on PROST simulation tool. employment in the economy and wage growth in private Furthermore, focusing on the composition of income sector can make an important difference. However, taxes, Brazil collects relatively more taxes from it is necessary that the parameters of contributions corporate income, underperforming when it comes to and benefits are consistent with pension schemes personal income. that balance adequacy and sustainability goals since any new addition of contributors (i.e., formalization of Fiscal sustainability could also be enhanced by workers) imply future benefits. reforming the indirect tax system. Especially at the state level, the current Imposto sobre Circulação de Fiscal sustainability could also be Mercadorias e Serviços (ICMS) tax lies at the core of tax enhanced by reforming the tax competition (guerra fiscal) among the states, harming system their revenues and fiscal balances and increasing the misallocation of production factors. Contrary to There are many opportunities to enhance the international standards, the ICMS tax follows the progressivity of Brazil’s revenue collection system. origin principle, such that tax revenues go to the state Brazil’s tax structure, overly reliant indirect and payroll where the product was produced, rather than where it taxes, departs from international standards: its is consumed. States being able to set differing effective revenue is heavily concentrated on taxes on goods and ICMS rates across activities creates an incentive for services and on payroll, which respectively account for them to offer tax discounts in order to attract mobile 43 and 24 percent of the tax burden. Income taxation economic activities. This type of tax competition makes up only 8 percent of total tax revenue, which is an extremely distortive instrument of regional is relatively low when compared to OECD average, development, as firms will choose their location based and taxes on property or wealth account for even on tax benefits instead of allocating production where less.60 This regressive structure harms the poor, who it will be the most efficient.61 The basis for this “fiscal spend a higher share of their income on consumption. war” would disappear if indirect taxes followed the 60  Gobetti and Orair, 2016. 61  Appy, 2015. destination principle and tax base and rates where Finally, the changing nature of work calls for the 25 harmonized across states, eliminating the possibility reform of payroll taxes to incentivize formal and T HE BR AZIL OF T HE F U T U R E for states to give special treatment to some activities. stable labor relationships. Taxes that are not directly This is achieved with the current tax reform proposal. related to contributory benefits for the employee should Such a reform would have the additional benefits be removed from the payroll and transferred to other of allowing local governments to focus on more tax bases in a revenue neutral way.64 Social security productive approaches to reginal development, rather contributions could be reduced and compensated by than engaging in beggar-thy-neighbor tax competition. an increase of contributions of favored categories such as autonomous workers and the upper tier of There is also room to make Brazil’s personal income the current beneficiaries of the “microentrepreneurs” tax more progressive. Simply raising personal income special regime, on a revenue-neutral basis. These tax rates for the richest taxpayers would have little measures can establish a clear connection between effect on fighting inequality in Brazil, since the main the value of the contributions levied on payroll and sources of income for the wealthy, such as income the benefits received by formal workers. Without this accruing to business owners, dividends and earnings connection, payroll contributions are only seen as one from financial applications, are currently tax exempt.62 more tax used to finance government expenses, which Hence, the country should harmonize income taxation disincentivizes work formalization, as workers will see across different tax bases – personal, capital and no benefit in being a formal employee.65 corporate income – to avoid incoming shifting. Profits should not only be subject to corporate income taxes, but should also be taxed at the personal level, after discounting the taxes paid inside the firm. Moreover, tax differences between labor and capital earnings should be mitigated.63 62  Gobetti and Orair, 2016. 63  For example, Gobetti and Orair (2016) suggest the adoption of a dual model, used in Scandinavia and Chile, where normal capital returns would be taxed at the business level using corporate income taxes, while super-normal returns would be taxed at the individual level using dividend taxes. As a reference to compute normal returns, one could use the SELIC rate together with methods currently used to compute interests on private capital (World Bank, 2018). 64  Gobetti and Orair, 2016, 2019., World Bank 2022b. 65  Appy, 2015. 26 T HE BR AZIL OF T HE F U T U R E 3. Building an inclusive social contract A new social contract will both require and enable Among several aspects of state-society interaction the participation of all Brazilians. Allowing more in Brazil, three appear central to improving the way Brazilians to contribute to Brazil’s economy can successive governments respond to citizen demands. make Brazil a more prosperous and inclusive society First, political promises in recent times have for the in the next 20 years. This will require overcoming most part focused on additional government spending, the historical legacy of exclusion, rooted in its early with less focus on reforming institutional design and development model, including a long experience with implementation mechanisms, including the incentives slavery. However, in recent decades, politicians have to increase the quality of policies by implementing tended to focus more on short-term benefits for stakeholders. Second, politicians often focus on narrow organized interest groups rather than reforms short-term benefits for individuals and well-organized and investments in public goods that take years to groups, rather than on long-term investments in public yield benefits to a broader public. The result has too goods and complex reforms that take years to mature. often been policy choices that fail to address or even Third, politicians have been too reluctant to challenge worsen social, economic, and political inequalities. the power of well-positioned interest groups that can easily capture large chunks of public spending, and Building social trust and civic capacity would often belong to the institutions that require renewal increase alignment for reforms associated with a to yield better results. The result is that politicians more inclusive social contract. Greater trust makes have only a narrow set of policy choices to respond to collective action easier and strengthens the bonds of pressures from citizens, and they do so in ways that citizenship (solidarity) that can move people to accept exacerbate social, economic, and political inequalities changes and costs (e.g., taxes) that improve the lives in Brazilian society. of others and serve them well in an uncertain future. Organizations and institutions that facilitate solving One of the keys to building trust is creating incentives collective action dilemmas, that reduce mistrust, for trustworthy behavior. First, judicial and public and that enhance civic behavior are all important to sector reforms can reduce the power asymmetries that progressively strengthening Brazil’s social capacity to reduce trust in the public and private sectors. These address future challenges. This implies a key role for reforms should give firms and citizens predictable and government agencies but also for nongovernmental rapid judicial and administrative resolutions of their organizations and the private sector. disputes with each other and with government. Second, information asymmetries can be addressed by requiring public sector agencies to carefully communicate the particularly important to build a shared narrative and 27 decisions they make and take responsibility for those understanding of the benefits of particular reforms. T HE BR AZIL OF T HE F U T U R E decisions and their consequences. Third, governments This is particularly needed for alignment towards should integrate concerns about trust, citizenship, and polices that will benefit future generations. inclusion into their programs by advancing reforms that build trust, such as digital transformation in the Strengthening society’s understanding of the administration of fiscal policy, uniform administration challenges brought by future megatrends, and their of tax and regulatory policies, and multistakeholder or cross-cutting impacts, can enhance the sense of citizen engagement platforms. urgency for comprehensive reforms. The sudden Covid-19 crisis resulted in large parts of Congress Providing states and municipalities with governance acting in unity to finance broad-based support to nearly and accountability mechanisms is particularly half of the population, through the temporary safety important to support improvements in public net Auxilio Emergencial. The program included many services. As Brazil relies on local governments to atypical non-poor beneficiaries, such as middle class deliver key public services—such as primary and self-employed, who never registered in Cadastro Unico secondary education, healthcare, and social work— before. Arguably, the experience had lasting impacts the quality of local bureaucracies matters for many on a highly contested issue: the size of the permanent of the services that constituents care the most safety net for the poor. The new Bolsa Familia program about. However, efforts by the federal level are often will be significantly larger than it was before the Covid lost at the local level, as municipal institutions are crisis—this can support inclusion if it remains fiscally more vulnerable to capture by political interests affordable, and this can be achieved through better and other distortionary interventions.66 Compared design of its benefit formula and by consolidating it with with peers such as Argentina and Colombia, Brazil other benefits. Similarly, many reforms recommended is usually regarded as having successfully created a here, require a broad understanding of facts and risks professional cadre of federal bureaucrats capable of associated with the future, and of their cross-cutting implementing complex economic and social policies. nature in society, including climate change and the However, at state and municipal level, bureaucracies benefits of investing in disaster preparedness. tend to be more politicized and heterogeneous. For instance, political appointment of principals in local schools leads to lower performance than in schools that use meritocratic technical standards. Corruption at municipal level in Brazil can also be curbed by tools that make information more accessible and scrutiny by communities less costly.67 Spaces should be opened for civic participation and representation by historically excluded groups, to support reforms that need broad-based coalitions. This process starts with strengthening bodies and spaces that allows the vulnerable middle class and the poor, those displaying the lowest levels of interpersonal trust in our assessment, to improve their social capital and ability to contribute. Philanthropy and transparent public financing of institutions that provide services to the vulnerable, including grass roots institutions that give them voice, are thus important to rebuild social capital foundations lacerated by historic inequalities. Political engagement of institutions that citizens at the margin of the social contract trust is 66  See Colonnelli, Prem, and Teso (2020) and Rougier, Combarnous, and Fauré (2021). 67  Ferraz and Finan 2008, 2011; Brollo and Nannicini 2012; Brollo et al. 2013; Casselli and Michaels 2013; 28 T HE BR AZIL OF T HE F U T U R E 4. Four alternative futures for Brazil Four alternative futures for Brazil are conceivable. Without reforms, Brazil is likely to stagnate. Scenario lays out a narrative of how history could play out by 2042 in a reform that makes no progress on inclusion, productivity or sustainability.   SCENARIO 1: A low-level equilibrium: limited productivity and inclusion, environmental degradation Continuing adherence to the old style of governing and a rejection of fundamental reforms between 2022-2042 produced a dismal outlook for Brazil. Following years of highly uneven service delivery and low job creation in the informal sector, the country is now approaching a new state of crisis. The rich kept getting richer, and with inequality reaching new peaks, there is strong unrest in the society, and the population seems to have lost faith in government and policymakers. The middle class and the poor are fed up with the lack of progress, the diminishing job opportunities, and the rise in inequality, jointly making them much more susceptible to populism and clientelist policies. Brazil continued specializing in agricultural production. The “arc of deforestation” continued to expand into the Amazon, with ongoing deforestation destroying many natural habitats. After the first tipping point had been reached in the 2030s, droughts affecting agriculture and power supply became much more frequent. Given Brazil’s heavy reliance on hydropower, the consequences have been severe for the entire population. The poor are disproportionately affected and experience frequent blackouts, which further worsens their precarious situation. Job creation is low and tends to be in the informal sector, adding to crime, insecurity, and extreme poverty. Since the economy remained weak and unproductive for many years, shocks—from global commodity markets, natural disasters, and internal political tensions—have disproportionate effects on the poor. Mass protests became more frequent, leading to violence, destruction of wealth, and spreading fear. The government tries to appease the voters by borrowing on international credit markets, but unreformed pension obligations and rising interest rates nullify these attempts. The debt has reached unsustainable levels, and a shock to any part of the budget could now trigger default.   SCENARIO 1: continue 29 T HE BR AZIL OF T HE F U T U R E The fourth industrial revolution, which advanced in many countries but Brazil, has left Brazil on the outskirts of the developed world. Given the proliferating informal sector and corrupt political elite, the country has become a haven for illegal, unsustainable, and otherwise questionable forms of business, which further depletes its natural resources and makes it unappealing for outside investments in innovation. These trends have weakened Brazil’s position on international markets and left it mostly isolated from emerging economic opportunities. Inclusion is critical for Brazil to become a more equitable society. However, without productivity growth there are limits to progress. This is expressed in a second scenario for 2042, in which reforms focused on critical areas such as better social protection. However, without the demand for workers, there are limits to poverty reduction and the middle class becomes more precarious. Transitioning away from an extractive growth model is more difficult in a stagnant economy and Brazil remains uncompetitive and struggles to integrated into global value chains.   SCENARIO 2: Progress on inclusion without productivity gains Following the Brazilian government’s far-reaching measures to strengthen inclusion, education, and service delivery, the initial buzz among the population has subsided. Continuous efforts to ensure more equal spending of taxes and to keep debt sustainable strengthened the social contract but were insufficient to stimulate productivity reforms. Brazil’s focus on redistribution from the rich to the poor is not enough to operate in a highly technological and productive world without serious upgrades to the economy. The lack of progress on structural reforms and modernization kept the old status quo and old institutional relationships that continue to block far-reaching societal transformation. While some Brazilians have benefited from the new inclusive policies, they are disillusioned about their country’s prospects. Combined with geographic inequality, since productivity gains are concentrated mainly in urban regions, social stability is not guaranteed. Over the two decades, education has improved for most people in the country, but the lack of growth still means that the demand for skilled labor is low. Overall, the labor market paints a mixed picture: domestic skill premia have fallen, jobs have grown modestly, inequality has fallen but overall wage growth remains constrained. Since productivity gains have been limited to a few sectors, many well- educated workers are forced into low-skilled jobs, enhancing the vulnerability of the middle class and increasing frustration. Low rates of technological innovation and productivity growth did not make Brazil more competitive on international markets, leaving it in the backwaters of international supply chains. Brazil remains a low- tech commodity-exporting economy. The strong continued focus on commodity exports meant that pressures on the “arc of deforestation” in the Amazon continued. Yet Brazil’s more inclusive and trusting society feels a joint responsibility for protecting its public goods, including its exceptional biodiversity, while contributing positively to the global climate change agenda. This has translated into stronger institutions to protect the Amazon and made Brazilians more sustainable consumers, somewhat attenuating deforestation. Yet without the gain in productivity, Brazil does not manage to leverage its opportunities in green value chains, outside of commodities. 30   SCENARIO 2: continue T HE BR AZIL OF T HE F U T U R E Although tipping points in the Amazon could be avoided, climate shocks remain serious and limited productivity growth constrains government revenue to invest in significant adaptation. Despite positive moves in inclusivity, education, and taxation, low productivity growth did not produce a dramatic increase in the welfare of the struggling population or promote enough change in the political climate to stimulate structural reforms. Even though the old elite has given up certain privileges and income, which is now used more productively, they are still in control of most initiatives for economic transformation. Given that the population did not gain much financial benefit from the reforms, Brazilians become less excited about the future and less trusting in formal institutions, perpetuating the environment of low reform and leaving Brazil in a state of stagnation. Productivity is critical to raise overall income and help the economy transition toward a more sustainable growth model. However, productivity alone does not necessarily foster inclusion. In the third scenario the rich disproportionately benefit from economic growth. Rising inequality in an already unequal country can eventually only be sustained through more authoritarian forms of government—or by reversing inclusion.   SCENARIO 3: Progress on productivity without inclusion and sustainability Over the two decades leading up to 2042, Brazil successfully implemented a wide variety of measures to increase productivity. The rise of a new digital age raised hopes within the population and as the economy shifted from commodities to urban production, Brazilians proudly saw Amazon deforestation gradually diminish. But this initial economic success came at the expense of slow progress on inclusion, which was neglected by several governments. The result: a deeply divided Brazil with the elites getting richer, the poor becoming ever more desperate, and the vulnerable middle class slipping into poverty—a disjointed construct held together by the remnants of its former national identity. While some Brazilians, especially among the upper middle class, enjoy higher wages due to increased productivity and accessing new opportunities such as the global digital trade in services, the cultural and economic divide between the poor and everyone else separates the population into enclaves that live in parallel realities promoted by widespread digitalization. The development of the digital economy gave rise to new technologies that are replacing unskilled labor and increasing the already extreme wage inequality. As a result, the digital space, now accessible to everyone, has fragmented into echo chambers of conspiracy theories. The disenchanted poor struggle to find jobs in the new economy, which leads to even more poverty. The elites enjoy the material benefits of the new industries developing in the South and Southeast while remaining numb to the suffering of the rest of the population in the Northern and Northeastern regions. To suppress rising discontent and maintain the discriminatory status quo, the government became more authoritarian and has been suppressing political voices offline and online—through real and digital disinformation campaigns. Besides the developing Southeast, agricultural regions like Mato Grosso are managing to move up the value chain, but poorer regions are declining, since they are not competitive, resulting in massive outmigration to the urban centers in the Southeast which, having neglected inclusion, is not prepared for the inflow of migrants. The disruption to society and rising inequality create new social tensions.   SCENARIO 3: continue 31 T HE BR AZIL OF T HE F U T U R E While the Brazilian government initially earned the political and financial support of the international community, its negligence of the poor and its authoritarian measures to quiet discontent turned many international partners away. Even though Brazil has been credited for reducing deforestation in the Amazon and has been seizing some opportunities from green manufacturing in a decarbonizing world, the government’s authoritarian tendencies have raised concerns among global consumers and investors, limiting the potential from global trade and FDI. A fourth scenario combines productivity, inclusion, and sustainability. Incomes grow for everyone, especially for the poorer parts of society. Pressures on the environment fall and a less extractive growth model combined with strong institutions to protect society’s natural wealth reverse environmental degradation. It is the scenario in which Brazil embraces technology (fostering productivity and countering the impacts of aging, without necessarily increasing inequality), integrates into global value chains, seizes opportunities from global decarbonization, and reduces emissions and turns more resilient to climate change, lowers inequality and celebrates its diversity in a vibrant democracy. It is a scenario worth celebrating on Brazil 220th anniversary.   SCENARIO 4: A high-level equilibrium: a prosperous, inclusive, and sustainable Brazil After a once highly unequal Brazil recognized the diversity of its people, heard the voices of the poor, and provided all with improved access to basic infrastructure and credit markets, the divisions between societal groups substantially diminished. As a result, the trust of the population in government institutions and each other has gradually improved and the belief in a bright shared future strengthened. This provided a solid foundation for ambitious reforms in education, the welfare state and private sector governance. Society’s longing for a prosperous and stable country has been fulfilled in recent years. With productivity growth sustained by competition and innovation, and a stronger social contract, the benefits of technological change and improved education were felt by most of the population. Although Brazil has maintained its diversity—socially, economically, and politically—the many Brazils have moved closer together. The goals of political players have become more aligned and focused on the prosperity of the nation (not just narrow interests) due to the new social norm of promoting inclusion and intergenerational equity. All this improved the business environment and raised public investment in economic and social infrastructure, making the economy more open. A newly acquired sense of stability, belonging, and community among Brazilians strengthened formal institutions through the wide support of the population and increased public support through governmental actions that increase prosperity. Brazilians today invest in themselves and into their society, with optimism about their own prospects and those of their country. By passing critical reforms that increased the returns to investing in education, introduced a more efficient and progressive tax system, and improved equity and sustainability in social protection, the Brazilian government transformed the social contract into a stable and productive relationship with the population. Critical structural reforms have led to harmonious productivity growth and technological change across the whole of society. Informality has declined significantly as the quality of jobs improved and the tax system raised the benefits of formalization. 32   SCENARIO 4: continue T HE BR AZIL OF T HE F U T U R E Political, societal, and macroeconomic improvements promoted the cycle of positive changes in many sectors of Brazilian economy. Strong job growth reduced poverty and brought much needed investments to the favelas. Fiscal accounts have improved due to a sustainable budget and stable economic growth, generating space for a range of public investments, from education to social protection to climate change adaptation. Overall, Brazilians are more educated and can apply their skills in a growing economy. They are more engaged politically, enjoy more stable economic conditions and social protection, are healthier and happier than ever. On the international stage, Brazil is now more integrated into the world economy, and its export base has considerably diversified beyond commodities. It has become an important exporter of green manufacturing goods, benefiting from the high demand for low-carbon production across the world. Brazil’s new green-energy matrix together with low land-use emissions have made it highly productive and competitive on international markets. And as a result of increased international cooperation, Brazilians are now active players in international business and global supply chains, opening new frontiers and possibilities for growth across all sectors of the economy. Brazil once again became a pioneer in fighting climate change. Strong institutions support effective carbon pricing systems, valuing natural forests and promoting economic growth based on productivity rather than resource extraction. This helped to successfully avert a tipping point in the Amazon. Brazil is an integral part of the world’s economy and ecosystems. What does the future hold for Brazil? It remains to be seen. This report will support a dialogue on the multiple 33 challenges that Brazilians have to address to achieve higher, sustained growth with greater productivity, improved T HE BR AZIL OF T HE F U T U R E inclusion and sustainability. Table 2 provides a set of policy priorities to start preparing for the best possible scenario. The challenges of implementing policies that will support these objectives should not be underestimated. Tackling them effectively demands a strong strategic vision, policy coordination and building state capacities. A key message from this report is that the future is not decided. Brazil has many opportunities, from its diversity (the many Brazils) to its economic capabilities, its ingenuity, and its exceptional natural resources. There is plenty of room for Brazilians to build the future they desire.   Table 2: Policies and reforms this report hold as priorities to build a virtuous cycle Theme Goal Priority • Optimizing design and sustainability of pensions Increase efficiency and • Optimizing design of unemployment insurance schemes progressivity of social Social & transfers • Consolidating and improving progressivity of social transfers for economic working families inclusion • Harmonizing income taxation across different tax bases and More efficient and removing exemptions for dividends and pension incomes progressive taxation • Eliminating regressive and inefficient tax exemptions • Increasing the quality of education through governance reforms, higher teaching quality and a more skill focused curriculum Place learning and skills back on the right track • Recovering learning losses that occurred during COVID-19 • Reducing dropout rates with multisectoral interventions Human capital, • Support labor market transitions and green transformation savings/ through active labor market and economic inclusion programs investment, productivity • Improve coverage and reach of lifelong learning systems Strengthen policies for longer working lives and economic • Improving workers protection through reforms of inclusion. unemployment insurance and labor benefits • Increasing the private sector’s contribution to economic inclusion through more robust diversity and inclusion policies in corporate governance structures Develop a credible fiscal • Reestablishing a credible fiscal anchor framework • Advancing regional integration and trade negotiations with the EU and other economies Economic growth and jobs • Reducing barriers to trade and investment in services Accelerate productivity, growth and job creation • Improving the business climate and promoting innovation and technological adoption • Reforming consumption taxation 34   Table 2: continue T HE BR AZIL OF T HE F U T U R E Theme Goal Priority • Preventing land-grabbing Curb illegal deforestation • Strengthening land and forest governance • Promoting sustainable forest livelihoods • Scaling-up climate-smart agriculture Resilient and climate-smart Environmental agriculture, industries, and • Decarbonizing the energy sector sustainability cities • Greening cities and their transport systems • Adopting a national emissions trading system • Considering the introduction of a carbon tax and initiating a Economy-wide interventions phaseout of subsidies to emission-intensive activities • Supporting households in managing the climate transition • Increasing the number of subnational entities that have adopted comprehensive pension reforms Better management of public sector pay and pensions • Adopting an administrative reform to narrow the wage premium and modernize the public sector’s human resource management practices Public resources • Revamping underperforming innovation policies Accelerate productivity, • Increasing the volume of financing for infrastructure to close the growth and job creation investment gap • Modernizing infrastructure and its management • Implement governance mechanisms to improve accountability Increase people’s trust in the and transparency state capacity to deliver its promises • Implement mechanisms that reduce incentives for corruption • Limit access to firearms and ammunition Increase people’s trust in the • Reduce environmental and individual risk factors for violence Social contract state capacity to keep them safe • Implement cross-section community interventions that enables conflict resolution through negotiation and nonviolent procedures • Reduce the spread of narratives build upon misinformation and fake news Reduce social fragmentation • Advance reforms that build trust, citizenship and inclusion References 35 T HE BR AZIL OF T HE F U T U R E Acemoglu, Daron, and James A. 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