Brazil Systematic Country Diagnostic - Update 1 Brazil Systematic Country Diagnostic Update JULY 2023 2 Brazil Systematic Country Diagnostic - Update Brazil Systematic Country Diagnostic - Update 3 Brazil Systematic Country Diagnostic Update 4 Brazil Systematic Country Diagnostic - Update © 2023 International Bank for Reconstruction and Development / The World Bank 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 with external contributions. The findings, interpreta- tions, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. 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Becau- se The World Bank encourages dissemination of its kno- wledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Attribution – The World Bank. 2023. Brazil Systematic Country Diagnostic Update. Washington D.C.: World Bank. Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: pubrights@ worldbank.org. Cover photos: Freepik and Shutterstock® Cover and Graphic Design: doublecom.com.br Brazil Systematic Country Diagnostic - Update 5 Contents Acknowledgements ii Abbreviations and Acronyms iii Executive Summary 1 1. Growth and welfare in the last decade 6 1.1 Growth and macroeconomic trends 7 1.2 Poverty, shared prosperity and welfare 10 1.3 A sustainable path will require policies to become a greener and resilient economy 13 2. Development challenges 16 2.1 Challenge 1: Creating opportunities for all Brazilians through a focus on  productivity-led growth and a competitive economy 19 IC1: Institutional constraints to boost productivity and a competitive economy 24 2.2 Challenge 2: Developing a people-centric strategy that increases the income  generating capacity of the poor 25 IC2: Institutional constraints to promote inclusion 29 2.3 Challenge 3: Unlocking the country’s potential as a green economy 30 IC3: Institutional constraints to pursue a greener economy 32 2.4 Challenge 4: Financing the country’s inclusive growth needs through a sustainable framework based on efficient fiscal policies 33 IC4: Institutional constraints for fiscal sustainability 35 3. Priorities and High-Level Outcomes 37 References 40 Appendix 1. A profile of the poor in Brazil 44 Appendix 2. Analytical foundations of the Systematic Country Diagnostic Update 48 Appendix 3. Reforms adopted by the Brazilian government after 2016, by chronological order 49 Appendix 4. Governance and Institutions in Brazil after SCD1 51 Appendix 5. Data and knowledge gaps about Brazil 56 6 Brazil Systematic Country Diagnostic - Update Acknowledgements We would like to thank the members of the World Bank Group’s Global Practices, the staff of the International Finance Corporation (IFC), and the Brazilian authorities, and other partners who contributed to the preparation of this Systematic Country Diagnostic (SCD) Update. This report has been prepared by a team led by Gabriel Lara Ibarra (Senior Economist), Ana Guer- rini (Senior Transport Economist) and Josefina Posadas (Senior Economist) under the leadership of Carlos Felipe Jaramillo (Regional Vice President), Johannes Zutt (Country Director) and Robert Taliercio (Regional Director), and the guidance of Carlos Rodriguez Castelan (Practice Manager), Bianca Bianchi Alves (Practice Manager), Pablo Gottret (Practice Manager), Doerte Doemeland (Practice Manager), and Sophie Naudeau (Operations Manager). Additional guidance was provi- ded by Manuel Reyes-Retana (Director, IFC) and Hiroyuki Hatashima (Chief Evaluation Officer, MIGA). The team thanks Pablo Acosta (Program Leader) and Luis Alberto Andres (Sector Leader) for their comments and contributions. Special recognition goes to Shireen Mahdi as the lead au- thor of the Brazil Policy Notes that served as testing grounds for the prioritization exercise that informed this update. Sector-specific knowledge, inputs and contributions were provided by Arthur Braganca (Senior Economist), Werner Kornexl (Senior Natural Resources Management Specialist), Carolina L. Vaira (Senior Governance Specialist), Gustavo Covolan (ET Consultant), Renzo Lavin (Consultant), Bru- no Perdigao (ET Consultant), Diogo Bardal (Associate Operations Officer), Marcos Vaena (Senior Strategy Officer), Fabiano Colbano (Senior Economist), Raphael Fernandes (Consultant), Marek Hanusch (Lead Economist), Luigi Calderon (Economist), Michael Weber (Senior Economist), Clau- dia Tufani (Consultant), Otavio Conceição (ET Consultant) and Ricardo Campante Vale (ET Con- sultant). This Update strongly benefited from the evidence collected by other colleagues’ analyti- cal reports on various development-related areas in the past year. Their findings and availability to answer our queries were important inputs to this Update. We thus would like to thank Gabriel Zaourak (Senior Economist), Ildo Lautharte (Economist), Matteo Morgandi (Senior Economist), Tiago Falcao Silva (Senior Social Protection Specialist), Diji Chandrasekharan Behr (Lead Environ- mental Economist), Stephane Hallegatte (Senior Climate Change Adviser), Anna Luisa Paffhausen (Economist) and Rita D. Costa (Consultant). The team would like to thank the peer reviewers Antonio Nucifora (Practice Manager), Rafael Muñoz Moreno (Lead Country Economist) and Samuel Freije (Lead Economist) for their insightful comments and suggestions. The team is grateful to Desiree Gonzalez (Program Assistant), Mirela Catuneanu (Operations Analyst) and the Country Office Administrative and Client Support staff for all the assistance and support in the preparation of this SCD Update. Brazil Systematic Country Diagnostic - Update 7 Abbreviations and Acronyms ABC plan Plano de Agricultura de Baixa Emissão de Carbono (Low-Carbon Emissions Agriculture Plan) ABEMA Associação Brasileira de Entidades Estaduais de Meio Ambiente (Brazilian Association of State Environmental Entities) AE Auxilio Emergencial (Emergency Aid) ALMP Active labor market programs B40 Bottom 40 percent BCB Banco Central do Brasil (Central Bank of Brasil) BPC Benefício de Prestação Continuada (Continuous Cash Benefit) BRIC Brazil, Russia, India, China BRL Brazilian Reais (the official currency of Brazil) BTI Bertelsmann Stiftung’s Transformation Index CADE Conselho Administrativo de Defesa Econômica (Administrative Council for Economic Defense) CAR Cadastro Ambiental Rural (Rural Environmental Registry) CGU Controladoria Geral da União (Office of the Comptroller General) CICC Comitê Interministerial de Combate à Corrupção (Inter-ministerial Committee of Corruption Fight) CO2 Carbon dioxide COFINS  Contribuição para o Financiamento da Seguridade Social (Contribution for the Financing of Social Security) CPI Consumer Price Index DETER Real-Time Deforestation Detection System Embrapa Empresa Brasileira de Pesquisa Agropecuária (Brazilian Agricultural Research Corporation) FGV-IBRE Fundação Getúlio Vargas – Instituto Brasileiro de Economia (Getulio Vargas Foundation – Brazilian Institute of Economics) FPE Fundo de Participação dos Estados (State Participation Fund) FPM Fundo de Participação dos Municípios (Municipal Participation Fund) GDP Gross domestic product GHG Greenhouse gas GtCO2 One billion tonnes of carbon dioxide HLO High-level outcomes HRM Human Resource Management IADB Inter-American Development Bank IBGE Instituto Brasileiro de Geografia e Estatística (Brazilian Institute of Geography and Statistics) ICMS Imposto sobre Operações relativas à Circulação de Mercadorias e sobre Prestações de Serviços de Transporte Interestadual e Intermunicipal e de Comunicação (Tax on Interstate and Intermunicipality Transactions of Goods, Provisions of Services and Communication) ICT Information and communication technology IDEB Índice de Desenvolvimento da Educação Básica (Basic Education Development Index) IMF International Monetary Fund INPE Instituto Nacional de Pesquisas Espaciais (National Institute of Spatial Research) 8 Brazil Systematic Country Diagnostic - Update IP Indigenous people IPI Imposto sobre Produtos Industrializados (Tax on industrialized products) IPR Intellectual Property Rights ISS Imposto sobre Serviços (Tax on services) LAC Latin America and the Caribbean LPI Logistics Performance Index MEI Microempreendedor Individual (Individual microentrepreneur) MSME Micro, Small and Medium Enterprises Mt Megatonne NDC Nationally determined contributions NTM Non-tariff measures OECD Organization for Economic Cooperation and Development PBF Programa Bolsa Familia (Bolsa Familia Program) PIM Public Investment Management PIMA Public Investment Management Assessment PIS Programa de Integração Social (Contribution to the Social Integration Program) PISA Program for International Student Assessment PJ Pessoa Jurídica (Legal person) PNL Plano Nacional de Logística (National Logistics Plan) PNMC Plano Nacional sobre Mudança Climática (National Plan about Climate Change) PPCDAm Plano de Ação para Prevenção e Controle do Desmatamento na Amazônia Legal (Plan for the Prevention and Control of Deforestation in the Legal Amazon) PPP Purchasing power parity PRODES Projeto de Monitoramento do Desmatamento na Amazônia Legal por Satélite (Project for Monitoring Deforestation in the Legal Amazon by Satellite) PTA Preferential Trade Agreement R&D Research and Development REDD+  Reducing Emissions from Deforestation and Forest Degradation in Developing Countries, and the Role of Conservation, Sustainable Management of Forests, and Enhancement of Forest Carbon Stocks in Developing Countries SCD World Bank Systematic Country Diagnostic SCD1 World Bank Systematic Country Diagnostic 2016 SEBRAE Serviço Brasileiro de Apoio às Micro e Pequenas Empresas (Brazilian Micro and Small Enterprises Support Service) SINE Sistema Nacional do Emprego (National Employment Service Office) SME Small and medium enterprises SOE State-owned enterprises SUS Sistema Único de Saúde (Unified Health System) TFP Total factor productivity TVET Technical and vocational education and training USD United States Dollars (currency) VAT Value-added tax WEF World Economic Forum Brazil Systematic Country Diagnostic - Update 1 Executive Summary After rebounding from an average which contrasts with a significant negative growth in 2014-2019 and progress in poverty reduction ob- the pandemic, Brazil’s economic served until 2013. Income inequality growth remains far below its peers. is also highly persistent. From 2001 to Brazil’s gross domestic product (GDP) grew on 2012, poverty was cut in half, and around 27 average by 3.3 percent annually in real terms million Brazilians were lifted out of poverty between 2001 and 2014 propelled by the inter- thanks to economic growth, increased labor national commodities boom and the domestic formalization, and the expansion of social poli- expansion of social programs, among other cies. However, after 2014, the crisis led to stag- things. However, falling commodity prices, po- nant income growth among the poorest and litical instability, and unaddressed structural little progress in poverty reduction. COVID-19 challenges led to an economic recession that emergency measures cushioned the effects of the pandemic on poverty, but by 2021 po- began in 2014 and from which the country has verty rates were still higher than in 2019 (28.4 yet to recover. Real GDP growth fell to an ave- percent and 26.2 percent, respectively). Brazil rage of -0.3 percent between 2014 and 2019. is still one of the most unequal countries in Productivity has remained stagnant in the ma- the world. With a Gini coefficient of 0.529 in nufacturing and many services sectors, where 2021, Brazil’s income inequality is as high as it over 90 percent of the workforce is employed. was in 2011. At the same time, the wealthiest The COVID-19 pandemic further impacted the 1 percent own almost half of the country’s economy, causing a contraction of 4.1 percent household wealth. Disparities across regions, in 2020. Growth turned positive in 2021 and particularly between the poorer North and the 2022, but potential growth is expected to re- richer South, are evident. Female-headed hou- main at a low 2.1 percenti, far below peers such seholds, Afro-Braziliansii, and Indigenous peo- as China, India, Türkiye, and Russia. ple (IP) are overrepresented among the poor, and they face worse labor market outcomes Poverty rates in 2022 are projected and enduring wage gaps (even within compa- to be at the same level as in 2014, rable sectors and skills). 2 Brazil Systematic Country Diagnostic - Update Brazil needs to revisit its develop- fiscal policy and growth model if the country ment model to halt deforestation was to sustain the gains of previous years.iii and be able to confront environmen- The country’s fundamental weaknesses relate to its struggle to generate strong and sustai- tal challenges due to the high risks ned broad-based productivity growth across posed by climate change. Similar to sectors and the (un)sustainability of public other countries in the Latin America and the spending commitments. Given the intrinsic Caribbean (LAC) region, land use change is the linkages of the bottom 40 percent to natural key driver of greenhouse gas (GHG) emissions assets, SCD1 also highlighted the need to im- in Brazil. However, the magnitude of deforesta- prove Brazil’s environmental impact, including tion significantly surpasses that of other coun- the management of land and water resources. tries, reaching 11,568 km2 in 2022. The Amazon rainforest alone, of which about 60 percent lies This SCD update argues that the in Brazil, delivers ecosystem services valued at development challenges identified a minimum of USD 317 billion a year to Brazil in SCD1 remain relevant. Moreover, and the world. Deforestation puts these servi- ces at risk, especially if a tipping point is trigge- there is a renewed urgency to build red and results in the permanent dieback of the the capacity of individuals to gene- Amazon. The country also faces significant, rate income and a reinforced need recurring, and increasing losses from climate for timely action in a transition to a -related events: in 2019, reported losses were greener economy. SCD1 identified three over BRL 22 billion, almost twice the long-term key requirements for Brazil to achieve the twin average of BRL 13.3 billion. Droughts are the goals: i) creation of sufficient productive and costliest hazard, followed by flash floods and well remunerated jobs to provide opportunities riverine floods. These events impact agribusi- for all Brazilians; ii) smarter management of ness, the energy sector (substantially relying Brazil’s natural resources and better mitigation on hydro energy), and rural areas, but also dis- of environmental pollution and the risk of natu- proportionately affect the rural poor, who have ral disasters; and iii) more efficient and better few options to protect themselves from natural targeted government spending. The Update builds on the evidence collected in a long se- hazards, and the urban poor, particularly those ries of recently published analytical reports to living in informal settlements. review the challenges identified in SCD1 and in- form the definition of the Update’s challenges. Brazil’s structural challenges to era- The first requirement is complemented by the dicate poverty and boost shared definition of another challenge so that not only prosperity identified in the World the need to have productive jobs is highlighted, Bank Systematic Country Diagnos- but also the poverty-reduction prerequisite of tic 2016 (SCD1) came to bear with building the income-generating capacity of all the end of the commodity boom. individuals (through human, natural, and finan- SCD1 showed how the drivers of socioeconomic cial capital) is explicitly stated. The third requi- progress in the 2000s had gone in reverse by rement is also expanded to underscore Brazil’s 2015. With commodity prices trending down, need to address increased exposure to climate Brazil found itself in great need of adjusting its change risks in a timely manner. Brazil Systematic Country Diagnostic - Update 3 The SCD1 documented that the pri- COVID-19 crisis further exposed the mary obstacle to increasing Brazi- vulnerability of Brazilian households lians’ incomes is the country’s lo- to shocks. The gains of earlier years in hou- w-productivity economic model in seholds’ income-generating capacity have not non-agricultural sectors. This challenge, been reproduced. SCD1 highlighted key achie- reflected in Brazil’s bias in employment crea- vements in widening access to public services tion in low-productivity services and low gro- for the poor and deprived: completion rates wth in total factor productivity (TFP) (1.3 per- of basic (primary plus lower secondary) edu- cent per year on average between 2006 and cation increased by 20 percentage points to 2014)IV, had several underlying causes. Among close to 70 percent, infant and maternal mor- them, SCD1 documented the high costs of tality decreased significantly (70 and 50 per- doing business, the poor state of physical in- cent, respectively) in the previous two decades frastructure, and the limits to competition due and access to power supply, drinking water to heavy regulation and relatively high tariff and sanitation improved. Limited gains have and non-tariff barriers against imports. occurred since then. In 2019, one-fifth of Bra- zilians are classified as chronically poor due As Brazil’s factor accumulation-ba- to their lack of basic assets to leverage their sed growth model reaches its limits, income – this share was 23 percent in 2012. the country stands a lot to gain from While access to education improved, its qua- boosting productivity growth. Brazil lity remains a concern, as the average student reached its upper-middle income status on the has low performance in both national and in- back of factor accumulation. Currently, this ternational assessments. The pandemic fur- approach delivers only limited growth, as de- ther worsened learning outcomes and inequa- mographic tailwinds are fading, low domestic lity due to school closures and higher dropout savings constrain capital formation, and land rates, which will have long-lasting consequen- accumulation manifests in deforestation. Bra- ces on the future productivity of children. It is zil needs higher savings and investment rates, now estimated that it may take up to 13 years and its future prosperity will hinge on its ability to recover the human capital losses caused by to raise productivity growth. Yet, total factor the pandemic. Access to relevant skills for the productivity has been falling by 0.8 percent job market, especially in science, engineering, between 2014 and 2022, especially in the non- and technology fields, is limited, and there are commodities sectors. While in the past agri- gender gaps in these areas. Higher education culture and mining achieved high productivity enrollment is still highly dependent on family gains, other sectors, especially manufacturing, income, reinforcing inequality. There are still fared much worse, reflecting a model where gaps in basic access to health services and primary sectors are export-oriented while ma- sanitation. Land tenure is unequally distribu- nufacturing is inward-oriented. ted, with high insecurity affecting low-income individuals. While financial inclusion has im- With a fifth of the population in chro- proved, certain groups still struggle to access nic poverty before the pandemic, the financial assets. 4 Brazil Systematic Country Diagnostic - Update Deforestation and agriculture are the go to the poor”. SCD1 documented that less main contributors to Brazil’s emis- than 15 percent of expenditure was discretio- sions. The country must confront nary in BrazilVI while recent estimates suggest it is now closer to 10 percent. Factors such as head-on the challenge of curbing de- public sector pay and pensions, and increased forestation. When SCD1 was completed, demand for social protection spending, con- Brazil stood out for its contribution to climate tinue to strain public finances, leaving limited change mitigation due to its success in reducing space for discretionary and much-needed in- deforestation: yearly deforestation dropped 82 vestment spending. The country’s tax sys- percent between 2004 and 2014, before in- tem, highly reliant on consumption of goods creasing again after the end of the commodity and services, offers opportunities for more super-cycle. Political pressure on environmental progressive taxation and increased efficiency. protection mechanisms intensified, and some The highly complex tax system is also an im- interest groups were effective in lobbying to portant contributor to the high costs of doing the easing of regulations on environmental pro- business in Brazil known as “Custo Brasil”. The tection. The lack of law enforcement in remo- intergovernmental transfer system needs re- te areas has exacerbated the issue, and weak vamping to address horizontal gaps between governance and financial constraints have hin- states. Several subnational governments are dered climate action efforts. Brazil’s institutio- facing a fiscal crisis, yet states and municipali- nal capacity for climate policies has gaps, and ties are responsible for the front-end provision there is a need of better coordination between of basic services to the population, such as government agencies and more enforcement education and health. Comprehensive admi- of environmental laws.V Weak management of nistrative reform is needed, focusing on fiscal natural resources had been flagged by SCD1 aspects, governance, and the quality of public as a challenge. Today, modernization of land service delivery. registration practices and incentives for more sustainable land use are crucial to address the Tackling these challenges must be country’s environmental needs. accompanied by improvements in governance and a complemen- Structural fiscal reforms, including tary removal of institutional cons- addressing persistent structural traints. Key legislation has been adopted spending issues and improving the in recent years, including the state-owned tax system, will be critical for the enterprises statute (2016), aimed at aligning country to find ways of creating state ownership practices with international space to support higher and more standards, the fiscal rule (2016), the labor le- inclusive growth. SCD1’s assessment of gislation reform (2017), the political reform public finances remains valid today: “revenues (2017), which gradually established more ri- [have a] high reliance on indirect taxes… [and] gorous criteria for political parties to have the share of truly discretionary spending… is access to electoral party funds, form coali- very low… [while] the bulk of spending is tied up tions and achieve a “performance clause”, and in social commitments... many of which do not the pension system reform (2019). Moving Brazil Systematic Country Diagnostic - Update 5 forward, there are additional reforms needed The Update identified four develop- to address the four development challenges. ment challenges that must be over- From opening up to trade and promoting in- come, which are linked to three de- novation to raise productivity, to enhancing sired High-Level Outcomes (HLOs). teachers training and a more skill-focused These outcomes, reflecting transformative educational system to boost human capital, changes that are critical to achieving the twin to improving forest monitoring and law en- goals, are defined as long-term sustained im- forcement to curb deforestation, to impro- provements in the well-being of the poorest ving the tax system and addressing human and most vulnerable. The HLOs are i) increa- resources challenges in the public sector to sed access to high quality job opportunities; ii) increase fiscal space. This update places the improved households’ accumulation and use of agenda of institutional reforms as a cross- productive assets; and iii) reduced vulnerability cutting priority for Brazil. to climate shocks. Table 1. SCD1 requirements to achieve the twin goals and challenges identified in the Update Requirements to achieve Development Challenges twin goals in SCD1 in SCD update Pursue productivity-led growth and a competitive economy Productive and well remunerated jobs Increased capabilities and income- generating capacity of the most vulnerable Smarter management of Meeting potential in green and Brazil’s natural resources climate friendly development More efficient and better Sustainable financing of inclusive growth targeted government spending Source: World Bank. 6 Brazil Systematic Country Diagnostic - Update 1. Growth and welfare in the last decade Brazil Systematic Country Diagnostic - Update 7 1.1 Growth and macroeconomic trends Following a strong growth momen- Productivity growth has been con- tum in the decade prior to 2014, Bra- centrated in primary sectors; but zil’s growth turned negative between was absent in manufacturing and 2015-2019 due to negative produc- services. Agriculture experienced strong gro- tivity growth. Brazil’s GDP grew on avera- wth in labor productivity between 1994 and ge by 3.3 percent annually in real terms bet- 2019, performing as well or better than many ween 2001 and 2014, powered by ambitious peers (Figure 1). This contrasts with weak labor structural reforms in the 1990s, the global productivity growth in services and manufactu- commodities super-cycle and strong external ring where Brazil was majorly outperformed by demand, coupled with a private consumption peers in other regions, like China, Türkiye, and increase supported by the expansion of so- India. This uneven sectoral productivity perfor- cial programs, minimum wage policy, a lower mance constrains Brazil’s development as com- unemployment rate (from 12.9 percent in the modities sectors contribute for a relatively small beginning of 2002 to 4.6 percent at the end share of both GDP and employment while put- of 2012) and increasing formal employment ting pressure on the country’s natural wealth. (growing 5 percent annually between 2003 and 2014).7 However, the combination of falling The economy rebounded quickly commodity prices, political instabilities, higher from the pandemic-induced reces- interest rates aimed at controlling inflation, sion, supported by a strong fiscal sti- and unaddressed structural challenges led mulus. Brazil’s GDP was still recovering from the country to an economic recession in 2015. the 2015-16 recession when it was hit by the Brazil experienced negative 0.3 percent ave- COVID-19 crisis, contracting 3.3 percent y/y in rage growth in the 2014-2019 period, as the 2020. The unemployment rate soared to 14.9 factor accumulation-based growth model was percent by March 2021, and Brazil experienced running into constraints, and negative produc- the world’s fourth highest death per capita tivity growth wiped out the gains from capital rate.8 Growth reached 5 percent in 2021 and and labor (Figure 1). 2.9 percent in 2022, propelled by a success- 8 Brazil Systematic Country Diagnostic - Update Figure 1. Growth and macroeconomic trends a. GDP growth rates between 1994 and 2022 (%) b. Factor contribution to growth (%) 2012-2019 8 tFp 6 1.27 4 Capital 0.39 2 0.27 0.82 Labor 0 human Capital -2 -2.21 gdp growth -4 c. Gross debt of Brazil and peers in 2021 (% of GDP) india 84.2 Brazil* 80.3 emerging market and middle-income La 72.2 China 71.5 south africa 69.0 Colombia 64.6 mexico 57.6 poland 53.8 türkiye 41.8 Low-income developing Latin america 41.4 peru 36.4 Chile 36.3 Russian Federation 17.0 d. Value added per worker in Agriculture, Services and Manufacturing for Brazil and comparator countries agriculture services manufacturing 14,000 40,000 40,000 12,000 10,000 30,000 30,000 8,000 6,000 20,000 20,000 4,000 10,000 10,000 2,000 0 0 0 Brazil Türkiye Mexico China India Source: a) World Development Indicators; b) World Bank (2022c); c) IMF Fiscal Monitor Data. Brazil’s gross debt from Central Bank (BCB) using official methodology; d) WDI. Notes: LA = Latin America. Brazil Systematic Country Diagnostic - Update 9 ful vaccination campaign, pent-up demand for and higher-than-expected revenue supported services and fiscal stimulus.9 Moreover, labor by inflation effects, the growth of the Brazilian market restoration after the COVID aftermath economy and elevated commodity prices led has been substantial, as the unemployment to significant fiscal consolidation in 2021 and rate declined to 7.9 percent by December 2022, 2022. Brazil reached a primary surplus in both the lowest unemployment rate since February 2021 and 202216, while the general govern- 2015 (7.5 percent). However, elevated food, fuel ment’s gross debt decreased to 72.9 percent and energy prices partly due to booming inter- of GDP in 2022 – a share lower than the 74.4 national commodity prices, bottlenecks in glo- percent of GDP from 2019.17 While important bal supply chains, and a depreciated exchange debt management reforms have significantly rate have pushed CPI inflation up to 10.1 percent reduced the government’s debt exposure to ex- in 2021 and 5.8 percent in 202210. Banco Central change rate and rollover risks,18 Brazil pays the do Brasil’s (BCB) proactive stance in raising in- highest interest bill – in terms of GDP and sha- terest rates (reaching 13.75 percent in Septem- re of spending – of any country in LAC, given ber 2022)11 and other measures to reduce fuel its relatively high public debt level (Figure 1).19 taxes helped reduce inflation further in 2023.12 Since the last SCD, Brazil has im- Despite the recent adoption of im- plemented other key reforms. Bra- portant reforms, steady growth in zil enjoys a sounder and more stable finan- cial sector because of the recently approved recurrent and rigid spending still cro- financial sector reforms that helped boost wds out critical public investment competition in financial markets and promote and poses challenges for long-term financial inclusion and market access.20 Other debt sustainability. In the post SCD1 pe- advancements include increased labor flexibi- riod, large public sector pensions and wage bill lity and reduced litigation costs introduced by payments continued to contribute to an ele- the labor reform in 2017 and the openness to vated public debt level13 (from 51.5 percent in competition and private sector participation 2013 to 69.8 percent of GDP in 2016) and led in key infrastructure sectors (water and sa- the government to approve a ceiling on fede- nitation, telecom, and energy). These reforms ral primary expenditures in 2016.14 Public debt are already paying dividends. In the sanitation kept raising to 75.3 percent of GDP in 2018 sector, for instance, investments committed before starting to gradually decline in 2019. for the following years after the new law pas- Payroll and pensions continued to increase, sed are currently estimated at BRL 100 bil- though at slower pace due to a freeze of public lion, above the level observed between 2016 salaries and the approval of a pension reform and 2020 (BRL 86 billion). Most recently, the in 2019. In 2020, when the country was hit by Central Bank independence law, approved in the pandemic, the spending cap rule was wai- February 2021, reassures the conduct of mo- ved to allow for the COVID-19 response.15 Ho- netary policy away from external interferen- wever, the compliance with the ceiling fiscal ces, allowing it to tame inflation in the me- rule, the rollback of COVID-related expenses, dium term and reduce risk premiums. 10 Brazil Systematic Country Diagnostic - Update 1.2 Poverty, shared prosperity and welfare The long-term decrease in poverty families became more dependent on documented in SCD1 came to a halt public transfers. Despite the historical eco- with the 2014 crisis. Estimates relative nomic collapse of 2020, poverty rates in Bra- to the first decade of the 2000s indicate a si- zil decreased from 26.2 percent in 2019 to 18.7 zable reduction in poverty: between 1999 and percent in 2020 thanks to the Auxilio Emergen- 2012, about 27 million Brazilians escaped from cial (AE) program that provided cash transfers poverty.21 Such a reduction is considered an amounting to 3.9 percent of the GDP. Brazil achievement of regional significance, represen- thus stood out as one of the few countries in ting half of the reduction in poverty in the who- which poverty did not increase at the onset of le LAC region during the period. Poverty rates the COVID-19 pandemic. In the LAC region, po- decreased only slightly after the 2014 crisis: verty went up by 1.2 percentage points between from 28.2 percent in 2012 to 26.2 percent in 2020 and 202123. In 2021, the Brazilian economy 2019. Extreme poverty rate, in turn, rose from bounced back, but the labor market was still 4.5 to 5.4 percent between 2012 and 2019 (Fi- struggling: the unemployment rate decreased gure 2.a).22 Combining the pre-crisis, crisis and by only 0.6 percentage points. Thus, the signi- recovery periods (i.e., 2012-2019), the real inco- ficant reduction in the coverage and benefits of me of the average Brazilian grew by an average AE led to an increase in poverty to 28.4 percent. of 1 percent annually while that of the poorest Indeed, non-labor income is estimated to be the 40 percent went up by only 0.6 percent. More main factor driving poverty dynamics in 2020- worryingly, the poorest decile’s income decrea- 2021 (Figure 2.b). The diminishing role of labor sed by an average of 1.1 percent yearly. income in families’ livelihoods was accompanied by income volatility24 that also explains the rise The pandemic and post-pandemic of food insecurity in Brazil.25 Projections of po- years decoupled the evolution of GDP verty rates for 2022 are estimated at 24.3 per- from that of poverty, as low-income cent – a similar rate to that of 2014. Brazil Systematic Country Diagnostic - Update 11 Brazil is still one of the most unequal Poor access to essential services, substan- countries in the world, with a Gini dard living conditions, and insufficient human coefficient of 0.529 in 2021. Income capital accumulation are all indicators that inequality in 2021 was as high as in can readily explain why households are una- ble to stay out of poverty over time. About 2011. Income inequality consistently decrea- 31 percent of households in the North and 27 sed in the first decade of the 2000s, from percent in the Northeast do not have access 0.584 in 2001 to 0.527 in 2012, but such gains to basic services such as water, sanitation or were reverted in the period 2012-2019. After electricity (Figure 2.c). It is also noticeable in reaching its lowest level since the 21st cen- the relatively richer Southeast, where 32 per- tury in 2015, inequality rose sharply in 2016 cent of the household heads did not complete and continued to increase during the recovery primary education, and this share reaches 51 until 2018. The sharpest increase was during percent in the Northeast. In the Southeast re- 2016 when inequality grew by 1.5 Gini points gion, 38 percent of workers do not have pai- in one year — the largest single-year jump in d-sick leave, and this share is 58 percent in inequality since the 1990s. Income disparities the North region. Heterogeneity in access to are evident along a north-south divide. States infrastructure completes the picture. In 2021, in the Northern region have high levels of po- access to electricity and water was estimated verty as well as those in the Northeast. Ala- to be over 99 percent in urban areas and over goas, Amazonas, Pará, Amapá and Piauí have 96 percent in rural areas. However, less than poverty rates of over 50 percent. The highest two thirds (62.9 percent) of rural areas have one is observed in the state of Maranhão (59.9 access to sanitation compared to the 94.1 percent), and it is about five times that of San- percent coverage rates among urban dwel- ta Catarina. Finally, income disparities transla- lers. Relatedly, 20 percent of poor women and te into wealth disparities. It is estimated that 1 26 percent of poor Afro-Brazilians, respecti- percent of the population owns almost half the vely, do not have improved sanitation.28 country’s household wealth in 2019, compared with 40.5 percent in 201026. This high concen- tration translates into a wealth Gini coefficient of 0.89 in 2019 up from 0.822 in 2010. Brazilian families continue to suffer in non-monetary dimensions, with their place of residence playing a key role in their access to economic opportu- nities and basic infrastructure. Appro- ximately one-fifth of Brazilians were iden- tified as chronically poor in 2019 – a share only slightly lower than in 2012 (23 percent).27 12 Brazil Systematic Country Diagnostic - Update Figure 2. Evidence on the poverty and welfare trends in the period 2012-2022 a. Gini and poverty rates b. Drivers of poverty changes 30 55 10 54 Contribution to poverty change (p.p) 8 25 6 53 4 20 52 2 51 0 15 50 -2 -4 10 49 -6 48 -8 5 47 -10 0 46 Working-age employment Labor income non-labor income pensions housing services ( ) total c. Non-monetary deprivation d. Marginal contribution at Consumable Income monetary poverty - (1/2 minimum wage) indirect taxes - 0.6 iptU/itR (dt) - 0.5 household head 0.4 direct taxes does not have 0.3 overcrowding other (dt) sick leave 0.2 0.1 0 salário Família (dt) household head Bolsa Família (dt) deprivation of did not complete basic services abono salarial (dt) primary BpC (dt) deprivation of Rural pension (dt) quality materials in dwelling north north-east south-east extreme poverty moderate poverty south midwest Source: World Bank (2022b) and Lara Ibarra et al. (2023). Notes: Income in panel B is in July 2019 prices. Extreme poverty based on $2.15 (2017 PPP) line. Poverty based on the $6.85 (2017 PPP) line. Inequalities are mitigated only par- Meanwhile, poverty rates among children and tially by the Brazilian fiscal system. adolescents go from 54.2 to 56.6 percent Recent evidence shows that the Brazilian fis- when comparing the pre- and post-fiscal in- cal system in 2019 is both inequality- and comes. Fiscal policies benefit all race groups poverty-reducing. Income inequality (measu- in terms of their effects on poverty, but hou- red by the Gini) is reduced by 6.4 percentage seholds headed by Afro-Brazilians (-6 p.p.) are points and extreme poverty by 5.1 percentage more benefited than those headed by whites points29. Nonetheless, the most effective po- (-5.1 p.p.) and non-AfroBrazilians/non-whites verty-decreasing programs are those targe- (-3.9 p.p.). However, poverty remains high ting the elderly (i.e., rural pensions and BPC). among households headed by Afro-Brazilians After considering fiscal policies, the elderly at 38 percent (compared to 18 percent among poverty rates go from 37.6 to 14.8 percent. those headed by whites). Brazil Systematic Country Diagnostic - Update 13 1.3 A sustainable path will require policies to become a greener and resilient economy SCD1 highlighted how the prospects pality reported some losses and damage during of the bottom 40 percent (B40) are the period, and 85 percent of the 5,570 muni- intrinsically linked with the country’s cipalities reported climate-related disaster los- natural assets, but against a back- ses. Although droughts affect far more people nationwide, floods caused 88 percent of deaths ground of high and increasing risk from disasters between 2000 and 2018—2,435 from climate change, the whole cou- altogether, mainly in urban areas.32 ntry’s development will need to ad- dress environmental challenges head Among other direct consequences, on. Extreme weather events such as droughts, natural hazards significantly disrupt flash floods, and riverine floods are already infrastructure negatively impacting causing and are expected to continue causing losses across the entire country. Between 1995 the competitiveness of Brazil’s eco- and 2019, reported nationwide losses from cli- nomy. Brazilian firms lose amounts equiva- mate-related events cost an average of more lent to 0.2 percent of GDP every year due to than BRL 13.3 billion per year (USD 2.6 billion infrastructure disruptions. The majority (55 or 0.1 percent of 2022 GDP) per year.30 Overall, percent) are caused by failures of transport drought is the costliest climate-related hazard infrastructure, followed by power (44 percent) in the country (BRL 199.8 billion between 1995 and water (2 percent).33 More than 5 percent and 2019), followed by flash floods (BRL 55 bil- (120,000 km) of Brazil’s road and railway in- lion) and riverine floods (BRL 32.2 billion). Extre- frastructure is exposed to flood risks. The pro- me heat is more frequent and intense in urban jected reduction in precipitation and changes areas due to the urban heat island effect. The in seasonal rainfall patterns are also likely to states of Rio Grande do Sul, Minas Gerais, Bah- create risks for Brazil’s hydropower-dominated ia, Pernambuco, and Santa Catarina have re- electricity supply.34 Notably, most of the na- ported the greatest losses, accounting for half tural hazards affect agricultural production, as of the total BRL 333.36 billion in reported losses private losses referring exclusively to agricul- between 1995 and 2019.31 Nearly every munici- ture are registered in 81.8 percent of damage 14 Brazil Systematic Country Diagnostic - Update occurrences (World Bank, 2020b). The value Figure 3. Brazil’s vulnerabilities to climate change of losses linked to agriculture represents 56.2 percent of the sum of public and private losses a. Climate vulnerability by municipality due to these events. Impacts from climate change on households’ welfare are expected to be broad and inequitable. About 3 out of 10 individuals live in either high socioeconomic vulnerability or high environmental vulnerability (Figure 3.a).35 At the same time, 19 percent of the population reside in municipalities consi- dered to be at high environmental risk, while about 8 percent are in municipalities conside- -3 to -2 red to be in high socioeconomic vulnerability – -2 to -1 -1 to 0 though not at high environmental vulnerability. 0 to 1 1 to 2 The urban poor in certain large metropoles are 2 to 3 particularly vulnerable to disasters: low-income 3a4 households typically reside in informal settle- Source: Adapted from World Bank (2022b). ments that are often located on low-lying, floo- d-prone land, and consist of structures that are easily damaged during floods and landslides. Finally, water shortages may disproportiona- b. Deforestation levels in the Legal Amazon (km2) tely impact smaller producer systems who do not have the financing for irrigation. 13,038 12,911 Despite progress in earlier years, de- 11,594 10,851 forestation rates have been increa- 10,129 sing steadily since 2014. Under the 7,893 2004 Plan for the Prevention and Control of 7,536 7,464 7,000 6,947 Deforestation in the Legal Amazon (PPCDAm) 6,418 6,207 5,891 and other environmental protection policies, 5,012 4,571 coupled with favorable economic forces taking pressure off frontier expansion, Brazil mana- ged to effectively reduce deforestation in the Amazon by over 80 percent between 2004 and 2014 (Figure 3.b).36 This decreased Brazil’s 2008 2009 201 0 2 01 1 201 2 201 3 201 4 201 5 201 6 2 01 7 201 8 201 9 2020 202 1 2022 emissions from land-use change by 65 per- cent. The trend has since reversed as interven- tions focused on command and control and a Source: PRODES / INPE. Brazil Systematic Country Diagnostic - Update 15 deteriorating economic environment accelera- sions in Brazil amounted to 2.16 billion tonnes ted frontier expansion once again, intensifying of carbon dioxide equivalent (GtCO2e). Howe- pressures to hollow out environmental protec- ver, these were lowered by the approximately tion policies, including the PPCDAm and the 600 million tonnes (Mt) of removals by Brazil’s Forest Code37. Illegal logging and land grabbing natural ecosystems, thus making net GHG practices38 accelerated, expanding cattle ran- emissions 1.52 GtCO2e.42 Although Brazil does ching and agriculture into the Amazon and Cer- not generate a large amount of emissions from rado biomes. Illegal mining, fishing and other fossil fuels it is becoming a major exporter of natural resource exploration also increased as fossil energy, increasingly supported by vast a result of the lack of law enforcement in re- offshore (“Pre-Salt”) deposits, unlocked by Bra- mote areas. Damages to the forest landscape zil’s highly productive and competitive extrac- caused by these practices also increased the tives sector. risk of large fire outbreaks from which tropi- cal forests can hardly recover. Fiscal measures Brazil has important reforms and that can implicitly incentivize extensive cattle sectoral plans to address climate ranching also add deforestation pressures.39 change. Various reforms in recent years have strengthened market flexibility (espe- While Brazil is one of the top 10 GHG cially land, capital, and product markets), ma- emitters in the world, its emissions king the economy more adaptable to shocks profile differs from that of most and aiming to strengthen productivity gro- upper-middle income and high-inco- wth.43 Agricultural policy uses rural credit as me countries.40 Brazil’s GHG emissions are its main policy tool, including the Low-Carbon primarily due to land use change (primarily de- Agriculture Plan (ABC plan) and the new Agro forestation) and agriculture. Land use change Law. To date, Brazil has applied 17.4 million and agriculture accounted for 52 percent and hectares of different combinations of integra- 24 percent, respectively, of Brazil’s total GHG ted crop-livestock-forest systems, surpassing emissions between 2000 and 2020. Electricity by 21 percent the original nationally determi- and transport accounted for 12.5 percent and ned contributions (NDC) targets by 2020. The 45 percent of GHG emissions from the ener- National Logistics Plan (PNL)44 aims to tackle gy sector in 2000. This is very different from the inefficiency and, in some regions, the large global averages: energy use (for electricity, environmental footprint of road-based trans- heating and cooling, transport, industry, and port infrastructure and low connectivity for a other uses) accounts for about three-quarters large portion of the national territory. The PNL of global emissions, while agriculture, forestry, projects investments in transportation infras- and land use combined contribute only with tructure between BRL 730 billion and BRL 1.2 about 18 percent.41 In 2020, gross GHG emis- trillion by 2035. 16 Brazil Systematic Country Diagnostic - Update 2. Development challenges Brazil Systematic Country Diagnostic - Update 17 Starting from the requirements for provided a wealth of post-SCD1 information poverty reduction and priority cons- that informed a review of the SC1 challenges.45 traints identified in SCD1 and con- For this update, the first SCD1 requirement is sidering new analytical findings, this complemented by the definition of an additio- nal challenge so as to highlight not only the SCD update identifies four develo- necessity of having productive jobs, but also pment challenges. SCD1 identified three the prerequisite of building the income-gene- key requirements for Brazil to achieve the twin rating capacity (through human, natural, and goals: i) creation of a sufficient number of pro- financial capital) of all individuals to reduce ductive and well-remunerated jobs to provi- poverty. The third requirement is also broa- de opportunities for all Brazilians; ii) smarter dened to underscore Brazil’s need to address management of Brazil’s natural resources and increased exposure to climate change risks in better mitigation of the risk of natural disas- a timely manner. ters and environmental pollution; and iii) more efficient and better targeted government spending. In this update, a rich collection of re- The first development challenge is to cently published reports was used as the main create opportunities for all Brazilians source of evidence for the changes, reforms, through a focus on productivity-led and extensions. The reports A Balancing Act growth and a competitive economy. for Brazil’s Amazonian: An Economic Memo- It is critical to raise productivity across all eco- randum (2023), Brazil Poverty and Equity nomic sectors. Reliance on agricultural pro- Assessment: Looking Ahead of Two Crises ductivity has been an enduring feature of the (2022), Alternative Futures for Brazil: Produc- Brazilian economy. While opportunities exist to tivity, Inclusion, Sustainability (forthcoming), further develop the agricultural sector, a large Opportunities for All (2022), Social Protection potential remains untapped due to low produc- for the future: a 2042 outlook (2023), The Bra- tivity in other economic sectors. This challenge zil Human Capital Review: Investing in People encompasses priorities that are still relevant (2022), The Brazil Infrastructure Review (for- for Brazil: further global integration and stron- thcoming), Agriculture Productivity Growth ger links to trade, improving the business en- in Brazil: recent trends and future prospects vironment, promoting innovation, modernizing (2017), A fair adjustment: efficiency and equity infrastructure and adopting a modern tax law. of public spending in Brazil : Volume I (2017), Higher productivity growth across Brazil would Jobs and growth: Brazil’s productivity agenda raise incomes and build wealth rather than (2018), Gestão de Pessoas e Folha de Paga- consume it through debt accumulation or the mentos no Setor Público Brasileiro: o Que Os destruction of natural wealth through frontier Dados Dizem (2019), and The Country Clima- expansion, making growth more fiscally and te and Development Report for Brazil (2023) environmentally sustainable. 18 Brazil Systematic Country Diagnostic - Update The second development challenge not novel for Brazil. However, a myriad of fac- is to develop a people-centric stra- tors make financing the required investments a tegy that increases the income-ge- fundamental policy priority, including the rising fiscal needs caused by the COVID-19 crisis, the nerating capacity of the poor. Econo- heightened climate change risks, and the slow mic development and the population’s ability progress in building a competitive economy. to sustainably escape from poverty will require Increasing the efficiency of government spen- building all individuals’ capacity to generate in- ding, harmonizing taxes across income sour- come. Inclusive policies that close the gaps in ces, eliminating regressive exemptions, and the accumulation of human, natural, and other improving the credit market are all promising types of capital are identified as priorities un- policy options to address this challenge. der this development challenge. Priorities in- clude measures to boost high-quality educa- tional attainment, improved access to digital Reforms to tackle these challenges services, and effective land tenure regulation. must be accompanied by a com- plementary removal of institutional The third development challenge is constraints. Despite Brazil’s struggle with policy stability, key legislation has been adop- to unlock the country’s potential as ted in recent years, including the state-owned a green economy. Brazil’s commitment to enterprises statute (2016), aimed at aligning net-zero and its increased exposure to natural state ownership practices with international hazards require renewed and broader efforts standards, the fiscal rule (2017), the labor le- to move towards a greener economy. Priorities gislation reform (2017), the political reform to address this challenge include the promo- (2017), which gradually established more ri- tion of cross-economy productivity, climate gorous criteria for political parties to have ac- -smart agriculture, increasing the resilience of cess to electoral party funds, form coalitions industries and cities, curbing illegal deforesta- and achieve a “performance clause”, and the tion, and improving the management of natu- pension system reform (2019).46 And while the ral resources. state administration system is relatively effi- cient, particularly at the federal level,47 gover- The fourth development challenge nment effectiveness is lower than expected. is to finance the country’s inclusive The country also ranks low on the World Eco- growth through a sustainable fra- nomic Forum (WEF)’s Global Competitiveness mework that relies on more efficient Index regarding the future orientation of the spending, better taxes and a sound government, including indicators like policy fiscal framework. Creating fiscal space in stability (130th), responsiveness to change a context of limited discretionary spending is (122nd), and long-term vision (129th).48 Brazil Systematic Country Diagnostic - Update 19 2.1 Challenge 1: Creating opportunities for all Brazilians through a focus on productivity- led growth and a competitive economy The most important obstacle to in- services, 3.7 percent in the manufacturing sec- creasing the incomes of Brazilians tor, but climbed by 53 percent in the agricultural is the lack of productivity growth in sector.49 However, services and manufacturing non-primary sectors which employ employ 90.8 percent of the workers, including 78.0 percent of the working poor, and 81.9 per- the majority of the workforce. Except for the enduring legacy of structural reforms cent of those in the bottom 40 percent. In addi- of the 1990s and the commodity super-cycle tion, higher growth in other sectors has the po- of the 2000s, when productivity improved, TFP tential to lift lagging regions such as Amazonia growth in Brazil has been negative on average, by rising demand for Amazonian products and with growth driven mainly by factor accumu- reducing pressures on natural forests. lation. Between 2011-2019, economic output benefited from an expansion in the labor force, Agriculture has been a key driver of an increased supply of skills, and the accumu- productivity in Brazil, and there is still lation of capital. However, negative productivity some potential for growth. Between growth over the same period all but eliminated 1996 and 2020, labor productivity in agriculture these gains. Productivity has been low in Brazil, grew by 6 percent on average annually, though even by Latin America’s lackluster standards. the sector’s TFP growth has been mostly con- In contrast, productivity has been the key dri- centrated on large producers and with large ver of economic growth in countries like China, gains observed in establishments in the Sou- India, and Türkiye (Figure 1). More specifically, theast region.50 Brazil’s productivity growth in labor productivity decreased by 7.9 percent in the agricultural sectors has also buffered the 20 Brazil Systematic Country Diagnostic - Update country against further economic contractions. versities, research institutes, and the Brazilian Evidence from the last two decades demons- Agricultural Research Corporation (Embrapa)54. trates that the agriculture industry has con- Still, Brazil’s agricultural production has room to sistently acted as a stabilizing force during pe- grow further. For instance, Brazil’s corn yield is riods of negative GDP growth.51 There are many about half that of the U.S. (5.8 vs. 11 metric tons reasons for the success of Brazilian agriculture, per hectare). Growth could come from improving including the migration (notably of European productivity of midsize farmers and regions, re- farmers) to the South of Brazil52, the availabi- forming agriculture policies towards agriculture lity of credit53 and the substantial investments financing, and further investments in irrigation in research and development by Brazilian uni- systems and transport infrastructure.55 Figure 4. Agricultural productivity in Brazil. a. TFP in Brazil’s Center-West agricultural b. TFP in Brazil’s Southeast agricultural establishments establishments 120 normalized tFp (0-5 ha in 1985 = 100) normalized tFp (base = 100) 150 140 100 130 80 120 110 60 100 40 90 Farm size Class Farm size Class 1985 1996 2006 1985 1996 2006 Source: Adapted from Helfand and Taylor (2021). Notes: ha = hectare. The high cost of doing business, des- in 2016, when Brazil was ranked 81st (out of 138 pite some recent progress, remains economies).57 Such improvements may be re- an important challenge in the coun- flecting Brazil’s Economic Freedom Law (i.e., Or- try. The last 15 years have seen improvements dinary Law No. 13,874 from 2019) aim to move in the Brazilian business environment, but it is towards a more business-friendly environment estimated that doing business costs companies and the launch of online systems for company BRL 1.5 trillion (USD 283 billion, or 22 percent of registration, licensing, and employment noti- GDP) more in Brazil than in OECD economies.56 fications58. “Custo Brasil”, a term that refers to In 2019, Brazil ranked 71st out of 141 economies the high cost of doing business in the country in the World Economic Forum’s Global Compe- compared to many of its competitors, is parti- titiveness Index. These figures were even worse cularly burdensome for small companies. Brazil Systematic Country Diagnostic - Update 21 Brazil’s tax system is an important credit. In Brazil, a very regulated market for contributor to the “Custo Brasil”. In bank credit (i.e., earmarked) coexists with a non 2021, the tax burden in Brazil was around 33.9 -regulated market (i.e., non-earmarked). State percent of GDP, one of the highest among de- -owned enterprises (SOEs) - in particular, Ban- veloping economies, though just below the co do Brasil, Caixa Econômica and BNDES - are average of OECD countries. With dozens of responsible for the largest share of earmarked different taxes managed by different levels of loans. As of April 2023, earmarked loans cor- government and a multitude of tax benefits responded to 40.9 percent of the outstanding and special regimes59, the complexity of Bra- bank credit, higher than 2007’s level (33.5 per- zil’s tax system creates high compliance costs. cent). The average cost of the earmarked cre- High costs are also due to various obstacles dit portfolio (9.3 percent) is well below that of that hinder business operations, such as ineffi- the non-earmarked portfolio (32.4 percent) and cient financial markets, complicated adminis- even lower than the average public debt cost trative regulations, and a constantly changing (10.7 percent). Differential access to earmarked regulatory environment. These costs make resources contributes to a non-leveled playing firms less competitive, reduce their motiva- field, distorting market prices and leading to a tion to innovate, and encourage rent-seeking misallocation of resources.64 behavior.60 Moreover, the inefficiencies caused by the indirect taxation framework are of par- Access to financing is particularly ticular concern.61 The majority of indirect taxes binding for small and medium enter- are levied on turnover, following a cumulative prises (SMEs) thus limiting potential regime that imposes higher effective rates on innovation capacity and producti- firms that are in the final stages of the produc- vity growth. Information asymmetries and tion chain. This cumulative structure creates concentration in credit markets have hindered an artificial incentive for vertical integration SMEs’ access to financing. According to the and market segmentation, creating incentives country’s small business support agency (SE- against firms that produce complex products. BRAE), there are almost 9 million micro and The ICMS tax62 follows the origin principle, so small companies in Brazil, who represent 27 revenues go to the state in which the product is percent of the country’s GDP and generate 52 produced. This puts ICMS at the core of a “fis- percent of the formal employment.65 Recent cal war” among Brazilian states, as its structu- estimates point that almost 2 million of the- re creates a strong perverse incentive for firm se companies are financially constrained, and location decisions to be based on tax benefits the finance gap is estimated at USD 437 billion and not on production efficiency. Effective tax or 24.7 percent of GDP. The finance gap was rates that vary greatly based on category of deepened by the COVID-19 crisis. According product, location and firm size create further to a poll made with micro, small and medium distortions to efficient resource allocation.63 enterprises (MSMEs) during the crisis, only 14 percent of MSMEs that sought credit were While some progress has been made granted loans.66 Bank credit for MSMEs, as a since SCD1 with regards to distor- percentage of GDP, was significantly smaller in tions in credit markets, Brazil still has April 2023 (9.6 percent) than it was in Decem- a very segmented market for bank ber 2022 (13.3 percent).67 22 Brazil Systematic Country Diagnostic - Update Despite the liberalization of the late such as the number of researchers and engi- 1980s and mid-1990s, Brazil’s tariffs neers as a proportion of the labor force. Brazil are still high, and the country is less has implemented several innovation policies, open to trade than its peers. Barriers mostly through fiscal incentives, but they have to trade in services and high non-tariff measu- had limited impact on technological adoption res (NTM) set additional constraints on trade. and innovation.71 Although the incentives have Services account for only 13 percent of Brazil’s induced some global information and commu- gross exports, a low share when compared with nication technology (ICT) hardware firms to 25 and 15 percent for the world and Latin Ame- produce locally, the beneficiaries have not been rican countries, respectively. This is reflected in able to produce internationally competitive ICT its underperformance in the OECD Services products. Similarly, evidence suggests that the Trade Restrictiveness Index, which shows a be- Fiscal Incentives Law (Lei do Bem) had a posi- low-average score in 18 of 22 sectors in 2020.68 tive but modest impact on innovation. Average Brazil also has high NTMs: the percentage of realized research and development (R&D) in- imports subject to at least one NTM is higher tensity has been low. The law favors larger and in Brazil than in other countries: 74 percent for older firms and does not reach most small or technical barriers, 55 percent for sanitary and new companies: it excludes firms that file inco- phytosanitary measures, and 23 percent for me tax returns based on their presumed profit, quantity controls, well above world averages. which includes most young firms. To the extent Simulations suggest that the actual negotia- that it favors incumbent firms, it may have slo- ted European Union–Mercosul agreement, in- wed the reallocation of resources from low-gro- cluding liberalization of tariffs and NTMs, could wth incumbents to high-growth young firms.3 increase GDP by 6.7 percent by 2040.69 Brazil’s infrastructure financing gap Although recent progress has been is approaching USD 800 billion, the made, Brazil ranks below most peers equivalent to 3.7 percent of GDP per when it comes to innovation. SCD1 year through 2030. Mobilizing priva- identified that circa 2015 Brazil ranked in the te capital will be essential to closing middle of a group of OECD and middle-income this gap. Investment in infrastructure hit a peers in terms of capacity for innovation and near all-time low in 2020, when only 1.6 percent 84th out of 140 countries in the Innovation In- of GDP was invested in transportation, electri- dicator. In 2016, for example, the average age city, water and sanitation, and telecommu- of patents (15.3 years) in force in Brazil was the nications combined. Notably, transportation highest in a sample of twenty economies. While accounts for more than half (53 percent) of this average decreased to 11.9 years in 2022,70 the country’s financing gap. Brazil also lags in Brazil still exhibits substantial lags against terms of investing in multimodal logistics solu- comparator countries in the global innovation tions to support the competitiveness of indus- index and in terms of key inputs to innovation trial and export value chains. Brazil ranked 56 Brazil Systematic Country Diagnostic - Update 23 out of 161 countries in the Logistics Performan- skills of the workforce. In Brazil, about one third ce Index (LPI) in 2018, lagging behind Mexico, of individuals aged 20-39 have not completed India, China, Canada, and the United States. secondary education, and about 78 percent of Brazil, which has dropped 15 places since 2010, the workforce and close to 95 percent of the is the only BRIC country whose performance working poor work in occupations facing a re- has decreased. Improvements in logistical per- latively high risk of automation.74 This means formance and mass transit services are essen- that skill-biased inequality in employment and tial for more productive industries and cities, wages and individuals’ differential ability to and even a more resilient economy to clima- overcome shocks are likely to widen in the fu- te-change. Indeed, addressing climate change ture, negatively affecting upward mobility and impacts an additional 0.8 percent of GDP per Brazil’s overall productivity. Finally, the quality year in investment needs between 2022 and of education in Brazil is a cause of concern for 2030.72 Better connecting coastal towns (ra- the ability of the future workforce to hold high ther than expanding rural roads into the hin- -productivity jobs: in upper secondary educa- terland, including into the Amazon) could yield tion nearly all students in Brazil graduate wi- considerable welfare gains for Brazil. Recogni- thout full proficiency in math.75 zing fiscal constraints, Brazil must meet the challenge of effectively design strategies to complement public investments and boost the participation of the private sector (e.g., public -private partnerships, concessions) to mobilize capital towards infrastructure projects. Finally, Brazil must address the limi- ted adaptability of its current and future workforce to a more modern labor market. Over the last ten years, the educational attainment of workers has been a significant predictor of the time needed to recover from labor market shocks. Following massive layoffs, workers with lower education levels take up to eight years to reach their pre- vious wage levels, whereas those with higher levels of education achieve this in less than two years.73 At the same time, the gradual scarcity of routine jobs and the rise of occupations requiring more cognitive and abstract skills are worsening the mismatch between requi- rements of the modern labor market and the 24 Brazil Systematic Country Diagnostic - Update IC1 Institutional constraints to boost productivity and a competitive economy Strengthening Brazil’s competition direct investment in key service sectors are es- enforcement framework is critical. sential for encouraging technological transfers A 2018 peer review on competition law and and fostering a more competitive economy. policy identified weaknesses in Brazil’s com- Brazil has made strides in patent and trade- petition enforcement system as part of the mark protection.76 However, patent processing country’s efforts to join the OECD. These wea- remains slow, with an average approval time knesses include issues with investigation and of eight years. In 2019, the federal government decision-making processes, the appointment introduced a strategy to address the longstan- system for the Administrative Council for Eco- ding patent backlog problem. nomic Defense (CADE) commissioners and the general superintendent, inadequate resources Public investment faces several ins- for competition enforcement, and the need for titutional challenges in Brazil. The improvements in the methodology for calcula- IMF’s Public Investment Management Asses- ting fines and substantive guidelines. Addres- sment (PIMA) 2018 found that Brazil’s PIM sing these issues is crucial for fostering a more institutions are stronger than that of other competitive economy. emerging market countries in the areas of na- tional planning, budget comprehensiveness, Brazil improved enforcement of in- company regulations and monitoring of as- ternational intellectual property ru- sets. However, they perform poorly in the allo- les, although a patent backlog per- cation and implementation phases, especially sists. The lack of enforceable Intellectual project appraisal and selection, protection of Property Rights (IPR) policies and substantive investments, funding availability and project rules on IPRs through preferential trade agree- management. In terms of effectiveness, most ments (PTAs) hinders innovation and producti- institutions were assessed as medium or low vity growth in the domestic market. Reforms scoring. Strategic prioritization of investment to lower tariffs for capital and intermediate and project selection and appraisal were found goods, reduce trade costs, and attract foreign to be the most significant areas of weakness Brazil Systematic Country Diagnostic - Update 25 in the country. Finally, the lack of coordination infrastructure needs due to the rigidity of state across levels of government and the low capa- budgets. Thus, infrastructure initiatives, assu- city at the subnational level were recognized as med to originate within the executive branch, serious constraints. require significant efforts and political capital to get approved and funded via the national legis- Political institutions in Brazil, charac- lature. Furthermore, private infrastructure pro- terized by coalitional presidentialism, viders frequently operate as monopolies or oli- pose challenges for long-term, within gopolies, creating challenges for infrastructure -budget infrastructure spending. Sta- investment. Limited flexibility in Brazil’s federal te governors depend on fiscal transfers from budget also makes it difficult for policymakers the central government to finance their public to allocate funds for infrastructure projects. 2.2 Challenge 2: Developing a people-centric strategy that increases the income generating capacity of the poor The effects of the pandemic made from it through reliable infrastructure, they will bare the vulnerability of Brazilian be able to sustainably get out of poverty. households to cope with shocks. Long- term economic development can only be achie- A major driver of the recent rise in ved if investments are made in their income- Brazil’s stock of human capital was generating assets.77 As individuals are able to improved access to basic education.78 accumulate their human capital, build other as- Between 2000 and 2019, net enrollment rates sets, securely own natural capital and usufruct jumped from 66 percent to 94 percent in pres- 26 Brazil Systematic Country Diagnostic - Update chool (5-6-year-olds) and more than doubled rates and large learning losses. Indeed, nearly in upper secondary school. As a result, avera- 1.4 million school-age students between 5 and ge years of schooling increased substantially 17 years old were out of school in 2021, half in the last decades. Upper secondary school of whom were from the North and Northeast dropout rates decreased from 10.3 percent in of Brazil. Moreover, the Human Capital Index 2010 to 4.8 percent in 2019, though increased dropped to 0.54 in 2021, compared to 0.601 in somewhat to 5.7 percent in 2022 partly as a 2019 – setting back to levels of 10 years ago. result of the pandemic.79 The number of college entrants, in contrast, kept rising from around Another challenge includes equi- 1.9 million in 2010 to around 3.6 million in 2019, pping the youth with relevant skills and 3.9 million in 2021.80 for the labor market. In 2012, for exam- ple, Brazil had the lowest share of graduates The quality of education has increa- in engineering and sciences among tertiary sed more slowly than enrollment. graduates in a sample of 11 countries. National Learning at the primary education level has statistics currently indicate that about 18 per- risen steadily as demonstrated in the Indi- cent of college graduates in Brazil specialize in ce de Desenvolvimento de Educação Básica science, engineering, and technology subjects, (IDEB), which includes standardized test sco- below the OECD average (25 percent). Gender res in Portuguese and math and school dro- gaps are substantial: one woman for every pout rates.81 However, the quality of education seven men graduate in ICT fields in Brazil and remains below that of Brazil’s regional peers. less than 1 in 2 in engineering and related sub- In the most recent Program for International jects. Technical and vocational education and Student Assessment (PISA) tests, almost half training (TVET) remains a little-pursued path: of 10-year-old in Brazil were unable to read or only 10 percent of upper secondary students understand a simple text (the World Bank’s de- are enrolled in TVET, four times less than the finition of learning poverty). Results in langua- OECD average, despite the estimated 9.7 per- ge and science improved over time, but those cent wage premium when compared to stu- in math stalled. In 2021, only 31 percent of stu- dents with only high school.83 dents completing upper secondary education attained adequate proficiency in language and Access to higher education in Bra- a staggeringly low 5 percent in math.82 zil has grown in recent decades, but enrollment continues to be highly The COVID-19 pandemic signifi- dependent on family income. Higher cantly affected learning levels and education degrees are strongly associated inequality through long school clo- with upper middle- or upper-class status in sures and higher dropout rates and Brazil. Data from PNAD-C 2019 indicate that exacerbated existing deficiencies in youth aged 18–24, almost 7 in 10 in the top the provision of education. About 50 income decile are enrolled in higher education, million students lost the benefit of in-person compared to 1 in 10 in the bottom 30 percent instruction during closures. Such a prolonged and less than 1 in 5 among the vulnerable mi- period of school closures has multiple conse- ddle class.84 Importantly, the adoption of affir- quences including increased school dropout mative action in Brazilian federal universities Brazil Systematic Country Diagnostic - Update 27 in the last decade has contributed to increase tors per capita.90 As highlighted in SCD1, there the enrollment of public high-school students are significant differences in terms of access and Blacks.85 Enrollment rates have increased, to health care by race and ethnicity. Unfortu- but the pace of progress may be too slow to nately, inequality in access to health care can reverse today’s stark income and class ine- start even before birth. At the time SCD1 was quality. Projections suggest that after three prepared, 74.9 percent of the white population generations, only 12 percent of the poor will had seven or more prenatal visits compared to have achieved tertiary education. 54.8 percent among Blacks and pardos, and 24.3 percent among indigenous people. More While Brazil has a comprehensive set recent data indicates that about 82 percent of of social protection programs and Brazilian white mothers do seven or more pre- policies that succeed in achieving natal care visit, compared to only 68 percent of Afro-Brazilian mothers.91 many desired outcomes, they tend to fall short in promoting economic Gaps in terms of basic access also inclusion for vulnerable workers. Even though Brazil’s total spending on labor mar- relate to sanitation and internet ket policies is similar to that of high-income services. Brazil has achieved near universal access to several key infrastructure services. economies, the active labor market programs Almost all Brazilians now have access to elec- (ALMPs) designed to promote skill develop- tricity and drinking water. However, there are ment, entrepreneurship and job intermediation still important racial, ethnical, urban-rural, and services for vulnerable workers receive only a gender gaps in terms of access to water supply. minimal share of this spending. Existing pro- About 13 percent of Brazilians poor households grams largely serve formal workers.86 In ad- have no access to water supply and this share dition, there is a lack of connection between is 39 percent in rural areas, 3 percent in urban Brazil’s public employment services network areas, 9 percent among female-headed hou- (Sistema Nacional de Emprego, SINE) and seholds and 13 percent among those headed ALMPs, as well as of linkages between income by Afro-Brazilians92. These figures are even support programs and SINE.87 worse among IP and quilombolas, as roughly 51 percent of IPs and 42 percent of quilom- Most Brazilians rely on the national bolas have no access to a water supply. The public health system (Sistema Único access to sanitation and internet services has de Saúde, SUS), but effective access also lagged behind, especially in the northern remains unequal. In fact, 97 percent of lo- and northeastern regions: over 60 percent of w-income rural households use the SUS when the population in these regions do not have sick, as do 88 percent of the low-income urban access to improved sanitation services, while households.88 While SUS is a universal system 85 percent of those in the Southeast do so. Si- that has progressively expanded access to milarly, almost 30 percent of the Northeast’s care, its true cost is reflected in long wait times population do not have access to the internet. to access health services89. Access to health Limited access to these services represents services is unequal across the country with an important constraint to connectivity, digi- rural areas having the lowest number of doc- talization and the quality of life of underser- 28 Brazil Systematic Country Diagnostic - Update ved communities. Despite the well-established about 143.6 million hectares (or 28.5 percent of framework of concessions and public-private the area) do not have a designation.97 partnerships, the poor quality of public servi- ces has been penalizing the quality of life in ci- Brazilians are increasingly avid users ties and productivity. of financial accounts, with many re- cent improvements in the digital are- Land tenure, a bastion of security na. About 84 percent of the population over 15 among vulnerable households, is years old had an individual or shared formal fi- unequally distributed. The Brazilian poor nancial account in 2021, up from 56 percent in have ownership rates of dwelling or land simi- 2011, according to the World Bank’s Findex da- lar to those of the non-poor. However, a major tabase on financial inclusion. The same survey difference stands out in the ownership of legal indicated that 51 percent of respondents have titles: about 61 percent of the Brazilian popula- used a mobile phone or internet connection to tion owns a land title, while only 50 percent of access financial accounts. These changes are the poor and 46 percent of the rural poor do.93 likely to have followed from BCB’s agenda that In fact, land concentration in Brazil remains introduced the PIX payment system in Novem- one of the largest in the world: one percent of ber 2020 and that counted over 138 million landholdings occupy almost half of the coun- users by October 2022, and the open-banking try’s rural area.94 initiative that started in November 2021.98 A related issue, land tenure security, Notwithstanding the recent progress, also tends to disproportionately af- there are still certain groups lagging fect low-income individuals. Insecure land rights can lead to underdeveloped rental in their ability to hold financial assets markets and inefficient investment decisions and benefit from the financial sys- in properties.95 Insecure land rights create high tem. Account ownership still lags among the obstacles to gaining access to credit that can bottom 40 percent. In 2017, 56 percent of the be very important for agricultural cycles. This bottom 40 percent had an account compared could partly explain why the properties of fami- with 79 percent among those in the top 60 liar agriculture are characterized by their small percent. Differential banking access has also size (up to 4 hectares) and low levels of produc- translated into gaps in credit access—many tion even when a relatively high proportion of entrepreneurs still face barriers to access the poor families in rural locations report to own financial system. According to SEBRAE, twenty their land. Within familiar establishments, even percent of small firms have not yet incorpora- among properties larger than 50 hectares, the ted the PIX payment system into their ope- registered value of production does not surpass rations. Brazil is one of the countries with the BRL 25 thousand.96 Land tenure insecurity is highest percentage of business discontinuity more pronounced in regions of expansion of the among women, with a female-to-male ratio at agricultural frontier, especially along the Ama- 1.6. Among LAC countries, Brazil is the country zon Forest borders. While it is difficult to quan- with the second highest share of female entre- tify how much of the land in Brazil is lacking preneurs who abandon their business activities a designation, in the Legal Amazon territory, due to lack of finance (8.1 percent). Brazil Systematic Country Diagnostic - Update 29 IC2 Institutional constraints to promote inclusion There are several institutional cons- tition rates, particularly in schools serving lo- traints that affect public sector ef- w-income students. Key governance reforms ficiency and human development in include enhancing the accountability of school systems, teachers, and principals for learning Brazil, particularly in the education outcomes, rewarding performance, selecting sector. These constraints include insufficient principals and regional education coordinators funding, inadequate teacher training, unequal based on technical criteria and abilities, and access to education, outdated curricula, limi- encouraging school management to prioritize ted vocational training opportunities, frag- the improvement of learning outcomes. mented responsibilities among different levels of government and inconsistent policies. These In higher education, governance re- constraints result in disparities in enrollment forms are crucial for promoting gro- rates between different regions and socioeco- wth and enhancing quality in the nomic groups and inadequate training for Bra- zilian teachers, contributing to widening dispa- sector. Diversifying funding sources, such as implementing means testing for tuition fees rities in education outcomes across different and scholarships, can make the higher edu- regions of Brazil. cation system more equitable and improve its quality. As public funding alone is insufficient, Governance reforms are essential performance-based financing formulas con- for achieving cost efficiency and im- sidering graduation rates and labor market proved learning outcomes in Brazil’s outcomes can boost efficiency and value for basic education system. States like students. Granting public universities more Ceará and São Paulo have demonstrated the autonomy in managing resources jointly with effectiveness of such reforms by leveraging fi- increased accountability is also another pro- nancial incentives, fostering cooperation and mising policy option to improve efficiency. To competition, and equipping school principals ensure learning quality, it is essential to fo- with management tools and training. These cus on refining teaching methodologies and capacity-building efforts have led to better approaches such as linking professors’ career school approval ratings and decreased repe- progression to research output. 30 Brazil Systematic Country Diagnostic - Update There is room for improvement in the Low-skilled workers are more vulnerable to au- design and implementation of gover- tomation and have longer recovery times from labor market shocks. Brazil needs to stimulate nment programs aimed at addres- students to enroll in promising fields, including sing the skill gap in the labor market. science and technology, and improve TVET. The growing mismatch between the workfor- While TVET courses have been found to lead ce’s skills and the demands of the labor market to a positive wage premium, uptake is still hin- affects employment, wages, and productivity. dered by limited information and undersupply. 2.3 Challenge 3: Unlocking the country’s potential as a green economy Deforestation in Brazil could soon ted impact from a potential Amazon tipping lead to a tipping point in the Ama- point on Brazil’s cumulative GDP through 2050 zon. Forest-conservation policies, associated is estimated at BRL 920 billion (USD 184.1 bil- with other economic factors, contributed to a lion or 9.7 percent of 2022 GDP). reduction of 80 percent on deforestation ra- tes in the Amazon from 2004 to 2012, when Brazil’s commitment to end defores- the deforestation in Amazonia Legal reached tation in the Amazon by 2030 is the a low of 4,571 km2. Deforestation has trended largest source of future emission re- upward: in 2018 there were 7,536 km2 defores- ductions and, as demonstrated by ted, increasing to 11,568 km2 in 2022. Thus, the Brazil in the past, can be achieved wi- combination of climate change, deforestation, thout compromising development.99 A and expansion of low-intensity pasture in the policy package that lowers deforestation, while Amazon biome is intensifying threats to Bra- simultaneously promoting growth of the eco- zil’s key ecosystems. This will have major con- nomy should (i) ensure effective forest law enfor- sequences for agriculture, urban water supply, cement and governance, (ii) increase productivity flood mitigation and hydropower. The projec- across the economy, and (iii) incentivize more in- Brazil Systematic Country Diagnostic - Update 31 tensive use of land.100 Simulations show that rai- and enhancing disaster preparedness and res- sing Brazil’s productivity performance in urban ponse mechanisms. Developing the capacity areas, in the manufacturing and services sector for disaster preparedness will also necessitate support deforestation efforts, as they help shift effective coordination with civil protection and economic activity to non-land-based sectors.101 defense systems, as well as active engage- ment with local communities. Stopping illegal deforestation holds the promise of contributing the most World Bank estimates place Brazil’s for Brazil to enter a path towards net annual investment needs for climate zero by 2050, but the country can action at around 0.8 percent of GDP also benefit from decarbonizing other between 2022-2030.104 These invest- important parts of its economy. More ments would yield significant savings, equi- climate-smart agriculture (including restoration valent to 0.3 percent of GDP over 2022-2030 of degraded lands and pursuing sustainable through avoided energy spending in transport value chains) and sustainable landscape ma- and industry and reduced costs from conges- nagement can help Brazil continue growing and tion and air pollution. Thus, such investments keep its agricultural powerhouse status. The could bring overall net economic costs of Bra- expansion of non-hydro renewables and the zil’s resilience and net zero pathway to about transition to a greener urban infrastructure and 0.5 percent of GDP annually over this period. transportation sector (especially decarbonizing logistics) could provide growth opportunities By implementing measures to adapt and better prepare the country for shocks. to climate change, Brazil has the po- tential to substantially decrease the Investments in enhancing the resi- negative effects on agricultural pro- lience of urban areas must tackle duction, although the specific im- multiple challenges simultaneously, pacts will vary by region. Utilizing an such as improving access to infras- effective adaptation strategy that involves real- tructure and services, and mitigating locating resources and adjusting the spatial dis- the risks and vulnerabilities associa- tribution of crops (for example, moving soybean ted with extreme climatic events.102 areas south and pasture areas south and east), This can be achieved through a combination models indicate that Brazil’s overall impact of physical and non-physical interventions. would be a minor loss at the national level, equi- Large-scale solutions may involve the renova- valent to 0.15 percent of GDP by 2042.105 Howe- tion of informal settlements, the development ver, the economies of the major soy-producing of both traditional and environmentally frien- states, namely Mato Grosso and Mato Grosso dly infrastructure to enhance drainage and do Sul, would be particularly affected by these manage flooding, and the restoration of eco- changes. The adaptation process, however, may logically valuable areas along water bodies.103 result in significant social disruptions and hou- Non-physical measures encompass improving sehold impacts. Therefore, ensuring a fair tran- the understanding of risks and the impacts of sition for agricultural workers would be essential hazards, strengthening early warning systems, and necessitate supportive measures. 32 Brazil Systematic Country Diagnostic - Update IC3 Institutional constraints to pursue a greener economy Brazil made some progress in deve- tion and sustainable development. loping institutional arrangements to The Coalition of Governors for Climate has led address climate change and advance at the subnational level plans and programs to sustainable growth, but there are still deliver on their climate action commitments, significant gaps in the government’s but these efforts have not helped to advance capacity to implement effective cli- a centralized and consolidated strategy. The mate policies. The adoption of the Natio- country’s federation units display varying le- nal Policy on Climate Change (PNMC) in 2009 vels of progress in terms of climate policies, provided a framework for addressing the issue, adaptation plans, and GHG reduction targets, leading to the development of nine mitigation which can be attributed to gaps in technical plans in key areas for reducing greenhouse gas and managerial capacities. Furthermore, weak emissions. But the installed technical capacity, governance and financial constraints create which resulted in development of the Secto- opportunities for illegal activities that undermi- ral Mitigation Plans, the National Adaptation ne climate action efforts. The overlapping func- Plan, the National REDD+ strategy and the tions of government agencies and inconsistent 2015 NDC has been impacted since 2019 by regulations exacerbate these challenges. the loss of influence of several technical bodies, particularly at the federal level. In 2023, subs- Immediate and urgent measures are tantive structural changes to reinstate the essential to prevent land-grabbing, needed institutional capacity were adopted. strengthen land, forest governance, For instance, the PPCDAm was re-launched and deter illegal deforestation. Bra- while the Forest Service is now under responsi- zil’s capacity to monitor forests through the bility of the Ministry of Environment (formerly Satellite Monitoring Project of the Amazon under the Ministry of Agriculture). Rainforest (PRODES) and the Real-Time Defo- restation Detection System (DETER) remains Stronger institutional coordination is strong, but law enforcement capacity and in- needed to reduce conflicting policies telligence must be improved to enable colla- and improve the coherence in the go- boration among federal, state, and municipal vernment’s approach to climate ac- institutions. Untitled public land mapping will Brazil Systematic Country Diagnostic - Update 33 provide crucial spatial data and facilitate the enabling the use of instruments in the current designation of protected areas. Additionally, forest code, such as trading forest certificates modernizing land registration, analysis, and and utilizing carbon finance for forest resto- validation practices will expedite the validation ration and enabling tracking systems of value of the Rural Environmental Registry (CAR), chains to work more effectively. 2.4 Challenge 4: Financing the country’s inclusive growth needs through a sustainable framework based on efficient fiscal policies Structural spending pressures con- business-as-usual scenario, and without a ro- tinue to strain the recurrent budget bust fiscal anchor, projections suggest a return and create important inefficiencies. to an unsustainable fiscal trajectory. These pressures encompass public sector wages, pensions, and the expansion of social Brazil’s social protection programs protection expenditures, which do not neces- achieve many of the desirable out- sarily benefit the poor. Notably, the country’s comes of a well-performing system, flagship cash transfer program has contribu- but an increased focus on the poor ted to this momentum, with its budget increa- is warranted. The flagship conditional cash sing from the equivalent to 0.5 percent of GDP transfer program (Bolsa Familia)106 has been in 2019 (as Bolsa Familia) to an anticipated 1.5 contributing to poverty reduction over the last percent of GDP in 2023. Moreover, Brazil’s al- two decades. Jointly with an early childhood location of funds towards interest payments is education program (Programa Criança Feliz) escalating. The significant budget rigidity fur- and school feeding, this network of programs ther intensifies the pressure, as discretionary has promoted human capital through condi- resources account for less than 10 percent of tionalities on children’s health and education. the budget, making it challenging to reallocate Keeping the costs of these programs under funds to meet evolving expenditure needs. In a control while improving effectiveness will be 34 Brazil Systematic Country Diagnostic - Update critical for their sustainability.107 Currently, ho- There is potential for improving the wever, fiscal policies provide income support management of the civil service wage to households in a fragmented way. The coe- bill. In 2021, Brazil allocated approximately 9 xistence of numerous benefits with different percent of its GDP to wages and salaries of ac- targeting approaches creates duplications in tive public servants lower than the 13 percent some households and a lack of coverage in of 2015. The federal government’s wage pre- others. World Bank estimates108 suggest that mium significantly contributes to the growth of about 40 percent of households in income de- the wage bill. The federal wage premium was ciles 2 to 5 receive two or three benefits often estimated at 96 percent, while the average due to the design of the programs in question. wage premium for state employees stood at 36 percent.113 Many professions offer high initial Brazil’s tax system imposes high salaries114 and enable rapid progression to the costs on growth while contributing highest salary level. Furthermore, states and little to reducing inequality. Taxation municipalities adhere to federal public adminis- of goods and certain services in Brazil exhibits tration human resources standards but have a high degree of inefficiency. The indirect tax also implemented diverse salary structures and system is primarily levied on turnover, opera- specific advancement rules for each profession, ting under a cumulative regime that imposes often offering more favorable incentives com- higher effective rates on firms at the final sta- pared to the private sector.115 ges of the production chain. Furthermore, even taxes that are meant to be non-cumulative in It is equally crucial to address the theory can become cumulative in practice due challenges arising from the civil ser- to inadequate institutional frameworks, such vice pension bill at both the national as inputs related to telecommunication servi- and subnational levels. In at least half ces or advertising.109 The high complexity of the of the Brazilian states, the growth in spending tax system significantly adds to the costs of with inactive servants exceeds that with active doing business (see section 1). Indeed, Brazil’s ones.116 Drivers of spending on inactive workers tax burden is heavily concentrated on taxes are the wage parity, the increase in the life ex- on goods and services, and on payroll, which pectancy of the population, the increase in the respectively account for 43 and 24 percent of number of retirees, and noncompliance with the tax burden.110 This structure of indirect ta- Constitutional Amendment No. 41 from 2003, xes is regressive: the poorest spend a relatively which foresees the establishment of a comple- larger share of their income on taxes levied on mentary welfare option to limit the retirement consumption.111 Meanwhile, special tax regimes of public servants to the ceiling of the general such as Simples Nacional for small firms and pension system.117 The federal pension reform the individual microentrepreneur (MEI) for sel- implemented in 2019 was a significant milesto- f-employed workers help high earners avoid ta- ne towards establishing more sustainable pen- xes by shifting income from the personal to the sion systems in states and municipalities, but it corporate tax base. This phenomenon, often has not been uniformly implemented. Key ingre- referred to as “pejotização” (from “PJ”, or Pessoa dients of the reform include the gradual increase Jurídica), limits the inequality-reducing impacts in the effective retirement age, taxing benefits of the tax system and decreases the tax base.112 beyond the minimum wage, and revising rules Brazil Systematic Country Diagnostic - Update 35 regarding survivor benefits, among others.118 Al- endeavor towards net-zero. Repurpo- though the federal pension reform of 2019 man- sing carbon-intensive subsidies to support the dated states to implement certain measures, low-carbon transition and expanding carbon the most important fiscal actions were optional taxes can help. Economy-wide interventions for subnational entities. In principle, subnatio- can also create new markets on the environ- nal governments are allowed to strengthen the mental front, providing the right incentives for changes in pension regulations beyond what the private sector to act on them. The creation was approved for the federal civil servant sche- of an emissions trading system, carbon taxes, me. However, so far, most of the first-mover or a mix of these instruments, to reduce emis- states have chosen to either replicate or weaken sions and reward emission reductions through the pension reform package implemented at the carbon markets have strong potential. There is federal level.119 As a result, their pension deficits huge untapped potential or Brazil for conserva- continue on an unsustainable path. To achieve tion finance linked both to carbon dioxide (CO2) greater long-term benefits, it is crucial to increa- reductions and protection of biodiversity. Other se the number of states and municipalities that areas include the development of emergent te- adopt comprehensive pension reforms. chnologies for decarbonization such as green hydrogen, offshore wind, second generation Making fiscal space for climate action ethanol, grid digitization and green buildings. is also critical: Brazil should tap into Potential gains from these innovations are lar- a wide range of sources and leverage ge: green hydrogen could generate USD 15-20 public and private investments for its billion in revenues for Brazil by 2040.120 IC4 Institutional constraints for fiscal sustainability Brazil’s intergovernmental transfer FPE (Fundo de Participação dos Estados) and system needs to be revamped to ad- the FPM (Fundo de Participação dos Municí- pios). Recently, the Supreme Court has decla- dress horizontal gaps between sta- red that the current formula to distribute FPE tes and promote regional redistribu- is unconstitutional121, which will force the exe- tion. The largest transfers between federal cutive and legislative branches to agree on a and subnational governments result from the new mechanism. FPE’s allocation formula has 36 Brazil Systematic Country Diagnostic - Update several drawbacks, including its pro-cyclical top salary in a relatively short time, with little nature, which amplifies economic shocks.122 In incentive for public employees to assume high addition, FPE’s current design does not promo- responsibility functions or leadership positions. te equity, which was its original goal. Impro- Performance management is still vague, with ving its allocation formulas could come from dismissal allowed just in case of no appeal law- ex-post-performance related criteria on trans- suits, administrative processes, or insufficient fer results, including for instance forest preser- performance, which is still to be regulated. vation indicators. In turn, FPM has incentivized Temporary contracts are allowed just in case the sprawling of hundreds of small municipa- of emergency situations and regulations are lities, which have limited capacity to provide unclear about the labor rights to these emplo- the services assigned to them.123 A formula yees.124 Personnel expenditures are incompres- to incentivize amalgamation of municipalities sible in the short term due to the stability of could improve both the fiscal situation of local civil servants and the impossibility of reducing governments and service delivery. Subnational salaries. Finally, increasing the efficiency of hu- difficult fiscal positions – exacerbated by the man resources management (HRM) must ac- COVID-19 pandemic – are expected worsen wi- company the goal of preserving sustainable fi- thout reforms on expenditures and allocation nances, and strengthening the governance and of resources. the quality of public service delivery: reducing the number of careers, establishing a single Human resources challenges in the salary scale, including recognition and com- public sector are mainly related to pensation mechanisms tied to performance pay, grading and performance is- and the exercise of leadership positions, syste- sues. There is a high wage dispersion among matic strategic workforce planning, promoting civil servants, accentuating inequalities bet- inter-agency cooperation to guarantee opera- ween careers, with an extremely fragmented tional flexibility and regulating the dismissal of and rigid structure in the federal and subna- public employees due to poor performance or tional levels. Numerous careers have high ini- outdated demand can all contribute to tackle tial wages and allow employees to reach the this challenge. Brazil Systematic Country Diagnostic - Update 37 3. Priorities and High-Level Outcomes 38 Brazil Systematic Country Diagnostic - Update Grounded in the evidence above, this preparation of this document, allowed tapping SCD update provides an updated into the most current data and analytics. All assessment of the country’s priori- emerging findings were discussed and broadly ties based on the following filters: the resonated with the groups consulted.125 potential impact on the twin goals, the con- firmation of their key role stemming from the Given the challenges identified, three knowledge developed in very recent analytical HLOs are proposed for the achieve- work, and consultations with external counter- ment of the goals of poverty eradi- parts and experts. cation and boosting shared pros- perity in Brazil. First, increase access to The wealth of recently concluded high-quality job opportunities. Second, impro- analytical work provides a solid fou- ve households’ income-generating capacity ndation for the identification of prio- through the accumulation and use of producti- rity areas with the highest potential ve assets. Third, reduce vulnerability to climate to address the constraints that de- shocks. Several priorities for policy action were fine Brazil’s four development chal- identified in this Update due to their strong lenges. The priorities have been highlighted potential to contribute to achieving the HLOs. as recommended policy actions in reports that While certain actions have a clear line of sight covered a broad range of issues relevant for to one HLO, it is important to recognize that Brazil’s development. The list of the SCD Upda- others – such as those related to fiscal sustai- te analytical foundations is included in Appen- nability- can be cross-cutting in nature. Figure dix 2. The collection of evidence, with many re- 5 provides an illustration of a mapping of the ports published only a few months prior to the priorities to the HLOs. Brazil Systematic Country Diagnostic - Update 39 Figure 5. Development challenges, priorities, and High-level Outcomes for Brazil TWIN GOALS Improved Increased access households’ Reduced HLOs to high quality job accumulation and vulnerability to opportunities use of productive climate shocks assets Boost quality of learning Update curricula to teach labor market-relevant Promote adoption of Global integration and skills climate-smart agriculture stronger links to trade Recover human capital Increase resilience of Improving business losses due to pandemic industries and cities environment and promote innovation Strengthen policies for Curb illegal deforestation economic inclusion Modernizing Improved management Achieve universal access infrastructure of natural sources to basic services Priorities Adopt a modern Effective land tenure Promote acquisition of consumption tax law regularization skills that fit a greener economy Reduce credit Improved and well distortions functioning credit market Incentivize private sector participation towards Harmonize taxes across Adopt more efficient and climate action income sources and better targeted eliminate regressive government spending Support adaptation of exemptions firms and individuals Enhance public service delivery Pursue a Increased Meeting Sustainable productivity- capabilities potential in financing of led growth and income green and inclusive Challenges and a generating climate growth competitive capacity of friendly economy the most development vulnerable Cross cutting Institutional constraints Source: World Bank. 40 Brazil Systematic Country Diagnostic - Update References Almeida, Rita; Anazawa, Leandro; Menezes Filho, Naercio; Vasconcellos, Ligia (2015). 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Interactive chart shows changes in the world’s top 10 emitters. https://www.wri.org/ insights/interactive-chart-shows-changes-worlds-top-10-emitters 44 Brazil Systematic Country Diagnostic - Update Appendix 1. A profile of the poor in Brazil Poverty reduction stagnated in Bra- Figure A1.1. Poverty rates for selected demographic groups 2012-2021 zil since the economic crisis started in mid-2014. As a consequence, the 60% profile of the poor population has ba- rely changed. In 2016, about 27.0 percent of 50% the population were living under the 6.85 USD 40% per day (2017 PPP) poverty line and 4.7 percent 30% below the 2.15 USD dollars per day (2017 PPP). These rates increased slightly in 2021, when 20% 28.4 percent and 5.8 percent of the popula- 10% tion were living under the upper and the lower 0% poverty lines, respectively. The long-standing disparities in poverty rates across the Brazilian Rural afrodescendant population have also persisted. The poverty headed by women overall rate among Black and pardos was 35.9 per- cent in 2016 and 36.6 in 2021, the equivalent 50% to 1.3 times the national average. Women are 45% also persistently overrepresented among the 40% poor: they lead 48 percent of the households in 35% Brazil but 56 percent of the poor households. 30% 25% Poverty in rural areas has been approximately 20% twice that of urban areas since 2016. In 2021, 15% poverty rates among rural households were 10% 49.0 percent. And, while just 6.3 percent of the 5% population aged 65 or more could be classified 0% as poor, this rate was 45.5 percent among tho- se aged 18 or less. age <18 age [18,64] age >64 overall Source: PNADC harmonized by SEDLAC. Notes: Poverty rates estimated at $6.85 (2017 PPP). Brazil Systematic Country Diagnostic - Update 45 Education attainment is lower the poor population has worse positions in the among the poor, but this cannot ex- labor market. The average hourly wage of the plain the differences in labor retur- urban non-poor was BRL 17.1 in 2021, 2.8 as ns alone. The average years of education high as BRL 6.1 of the poor. The ratio is 2.3 in among adults aged 25 or more in the urban rural areas, where the wages are respectively population is two years lower for the poor BRL 11.4 and BRL 5.0. About one half of the (7.9) than for the non-poor (9.9). The gap also working-age poor (52 percent) are actively see- holds in rural areas, where non-poor working king a job or working in urban areas, and less adults have 6.2 years of education on average, than a half (44 percent) are doing so in rural against 7.8 of the non-poor. Limited improve- areas. These rates are higher for the non-poor, ment in formal education levels across gene- 65 and 56 percent, respectively. Notwithstan- rations also hinders economic development of ding, once education attainment and residence historically disadvantaged groups. For instan- area is controlled in an estimation of a Mincer ce, Brazil ranked in the second quintile of rela- equation, being male is significantly correlated tive intergenerational educational mobility in a with 18 percent higher wages on average. At comparison of 153 countries (van der Weide et the same time, AfroBrazilians have 11 percent al. 2021). These facts can partially explain why lower wages everything else hold constant. Figure A1.2. Distribution of assets by demographic groups Share in population Share of children (<15 years old) within the group Labor force participation Non-salaried Unemployed Would like to work more CLT formal worker Precarious materials NO water connection Unimproved sanitation NO private bathrooms Ownership title Ownership of computer or laptop Acess to internet Car ownership 0 25 50 75 100 Percentage (%) Non-poor Rural poor Urban poor Female-headed poor AfroBrazilian-headed poor Source: PNADC. Notes: Statistics of the population headcount and related to labor market are from 2021, while the others are from 2019. IBGE has not released the dwelling module of PNADC since 2019 by the time the SCD update was prepared. 46 Brazil Systematic Country Diagnostic - Update Besides the disparities in the accu- The rural poor are usually family far- mulation of human capital, the eco- mers living of subsistence culture nomic status of the Brazilian po- and lacking the assets to upgrade pulation is also linked to structural their productivity. Among the workers in heterogeneity in the access to phy- agriculture in Brazil, 73 percent are relatives of sical capital and opportunities. About the farming owner (Agricultural Census 2017). one-third (34 percent) of the poor work in These small farmers primarily consume their agricultural or construction activities. Among annual crop production, mainly grains, for sel- women, 13 percent work in activities of priva- f-sustenance, including animal feed. Howe- te households. Many of these have low educa- ver, horticultural production is focused on the tion attainment and no other capital to seek market and concentrated in peri-urban areas. better economic opportunities. The precarious Family farmers face challenges due to limited conditions of the dwellings are one of the fac- access to infrastructure, technical assistance, tors that can harm the poor households’ in- capital, and education. They often lack elec- come generating capacities. In the rural zone, tricity, receive minimal technical support, and more than one-fifth (21 percent) is forced to have limited cooperative membership. Edu- practice open defecation due to the lack of cation and cooperative membership are key bathrooms, more than a half (55 percent) do factors influencing smallholder productivity not have appropriate sanitation in their house, (Hanusch, 2023). Access to credit is crucial for and 6 out of 10 have no water supply indoor. productivity-improving inputs, but it remains The situation is not much better for some of low for small farmers (i.e. only 15 percent of the urban poor, where 9 percent lack connec- family farmers are borrowers according to the tion to the water network, and 15 percent have Census), with limited availability of long-term no access to sanitation network or adequate investment loans. The agricultural work is be- sanitation facilities. The gap in land titles ow- coming increasingly less attractive to younger nership highlights another facet of the Brazi- generations of family farmers, thus making lian inequality. The difference in land ownership aging of the labor force another challenge to rates is 7 percentage points between poor and their competitiveness. One-fourth of family non-poor in urban settings (respectively 61 farmers are 65 or older, while this is the case for and 68 percent report to own their land) and 15.4 percent of non-family farmers (Agricultu- 4 percentage points in rural zones (72 versus ral Census 2017). Poor family farmers heavily 76 percent). But, when it refers to entitlement rely on nonfarm income, with pensions and re- of the lands, the gaps come to 17 and 16 per- tirement payments being their primary sour- centage points, respectively. In fact, only half ces (Hanusch, 2023). Less competitive farmers of the urban poor and 46 percent of the rural adapt by changing their production mix, selling poor hold their ownership title. The absence of labor or land to more productive farmers, or land tenure is frequently associated with lack shifting to labor-intensive products. of collateral to access credit, and, even worse, insecurity and violence surrounding land dis- Indigenous people and quilombolas putes (Damasceno et al. 2017). have been usually overlooked by the Brazil Systematic Country Diagnostic - Update 47 Brazilian statistical system, but the rials in their floors and walls and limited access available survey data and adminis- to electricity, which may pose health risks and trative registries suggest they are hinder economic integration. Despite some pro- mostly poor families living in rural gress in previous decades, both IP and quilom- areas. The indigenous people (IP) and quilom- bolas have low levels of formal education at- bolas registered in the CadUnico system are tainment. While the Census data indicate that predominantly impoverished families residing the illiteracy rate among indigenous people has in rural areas and living under half a minimum decreased from 51 percent to 23 percent bet- wage per capita. Among the IP registered in ween 1991 and 2010, it remains twice as high CadUnico, 75 percent live in rural areas. Simi- as the national rate. Most household heads larly, the situation for quilombolas registered among IP and quilombolas have not completed in CadUnico is not significantly different, with primary education, with only a small percen- 80 percent residing in rural locations. Consi- tage having secondary or tertiary education. dering their historical context and the legacy Furthermore, a lower proportion of indigenous of escaping slavery, it is not surprising to find and quilombolas household heads report being high levels of monetary income poverty. Hou- employed compared to disadvantaged rural sing conditions for IP and quilombolas appear families, with self-employment being the pre- to be worse than those of poor rural families in dominant form of work, often on their own general, with limited access to essential servi- lands. Temporary employment in agriculture ces such as water supply and waste collection. and other rural activities also contributes signi- Their households also exhibit low-quality mate- ficantly to their economic activities. 48 Brazil Systematic Country Diagnostic - Update Appendix 2. Analytical foundations of the Systematic Country Diagnostic Update TITLE DESCRIPTION A Balancing Act for Brazil’s Policy options on how to simultaneously provide a pathway to higher incomes for the States of the Legal Amazon: An Amazon States while also protecting natural forests and traditional ways of life. Economic Memorandum (2023) Alternative Futures for Brazil: The report contributes to the debate in Brazil about how to overcome growth and Productivity, Inclusion, inclusion challenges ahead, over a 20-year horizon. Sustainability (forthcoming) A compilation of poverty and inequality analytics produced in the past decade, with an Brazil Poverty and Equity emphasis on the impacts of the COVID-19 pandemic - on Brazil’s labor market, the role of Assessment: Looking Ahead of the social protection system in supporting the poorest, and the increased vulnerability Two Crises (2022) due to climate change. Social Protection for the future: An assessment of Brazil’s social protection and labor systems and the reforms needed a 2042 outlook (2023) to address the challenges Brazil will face in the next two decades. The document presents an evolution of the agriculture productivity growth focusing on Agriculture Productivity Growth recent trends and future prospects at the time of its publication. It also provides policy in Brazil: recent trends and recommendations and discusses how to close the agriculture productivity gap for those future prospects (2017) left behind. The Brazil Human Capital The report produces a detailed analysis of the gaps in quality education and health for Review: Investing in People every child, and how these limit the potential of an individual’s productivity. (2022) The Brazil Infrastructure Review The report looks at how to modernize and close Brazil’s infrastructure gap to improve (forthcoming) productivity and secure long-term growth. The Country Climate and The report examines the implications of climate change and climate action for Brazil’s Development Report for Brazil development objectives, priorities, and pathways. It identifies opportunities for Brazil to (2023) achieve both its development goals and its climate commitments. A fair adjustment: efficiency and The report conducts a throughout analysis of the quality of public spending in Brazil, equity of public spending in covering various aspects from the public sector wage bill to public procurement, the Brazil: Volume I (2017) efficiency of labor market programs and the level of expenditures in the health sector. Jobs and growth: Brazil’s The report provides a comprehensive investigation on the causes of low productivity productivity agenda (2018) growth in Brazil and the main barriers to realizing Brazil’s productivity promise. Gestão de Pessoas e Folha de Pagamentos no Setor Público The report documents a series of facts about the evolution of the public sector wage bill Brasileiro: o Que Os Dados Dizem and discusses policy options for reform. (2019) Opportunities for All The notes aim to spark discussion around the key challenges that Brazil is currently Brazil Policy Notes 2022 (2022) facing and presents potential ways to address them. Source: own compilation. Notes: Full citations can be found in the references section. Brazil Systematic Country Diagnostic - Update 49 Appendix 3. Reforms adopted by the Brazilian government after 2016, by chronological order LAW OR YEAR REGULATION INTENDED OBJECTIVES LEGAL ACTS Intended to limit public spending to inflation in the 20 years following the enactment of the Constitutional Amendment. The cap is applicable to all administrative levels of govern- Spending ment (federal, state and municipal) including the Public Emenda Constitucional N. 2016 Cap Prosecutor’s Office and the Public Defender’s Office. 55/2016 Reform The main measure of the reform is to limit public spending and investments to the same amount of previous year, adjusted for official inflation. Novo Aimed to increase youth’s interest in the school, reducing Ensino dropout, and adapt the curricula to the current labor Médio market requirements. There are many challenges to Lei 13.415/2017; 2017 (High implementation, especially in low socioeconomic contexts, School Portaria 727/2017 do MEC since it demands more resources from the schools and Reform) more time in classroom from the students. Intended to increase employment and formality, particularly offering legal security to employers through the regulation of practices that were not Labor established de jure. The law allowed part-time 2017 Legislation employment, relaxed the rules over the labor journey Lei 13.467/2017 Reform period, set collective agreements as prevalent over the legislation, allowed the split of annual vacation period, increased the costs of legal litigation, and ended the mandatory contribution to unions. Envisioned increased competition and access to credit in the financial sector. Through a handful of legal normative acts, the Central Bank of Brazil created the legal framework Fintechs Resoluções 4.656/2018; Legal to allow the establishment and functioning of financial 4.657/2018; 4.658/2018; 2018 Framework institutions that do not follow traditional banks business 4.865/2020 do BCB model. For instance, it created Direct Credit Society, and Interpersonal Lending Society, and established FinTech Regulatory Sandbox. 50 Brazil Systematic Country Diagnostic - Update LAW OR YEAR REGULATION INTENDED OBJECTIVES LEGAL ACTS Had the objective to pave public debt sustainability. The pensions reform tried to contain the explosive trajectory Pensions of the expenses with pensions by increasing the retirement System 2019 requirements and reducing the value of the benefits. The Emenda constitucional 103 Reform age and time of contribution to retire were combined and raised. The load factor on past contributions determining the value of the pensions was diminished. Reduced barriers to entry in the water and sanitation sector, making it possible to attract more private Water and investments. It encompasses norms that should promote 2020 Sanitation the adequate provision of services, with full service to Lei 14.026/2020 users, and ensure the simultaneous provision of water supply and sanitary sewage services. Intended to foster economic growth through the facilitation of monetary transactions and financial inclusion. PIX legal framework was being enacted since 2018, but the system was only implemented in 2020. Instantaneous The PIX transactions are done in instants of seconds, can Payment Comunicado 32.927/2018 do 2020 be executed easily with a mobile phone (i.e.: by typing a System BCB (PIX) phone number in a bank app or reading a QR code in camera), and charge no costs at the users. PIX has been widely adopted as a mean of payment and its acceptance ranges from micro informal business to luxury goods vendors. Intended to ease bureaucracy and diminish the costs of doing business. The government passed several decrees Parecer and normative acts to lower environmental conservation 00115/2019/DECOR/CGU/AGU; Environmental standards required of enterprises and agricultural Despacho 4410/2020 do MMA; 2020 Easing producers. Among others, the government changed the Resolução 37/2020 da legal understanding from the Atlantic Forest Conservation ANM/MME; Ato 42/2020 do Law that required landowners to restore Areas of MAPA Permanent Preservation (APP) in that biome. Lei 13.982/2020; MP The changes had the objective to increase the social 1.000/2020; Decreto protection of the most vulnerable during and after the 10.661/2021; MP 1.061/2021; Flagship Cash covid-19 pandemic. It increased the coverage as well as Decreto 10.851/2021; Decreto 2021 Transfers the benefits of the program, but at the expense of 10.852/2021; Decreto Reform relaxing inclusion criteria verification, reducing the 11.013/2022; Emenda conditionalities of permanence monitoring, and diminish- Constitucional 123; MP ing the cost-effectiveness of the program design. 1.164/2023 Source: own compilation. Brazil Systematic Country Diagnostic - Update 51 Appendix 4. Governance and Institutions in Brazil after SCD1 Brazil’s legal system is anchored in in 2022 (Figure A4.1). The Rule of Law Index the principle of the rule of law and of the World Justice Project has also seen the separation of powers. However, Brazil’s score and ranking drop from 2016 the country’s declining performance to 2022. The WEF’s Global Competitiveness on international indexes highlights Index (2019) reveals significant weaknesses ongoing challenges. Brazil’s performance in the areas of checks and balances (Figu- on the Bertelsmann Stiftung’s Transforma- re A4.2), with Brazil ranking poorly in judicial tion Index (BTI) has seen a decline in the De- independence (94th), incidence of corruption mocracy Status dimension, with the country’s (91st), and efficiency of the legal framework in ranking dropping from 19th in 2014 to 29th challenging regulations (115th). Figure A4.1. BTI Democracy Status si | democracy status Q5.4 | social capitalQ 10.00 1 | stateness Q5.3 | approval of democracy Q1.1 | monopoly on the use of force 8.00 Q5.2 | interest groups Q1.2 | state identity 6.00 Q5.1 | party sysytem Q1.3 | no interference of religious dogma 4.00 Q5 | political and social integration Q1.4 | Basic administration 2.00 Q4.2 | Commitment to democratic institutions 0.00 Q2 | political participation Q4.1 | performance of democratic institutions Q2.1 | Free and fair elections Q4 | stability of democratic institutions Q3.4 | Civil rights Q2.3 | association / assembly rights Q2.4 | Freedom of expression Q3.2 | independent judiciary Q3 | Rule of Law Q3.1 | separation of powers 2022 2014 Source: Bertelsmann Transformation Index 2022 52 Brazil Systematic Country Diagnostic - Update Figure A4.2. Rule of law and governance Judicial independence 80 70 60 50 government long 40 incidence of corruption term vision 30 20 10 0 government’s responsiveness to change government ensuring policy stability Brazil China india mexico malaysia Russian Ukraine United states south africa Federation Source: Global Competitiveness Index 2019 Brazil has a robust legal framework weakening of corruption control bodies in the to combat corruption, but it faces country due to political interference. For ins- challenges in effectively implemen- tance, Brazil’s ranked 94th out of 180 countries ting and enforcing these laws. Accor- in the 2022 Corruption Perceptions Index. ding to a 2021 survey conducted by the fede- ral government in partnership with the World Party fragmentation in the country Bank, 58.7 percent of sampled civil servants is the highest in the region and one witnessed unethical practices during their ca- of the highest in the world. The Bra- reers, and 51.7 percent did not feel safe enough zilian Congress has experienced significant to report illegal conduct. The fight against cor- party fragmentation over the past two deca- ruption in Brazil, however, has seen significant des. The probability that two deputies picked developments. For instance, the creation of at random from the legislature will be of diffe- the Inter‐ministerial Committee against Cor- rent parties has risen every year since 2000, ruption (CICC) in April 2019 was a step for- going from 0.86 to 0.95 in 2020 (Figure A4.3), ward towards strengthening the enforcement the highest in the region and only surpassed of the accountability and anti‐corruption legal by a few countries in the world. Fragmen- framework. The CICC launched the 2020‐25 tation in government parties is often higher Anti‐corruption Plan with the aim of improving than fragmentation within opposition parties. the mechanisms for prevention, detection, and This suggests that even within ruling coali- accountability for acts of corruption. Despite tions, there is considerable fragmentation and these efforts, there is still concern about the diversity. Brazil Systematic Country Diagnostic - Update 53 Figure A4.3. Party fractionalization 1 1.20 0.9 1.00 0.8 0.7 0.80 0.6 0.60 0.5 0.4 0.40 0.3 0.20 0.2 0.00 0.1 0 guatemala Costa Rica Uruguay Colombia honduras mexico peru paraguay Chile Brazil ecuador argentina Bolivia Fractionalization government parties fractionalization opposition parties fractionalization Source: IADB’s Database of Political Institutions (DPI2020) Significant efforts have been made Constitutional expenditure commit- to minimize the fragmentation of the ments, evolving social demands, and Brazilian party system that was ob- political system dynamics, has per- served in SCD1, but consensus buil- petuated the growth of the public ding around key reforms remains dif- sector over the past years. Between ficult. A constitutional amendment passed in 2014 and 2021, government expenditure in Bra- 2017 with the aim of reducing the prevalence zil averaged 42.8 percent of GDP (Figure A4.4). of smaller, transient parties. Another significant This is significantly higher than the average of development was the introduction of ‘party fe- 34.0 percent for Latin American and Caribbean derations’ through Law 14.208 in 2021 to pre- countries, and surpasses the average for ad- vent the formation of mere electoral coalitions, vanced economies (40.4 percent of GDP). Pu- as was common until the 2018 elections. Howe- blic employment, which includes federal, state, ver, fragmentation is still high, and the process and municipal positions, has stabilized in recent of consensus-building remains intricate. The years, but the wage bill is still considerable (Fi- political landscape has seen the emergence of gure A4.5). Federal employment dropped from political fractions wielding substantial influen- 1.2 million in 2014 to 0.9 million in 2019, repre- ce over the legislative agenda, following minor senting a decline of 25 percent. However, state reforms in the internal regulations of the Con- employment saw a less drastic decrease, from gress and Senate. This has resulted in a higher 3.9 million in 2014 to 3.4 million in 2019, a re- bargaining power for these groups when nego- duction of 12.8 percent. Meanwhile, municipal tiating with the Executive branch, and a signifi- employment remained stable at around 6.5 mil- cant cost on the national budget. The power of lion since 2013. While the public sector wage bill the Brazilian President to pass major reforms accounted for about 9 percent of GDP in 2021, hinges on their ability to create supportive coa- down from 13 percent in 2015, it is still consi- litions within Congress, a process that can be derable, largely due to the wage premiums, es- time-consuming and costly. pecially in the federal government and judiciary. 54 Brazil Systematic Country Diagnostic - Update Figure A4.4. General government expenditure, average Figure A4.5. Public employment in Brazil, 2002-2019 2014-2021 (percent of GDP) (Millions) 45 7.0 40 6.0 35 30 5.0 25 4.0 20 3.0 15 10 2.0 5 1.0 0 0.0 Brazil advanced United states Ukraine economies Russia LaC south africa China emerging mexico malaysia markets india Federal state municipal Source: World Economic Outlook (WEO) database, April 2023 Source: IPEA-Atlas do Estado Brasileiro, based on Relação Anual de Informações Sociais (RAIS)/ME Despite a well-established adminis- Brazil’s intergovernmental trans- trative system, particularly at the fer system needs to be revamped federal level, government effective- to address horizontal gaps between ness challenges persist. Rules require states and promote regional redistri- the civil service to maintain neutrality, inde- bution. By international comparison, Brazil’s pendence, and equitable management, with vertical fiscal disparities are relatively low (27 the majority of appointees selected through percent in 2017) compared with other coun- public examinations. In certain areas, the hiring tries such as Peru and Mexico (80 percent) or of civil servants is based on strict professional the UK and South Korea (above 60 percent). evaluation criteria. However, Brazil’s govern- However, Brazil has experienced large horizon- ment effectiveness is lower than anticipated, tal gaps. The allocation formula for the State given its robust administrative capacity. Since Participation Fund (FPE) relies entirely on ta- SCD1, Brazil has seen a decline in most varia- xes, thereby causing the annual volume to be bles of the Worldwide Governance Indicators, heavily correlated with the economic cycle, including a significant drop in ‘Government and the rule mandates the distribution of 100 Effectiveness’.126 In terms of government spen- percent of the values every year, resulting in ding efficiency, as measured by the World Eco- low flexibility for shock absorption. To improve nomic Forum’s Global Competitiveness Index, local public policies, allocation formulas could Brazil’s score is significantly lower than many other major and emerging economies. This include ex post performance-related criteria relatively low score underscores the existing on transfer results, mostly in the efficiency of gap between Brazil’s public sector resources states public resources management. and the actual effectiveness of its govern- ment operations. Also, performance variances Fiscal capacity at the state level is across federal agencies, and inconsistencies in uneven across the country. To lessen capacity and bureaucratic profiles at state and this situation, the federal government created municipal levels, have persisted over the years. in 2017 the Fiscal Recovery Program (RRF) and Brazil Systematic Country Diagnostic - Update 55 Fiscal Sustainability Program (PEF). RRF of- fers debt relief to highly indebted states that comply with various fiscal adjustment requi- rements, such as reducing tax exemptions, privatizing state-owned enterprises, and im- plementing pension reforms. PEF aims to help subnational governments in fiscal distress re- gain creditworthiness by improving current sa- vings and fiscal liquidity. Under PEF, the Federal Government provides guarantees for new len- ding against the implementation of a fiscal ad- justment program, which must include at least three fiscal measures from the RRF. The Federal Government, through the Ministry of Economy, developed in 2021 the Progestão program127 to support fiscal measures with management system reforms to increase efficiency in public expenditure. The program aims to help states improve their management capacity, increase efficiency in public expenditure, and address management challenges in a coordinated, cou- ntry-wide technical assistance program in line with ongoing and upcoming reforms. 56 Brazil Systematic Country Diagnostic - Update Appendix 5. Data and knowledge gaps about Brazil AREA/SECTOR DATA/KNOWLEDGE GAP DESCRIPTION Estimates suggest that almost one-third of all water produced in Brazil is lost. Such figures, however, are frequently underestimated due to a lack of data, Nonrevenue water especially at the municipal level. This is an area where very little progress has been made over the past few decades. Data on how much citizens declare and pay in taxes has remained highly secretive beyond aggregate statistics in Brazil even to other areas of Administrative government. International experience shows that there are ways to make such tax data data available in forms that protect the privacy of the more identifiable (usually high-income) contributors. Brazil stills lacks reliable disaggregated information about some specific population groups. One limitation is related to gender-sex data. The National Basic Education Assessment System (Sistema Nacional de Avaliação da Educação Básica, SAEB), for example, stopped releasing its disaggregated Data on certain data by sex in 2019. In some databases, race is self-identified, and in others it population is reported by a third person, what creates some inconsistencies when vulnerable groups comparing different data sets. Third, data about the indigenous population are often underreported. There is room for improvement in producing evidence that mirrors the “many coexistent Brazils” in terms of human capital indicators across different population groups. Timely data on losses Information on loss estimates is dated. Better and more timely information related to natural should be produced to more accurately monitor the impacts of climate change hazards as well as potential effects on livelihoods of vulnerable populations. Source: own compilation. Brazil Systematic Country Diagnostic - Update 57 Notes i World Bank (2023d). IBGE distinguishes five racial and ethnic categories in its household surveys, according to self-declaration: preto (generally understood as dark- ii skinned Afro-descendants), pardo (generally light-skinned Afro-descendants or those of mixed race), indígena (indigenous), amarelo (Asian-de- scendants), and branco (white). Pretos and pardos comprise the broader group of Afro-descendants. In this Update, we use the term “Afro-Bra- zilian” when referring to both preto and pardo demographics together. iii World Bank (2016). IV Calculations using the TFP indicators series from FGV-IBRE’s Regis Bonelli Observatory of Productivity. V In terms of financing challenges, cities face a significant disparity between the various responsibilities they have and their limited ability to gen- erate revenue. Only 18 percent of the overall public budget is allocated to municipalities, which means that their capacity to invest heavily relies on income from sources like property taxes, service fees, and direct federal investments (World Bank, 2023a). VI World Bank (2009) and Brumby, Mendes, and Velloso (2012). 7 Campos and Souen (2017). 8 Data from Johns Hopkins Coronavirus Resource Center: https://coronavirus.jhu.edu/data/mortality 9 Brazil’s fiscal stimulus package was one of the biggest in the LAC region though below that of Chile and Peru and one of the largest among emerging economies (IMF, 2021). 10 These were above the Central Bank’s inflation target upper band for both years (5.3 percent and 5 percent, respectively). 11 From historically low 2 percent in early 2021 to counter the negative effects from the pandemic in 2020. 12 In May 2023, inflation was 3.9 percent, less than a third the rate in April 2022 (12.0 percent) and the lowest rate since October 2020 (3.9 percent). 13 Public debt is defined as the general government gross debt, including Central Bank repo operations. This definition differs from the one used by the IMF, which includes all Treasury securities held by the Central Bank, not only those related with repo operations (IMF, 2017). 14 The ceiling limited the growth of federal primary expenditures (net of transfers to other levels of government) to the previous year’s inflation for 20 years (between 2016 and 2036) and imposed a reduction of 3 percentage points of GDP on all primary expenditures by 2030, therefore maintaining constant these expenditures in real terms. 15 A 11.2 percent of GDP fiscal stimulus package cushioned the plunge and supported subnational governments, companies, and vulnerable house- holds (including through a large, generous temporary emergency social program, Auxilio Emergencial), allowing a consumption-led recovery. The fiscal expansion to support activity in 2020 led to the primary deficit to rise from 1 percent of GDP in December 2019 to 9.3 in 2020 and general government’s gross debt from 74.4 percent in 2019 to 86.9 percent in 2020. 16 Primary surplus was 0.7 percent and 1.3 percent of GDP, respectively 17 This share was certainly lower than the 86.9 percent of GDP in 2020 and 78.3 percent of GDP in 2021. 18 FX-denominated government debt represents 5.9 percent of GDP and 94.7 percent of debt was held in the domestic market in February 2023, with about 29 percent of the outstanding debt maturing within one year (37.9 percent in December 2020). Additionally, Central Bank reserves stood at high USD 328.1 billion (16.7 percent of GDP) in February 2023. 19 See Echavarria and Grittayaphong (2021). Other indicators also point to an improvement in Brazil’s debt position. About 28.8 percent of the outstanding debt will mature within one year, compared to 37.9 percent in December 2020. 20 Distortions in credit markets were mitigated by a reduction in earmarked loans, with the share of earmarked credit in total credit decreasing from 49 percent in 2015 to 40 percent 2022. Also, earmarked loan rates are now closer to non-earmarked rates, with a substantial impact of the Long-Term Rate (TLP) approval. These developments in the financial sector contributed to a booming private capital market, including for long-term financing, represented by a 263 percent increase in debentures issuance between 2014 and 2022. 21 Cord et al. (2015). 22 The poverty headcount rate is measured at USD 6.85 per day (2017 PPP), while the extreme poverty rate is measured at USD 2.15 per day (2017 PPP). 23 World Bank (2021). 24 Neri and Hecksher (2022). 25 World Bank (2022b) and World Bank (2023c). 26 Credit Suisse (2021). 27 World Bank (2022b). At the time the SCD update was written, the PNAD-C 2019 was the latest available survey with the data on households’ characteristics needed to estimate chronic poverty. IBGE did not publish the dwelling module of PNAD-C for the annual release of 2020 and 2021. Data for 2022 was published in the second week of June 2023. 28 See Appendix 1 for a more detailed profile of the poor in Brazil. 29 Lara Ibarra et al. (2023). 30 Costs may have been increasing, as the average costs for the period 1995-2005 is estimated to be around BRL 7 billion. Unfortunately, the most recent cost estimates are for 2019 (see World Bank, 2020b). Data collected within that report comes from incident reports submitted by municipalities to access federal funds for response and recovery. Therefore, the cost of disasters in Brazilian cities is estimated to be much larger. Some cities, such as São Paulo, have not submitted many reports, and this may indicate not that they are not experiencing disasters or that these cities (usually the most financially sound ones) are covering most of the costs without reaching out for federal support. 31 The Northeast region has the largest losses: BRL 125.55 billion, the equivalent to 47 percent of the country’s registered losses and 49.4 percent of the total number of occurrences, most of them being caused by climatological events such as droughts (World Bank, 2020b). 58 Brazil Systematic Country Diagnostic - Update 32 See EM-DAT dashboard for Brazil: https://www.emdat.be/emdat_atlas/sub_html_pages/sub_html_BRA.html. 33 World Bank analysis using data from Hallegatte, Rentschler and Rozenberg (2019). 34 The current hydropower assets are aging, with large-scale hydropower assets averaging 55 years, with reduced efficiency and capacity - due to both their age and inadequate maintenance. 35 World Bank (2022b). 36 West and Fearnside (2021). 37 Sant’Anna and Costa (2019). 38 Illegal deforestation is most prevalent in undesignated lands. 39 Two examples are the outdated rural land tax and untargeted agricultural subsidies. 40 World Resources Institute (2023). 41 Climate Watch (2022). 42 Data from the Greenhouse Gas Emission and Removal Estimating System (SEEG); see http://seeg.eco.br. 43 Reforms focuses, amongst others, on improving the efficient allocation of credit, labor market efficiency, reducing the cost of doing business, attracting investment (for example in sanitation), and opening the economy to trade. 44 See https://www.epl.gov.br/plano-nacional-de-logistica-pnl. 45 The list of the SCD Update analytical foundations is included in Appendix 2. 46 See Appendix 3 for a compendium of reforms adopted after SCD1. 47 Brazil is generally seen as having effectively developed a competent group of federal officials who can implement intricate economic and social policies – especially when compared to countries like Argentina and Colombia. However, at the state and local levels, administrative systems often exhibit greater political influence. 48 Institutional constraints are presented for each of the challenges identified in the Update. Additional information on governance and institu- tions in Brazil after SCD1 are presented in Appendix 4. 49 Productivity was estimated using the gross product by sector at 1995 prices (IBGE – National Accounts) divided by the number of employed individuals by sector from PNAD-C. 50 TFP increased in large agricultural establishments (i.e., with 500 hectares or more) in the period 1985-2006, while it remained mostly stagnant among small producers (i.e., with up to 5 hectares). In all regions but the North, the TFP level of small producers in 2006 was smaller than that of 1996. In the North, TFP among small farmers was higher than those of large producers in 2006, but the TFP growth was lower: between 1985 and 2006 large producers saw increases of about 60 percent while TFP grew about 30 percent among small farmers (Helfand and Taylor, 2021). Moreover, TFP growth of small farmers was mainly driven by increases in land productivity, while this was not observed among large agricultural establishments. Data from the Agricultural Census 2017 suggests that small farmers in the North are a relatively small group: they represent 27 percent of the total number of establishments in the North (3.1 percent of the establishments in Brazil) and the value of their agricultural produc- tion is 6.2 percent of the agricultural production in the North (0.4 percent of the production in Brazil). 51 Arias et al. (2017). 52 Luna and Klein (2014). European migrants also settled in other parts of the country including Paraná (1940s) and in the Cerrado, mainly Mato Grosso (1970s). 53 Assunção et al. (2019) and Souza et al. (2022). 54 Rada and Buccola (2012), Assunção and Bragança (2015) and Assunção et al. (2023). 55 Increased productivity in agriculture and mining could have negative impacts on environmental sustainability unless it is combined with more effective land and forest governance. Higher productivity in agriculture and mining, also means more efficiency, so less resource use. However, if demand is elastic, higher productivity means more consumption of the good (the so-called Jevons effect), which may lead to more pressure on natural resources. For oil exports, higher oil productivity could lead to higher oil exports, potentially contributing to higher global damage from GHG emissions. Similarly, the Jevons effect can also arise in agriculture, potentially putting more pressure in the “arc of deforestation” of the Legal Amazon - where forest governance is weak (Hanusch, 2023). 56 Source: Research developed by the Competitive Brazil Movement (available at https://www.mbc.org.br/programa-custo-brasil/) 57 Global Competitiveness Report 2016-2017. World Bank data from the Doing Business report cannot reflect that because the latest information for Brazil refers to 2019. These figures were even worse in 2016, when it used to take 83 days to start a business in Brazil. Since then, the time required to start a business has reduced substantially, reaching 17 days in 2019. 58 World Bank (2020a). 59 Dutz (2018). 60 Hanusch (2023). 61 There are four taxes of such kind: two 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. 62 The ICMS - Imposto Sobre a Circulação de Mercadorias e sobre Prestações de Serviços - is an origin-based VAT on consumption of goods and selected services administered by the States. 63 A more in-depth assessment of the Brazilian tax system is limited due to the unavailability of some tax data. See Appendix 5 on this and other knowledge gaps identified in this Update. 64 Bonomo et al. (2015) and Bonomo et al. (2018) discuss how small firms with innovative and risky projects are expected to find it difficult to receive credit and, as such, they are natural candidates for earmarked credit. In Brazil, however, they find evidence that larger, older and less risky firms have benefited the most from the government sponsored credit expansion of the period 2004-2012. Thus, earmarking may be contributing little to boost innovation in Brazil. 65 SEBRAE (2014). 66 Central Bank of Brazil (2023). 67 SME Finance Forum (2023). Brazil Systematic Country Diagnostic - Update 59 68 Air transport, rail freight transport, legal services, and architecture services have the lowest score relative to the average across sectors (indi- cating lower restrictions on trade). In recent years, STRI scores improved for commercial banking and insurance, reflecting the ease of licensing conditions for foreign banks and insurance providers. 69 World Bank (forthcoming a). 70 WIPO (2023). 71 Lei de Informática (Informatics Law) of 1991 (renewed in 2001, 2004, and 2014) promotes increased local content of information and communi- cation technology (ICT) hardware and related electronics assembly, as well as investments in local R&D operations. Lei do Bem (Fiscal Incentives Law) of 2007 expanded incentives for investments in R&D, authorizing companies that invest in R&D and meet certain requirements to claim tax incentives automatically. 72 World Bank (2023a). 73 Silva et al. (2021). Additionally, during the period spanning the economic crisis of 2014-2015 and the onset of the COVID-19 pandemic, employ- ment rates continued to decline for individuals without a secondary education, while recovering for those who had completed at least secondary education. 74 World Bank (2022b). 75 More specifically, less than 5 percent of all students from upper secondary schools in Brazil perform above level 9 in the Sistema de Avaliação da Educação Básica (SAEB), which measures of proficiency in a certain area of knowledge by students. Commonly students below proficiency level 4 present inadequate learning levels for her grade. More information can be found here: https://download.inep.gov.br/saeb/resultados/ apresentacao_saeb_2021.pdf 76 Brazil is a signatory of various international agreements, including the Uruguay Round Accords of the General Agreement on Tariffs and Trade and the Paris Convention for the Protection of Industrial Property. 77 A useful framework to understand the income generating capacity of households is found in Attanasio and Székely (1999), Bussolo and Lo- pez-Calva (2014) and Lopez-Calva and Rodriguez-Castelan (2016) whereby households’ assets (including various types of capital), the rate of use, the returns gained from them and key components to understand their capacity to escape poverty. 78 The Brazilian Constitution allocates responsibility for education to the federal, state, and municipal levels of government, which jointly provide public pre-tertiary education to 38 million students. Preuniversity education in Brazil consists of ECE for children from birth to age 5, primary and lower secondary education (grades 1 to 9) and upper secondary education (grades 10 to 12 on the general track or grades 10 to 13 for tech- nical programs). The federal government is responsible for overall education planning and policymaking, such as setting the minimum wage of teachers and the rules governing funding formulas. Municipalities are responsible for providing ECE and primary and lower secondary education, while states are responsible for providing lower and upper secondary education. Municipalities and states overlap in their responsibilities for lower secondary education because not all municipalities can afford to provide it. Out of the 47 million students in preuniversity education, 15 million are enrolled in state school networks, 23 million in municipal school networks and 9 million are enrolled in private schools, which represent 31 per- cent, 49 percent and 19 percent of total national enrollment, respectively. The federal government manages a few mostly technical and military schools but focuses on providing tertiary education. 79 INEP (2022). 80 INEP (2023). 81 The state of Ceará and the municipality of Sobral, for instance, are well-known examples of success in primary and lower secondary education thanks to a combination of results-based financing, technical assistance to school administrators, and a culture of monitoring and evaluation. 82 QEDU, accessed in 2021. https://qedu.org.br/ 83 Almeida et al. (2015). 84 Based on PNAD-C 2019. 85 Viera and Arends-Kuenning (2019). 86 Although the number of those in formal employment that lose their jobs is relatively low, the programs financed by the federal government’s Workers’ Protection Fund (Fundo de Amparo ao Trabalhador) are almost entirely devoted to this group. In addition, funding for the national sys- tem for job search and employment (Sistema Nacional de Emprego – SINE) has been minimal and falling. 87 Examples include the federal skills programs such as Employ More (Emprega Mais), which promotes qualification and employment opportuni- ties aligned to companies’ needs, and the Learning Contract (Contrato de Aprendizagem), which assists approximately 400,000 young people annually with on-the-job training and formal education. 88 Low-income refers to households belonging to the bottom 40 percent of the income distribution. See World Bank (2022b). 89 Marinho (2009). 90 Scheffer et al. (2020). 91 World Bank (2022b). 92 World Bank (2022b). 93 According to survey data from 2019 (World Bank 2022b). 94 Fandiño, Arretche and Hanusch (2022). 95 See Damasceno, Chiavari, and Lopes (2017). 96 World Bank (2022b). 97 See Castro (2021). 98 The open banking initiative aims to enable bank users to transfer their own information between banks and to other providers of financial services more easily. The measure seeks to better align interest rates with borrowers’ creditworthiness, increase competition and spur financial inclusion. 99 On June 23, 2023, Brazil’s president announced the country’s commitment to end deforestation in the Amazon by 2030. The announcement was made after Lula’s participation in an event organized by the French government to discuss a new global financing pact. In a similar vein, in 2021 during COP26, the then-president Bolsonaro announced that Brazil was committed to end illegal deforestation by 2028. 100 World Bank Group (2023). Interventions need to be well designed, however. Recent evidence shows that incentivizing land use in tropical for- 60 Brazil Systematic Country Diagnostic - Update ests can increase deforestation: https://link.springer.com/article/10.1007/s10531-022-02540-4 101 Hanusch (2023). 102 World Bank (2023a). These interventions are particularly suitable for Brazilian metropolises and larger regional capitals and should be executed in a systematic 103 manner. 104 World Bank (2023a). 105 World Bank (2023a). The program was renamed Auxilio Brasil in 2022 following the ending the of emergency cash transfer Auxilio Emergencial. However, the original 106 name was adopted once more in 2023. 107 See Morgandi et al. (2023) for a set of medium-term recommendations to strengthen the social protection system. 108 World Bank (2017). 109 ICMS, a key revenue sources for Brazilian states, can be adjusted by local authorities and only inputs that are physically incorporated into the final products are eligible for credits. Thus, telecommunication services or advertising do not generate credits and become cumulative within the tax structure. 110 See Orair and Gobetti (2019). Indirect taxes on the production of goods and some services constitute almost half of the entire tax revenue (World Bank, 2018). In contrast, income taxation in Brazil accounts for only 8 percent of total tax revenue, which is relatively low when compared to the OECD average. 111 Lara Ibarra et al. (2021). The distortions arise because high-paid workers can choose to offer their labor as a company, instead of as a formal worker. What the worker 112 would receive as wages now become profits, which are only taxed inside the firm at the SIMPLES rate (which is normally lower than the income tax rate for the corresponding level of income). Since profits are exempt from taxation after distribution, those workers can avoid higher tax rates that would fall on personal income. 113 Word Bank (2019). 114 Such as the legislative, judiciary and the federal prosecutor’s office. Some examples are: leave permissions, annual holidays longer than 30 days, benefits for time of employment (“anuênios, quinquenios”), incor- 115 poration of temporary function benefits to the actual wage. 116 World Bank (2019). According to Constitutional Amendment No. 41 of 2003, public servants that entered the public service until December 19, 2003 are entitled 117 to full retirement, i.e., retirement with the last salary for contribution, and parity, i.e., receive the adjustments granted to active workers (World Bank, 2019). 118 Exceptions to the reform were made for uniformed personnel, civil servants hired before 2003, and teachers who still retained preferential treatment in retirement eligibility conditions. 119 World Bank (2022c). 120 According to a McKinsey study. The same report suggests that the carbon trading market related to Article 6 in the Paris Agreement could reach up to USD 1 trillion globally in 2050. 121 Supreme Court ruling was published on June/2023. More information can be found at https://portal.stf.jus.br/processos/downloadPeca.as- p?id=15359322188&ext=.pdf 122 The Fund relies entirely on taxes, thereby causing the annual volume to be heavily correlated with the economic cycle, and the rule mandates the distribution of 100 percent of the values every year, resulting in low flexibility for shock absorption. 123 Services provided by subnational governments include health, education, security, and environment. 124 Each government agency is responsible to regulate the prerogatives and labor rights of its temporary contracts. This legal uncertainty has led to lawsuits, at all levels, seeking the recognition of broader rights. 125 Consultations included representatives of the Government of Brazil and of international institutions. 126 Worldwide Governance Indicators are a research dataset summarizing the views on the quality of governance provided by a large number of enterprise, citizen and expert survey respondents in industrial and developing countries, that are gathered from a number of survey institutes, think tanks, non-governmental organizations, international organizations, and private sector firms, and do not reflect the official views of the World Bank, its Executive Directors, or the countries they represent, and are not used by the World Bank to allocate resources. 127 A partnership was also established with the World Bank to support State governments’ public sector management reforms. Brazil Systematic Country Diagnostic - Update 61 62 Brazil Systematic Country Diagnostic - Update www.worldbank.org