The Lula Government and the Challenge of Inequality
Paulo Correa is executive director for Brazil at the IDB (Inter-American Development Bank). He was an economist at the World Bank and Secretary of Economic Monitoring at the Ministry of Finance during Dilma Rousseff's second term. This article was written by Correa for issue 102 of the WBO weekly newsletter, distributed on February 2, 2024. To subscribe to the newsletter, enter your email in the form below.
The first year of President Lula's third term showed promising results in the economy and social areas.
Measures to prioritize spending and review tax exemptions, and a plan to increase tax revenue by 1 percent of GDP helped contain the public deficit. The adoption of a new fiscal framework improved budget governance. The approval of a tax reform that has been under discussion for almost three decades will simplify one of the most cumbersome tax systems in the world. The year 2023 ended with controlled inflation, economic growth above expectations, solid expansion of formal employment and reduction of the country risk.
The Bolsa Família program was expanded, the policy of increasing the real minimum wage was resumed, and the law guaranteeing equal pay between men and women was sanctioned. Health, including those aimed at the indigenous population, and education policies are being recovered. The National School Meal Program, for example, was resumed and a new program, which encourages low-income students to remain in school and complete their studies, was created by congressional initiative and sanctioned by the president.
In the environment, deforestation in the Amazon fell by 68 percent, and key organizations in the sector, such as the Brazilian Institute for the Environment and Renewable Natural Resources (Ibama) and the Brazilian Forest Service, are being strengthened. The creation of the ministries of Women, Racial Equality, Indigenous Peoples, and Human Rights are also important institutional advances.
A delicate balance between macroeconomic stability and social justice – the agenda that elected President Lula – was therefore achieved. With the year of “reconstruction” concluded, what is the main challenge going forward? I think it would be attacking inequality in income distribution head-on.
Despite advances in recent decades, income inequality in Brazil remains persistent and extremely high. According to the World Inequality Database, the richest 10 percent of the population received more than 50 percent of the total income in 2020, while the poorest 50 percent received approximately 10 percent. The Gini index (measure of income distribution inequality that varies from 0, total equality, to 100, total inequality), estimated at 0.529 in 2021, was one of the ten highest in the world and equivalent to the level reached in Brazil in 2011. Income inequality translates into wealth inequality: 1 percent of the Brazilian population owned almost half of all wealth in 2019. The Gini index for wealth distribution was 0.89 in 2019, according to data from the World Bank.
“The first year of President Lula's third term showed promising results in the economy and social areas”
Paulo Correa, executive director for Brazil at the IDB (Inter-American Development Bank)
Some inequality may be necessary to encourage differentiated efforts and reward entrepreneurship. But there is no economic rationality for levels of inequality like those in Brazil. On the contrary, very high levels of income inequality hinder economic growth when they cause political and social instability, leading to increased insecurity and, therefore, less investment and innovation. Very high inequality can also end up making the development of public or semi-public goods, such as health and education, unfeasible, when the rich opt for private consumption of these goods. This “social separatism” hinders the progress of the poorest and reinforces the more concentrated income distribution pattern. More generally, very high inequality can compromise the quality of institutions and, therefore, economic prosperity, to the extent that institutions are a fundamental cause of long-term growth.
In this sense, the existing level of inequality is possibly one of the biggest obstacles to accelerated and inclusive growth in the country. But what can be done about it?
First, prioritize policies that are both pro-growth and reduce inequality. The literature identifies, among other policies: early childhood or pre-school development programs, quality universal health service, quality education, and conditional and unconditional cash transfers. All of these measures favor the accumulation of human capital. Others, such as land regularization and access to financial services, including insurance, favor the accumulation of physical assets. Some of these measures like Bolsa Familia are already in place, others are in their inception phases and some need more attention.
Second, advance State reform to increase the impact of public spending on reducing poverty and inequality. A recent study conducted by the Interamerican Development Bank estimated that State interventions via taxes and transfers in Brazil reduced inequality by up to 10 points in the Gini index in 2019, compared to 33 points on average for OECD countries. This indicates that there is room to make taxes and spending more progressive in Brazil. Consider, for example, that in 2015, tax expenditures on companies corresponded to 4.5 percent of GDP or nine times the cost of Bolsa Família. Although this proportion has changed recently, such composition of spending in itself does not favor much the reduction of poverty or inequality.
Third, strengthen reforms that increase labor productivity, especially in sectors that are more intensive in low-skilled workers, such as civil construction services. Productivity gains not only make economic growth more lasting but also make distributive policies, such as a real increase in the minimum wage, more viable from both fiscal and balance of payments perspectives. Reforms that increase competition, for example, can induce the reallocation of labor in more productive companies. Investing to make cities more efficient (better mobility and access to the digital economy, etc.) would increase the productivity of self-employed people.
Fourth, consider the impact of policy choices on the labor market. Most of the gains in reducing inequality in Brazil between 2001-2014 came from increased employment and real wages of the poorest. In fact, much of the reduction in poverty and income distribution that occurred between 2004-2014 came from faster income growth for the poorest 40 percent (6.8 percent, compared to 4.5 percent per year on average for the population as a whole). For example, it is very important that industrial policies do not end up reducing the demand for low-skilled labor.
Lula’s third term in office has managed to place the country on a positive path of economic growth and social gains. Deliberate and targeted actions to reduce income inequality in the country could enhance the gains even further. But, as it turns out, they will involve difficult choices.
