The Brazilian Bear: Why Corruption Continues to Hinder International Investment

Brazil, once the darling of economists, continues to waddle through an economic bust. In need of foreign investment, the country’s enormous corruption problem ensures that multinationals will watch from afar for some time to come.

In a 2010 60 Minutes piece, a Brazilian billionaire called his country’s economic turnaround “unbelievable.” Too good to be true was more like it. The same CBS report even foreshadowed Brazil’s bust, recalling economic fits and starts that resulted in the development of Brasilia… and an IMF financial rescue. While history reveals why Brazil’s current bust is no shock, it has been less than instructive to the political classes who grapple with Brazil’s economic challenges. The Car Wash scandal, which is still shaking out rotten fruit, along with complex regulations and an antiquated tax code, continue to portend a bearish investment climate.

The 2016 Car Wash scandal saw numerous political casualties, including former President Dilma Rousseff, who was impeached last October, her Vice President (and current President), Michel Temer, was recently indicted for corruption, and former President Lula da Silva is facing a nine year imprisonment for corruption. The Temer indictment and Lula conviction are particularly challenging to Brazil’s investment climate. The corruption scandal has commanded the attention of Brazilian politicians, who worry that their names could surface next. Temer’s focus is undoubtedly divided between keeping his government intact and pushing through market-friendly reforms. On the other hand, Lula, who was previously an attractive candidate for the 2018 presidential election, now may be barred from running. The question mark left looming over Brazil’s presidency also looms over the short-term investment climate.

This political turmoil does not only discourage foreign investment in the short-term, it highlights a long-term problem plaguing many Latin American markets: corruption. While some foreign investors may have the appetite for bribery, American companies are rightly restricted by the Foreign Corrupt Practices Act. Even if U.S. industry decided to enter the Brazilian market, restrictions on our own industry ensure an uneven playing field when competing against other foreign investors with no such restrictions.

The field becomes even more difficult in light of the complex rules of the game. The World Economic Forum ranked Brazil 139 out of 140 countries for burden of government regulation in 2015–2016, and for a number of reasons: Brazil’s regulatory framework is still highly favorable to unions and overly protective of labor. Already expensive (employers must pay $17,000 in taxes and benefits for every $30,000 of salary), the system has led to a large swath of informal labor and little investment in the development of skilled employees. Additionally, Brazil’s pension system currently allows many to retire with full benefits at 50 — an incredibly pricy and politically fraught problem.

The WEF also named tax rates as the largest barrier to doing business in Brazil. According to the World Bank, it takes corporate tax preparers 2,038 hours to prepare filings each year, compared to the average of 169 in OECD countries. While Brazil’s Finance Minister argues that its political turmoil provides a rare opportunity to advance a reform agenda, Brazil’s needs likely outmatch the attention of politicians in the throes of corruption scandals: labor, pension, tax, and regulatory reforms are all conditions to wooing companies. While recent changes to the petroleum regulatory environment have increased the likelihood of multinational investment in Brazil’s massive pre-salt oil reserves, industry as a whole should be looking for large-scale changes, not pin pricks.

Just this week, Brazilian authorities hinted at another pin prick: changes to the royalties and regulatory framework governing the country’s mining industry. For as long as these have been in the works, politicians have stymied the regulatory improvements aimed at increasing foreign investment. The proposed increases in royalties and stake limits for foreign investors may be enticing, but Brazilian promises have let down multinationals in the past. Until reforms are signed, sealed, and delivered, Brazil’s culture of corruption and upcoming election cycle will play an outsize role in foreign investment, likely resulting in a ‘wait and see’ mentality for all but the least risk-averse.