Economic Situation in Brazil and Latin America


September 26, 2016, 8:45 AM to 10:00 AM EDT
PIIE Webcast, Washington, DC

Arminio Fraga (Gávea Investments) and Robert B. Zoellick (Goldman Sachs' International Advisors)

Event Summary

Arminio Fraga of Gávea Investments and Robert Zoellick, chairman of Goldman Sachs’ International Advisors, spoke at the Peterson Institute for International Economics on September 26, 2016.  Fraga discussed the economic situation in Brazil and Latin America, and Zoellick provided his views on how the next US president should approach Latin American economies.

Fraga founded Gávea Investments in 2003. He was president of the Central Bank of Brazil from 1999 to 2002. He is also a former associate of George Soros and his Quantum Fund. Since 2001 he has been a member of the influential Washington-based financial advisory body, the Group of Thirty. He received his PhD in 1985 from Princeton University.

Robert B. Zoellick is the chairman of Goldman Sachs’ International Advisors. He was the president of the World Bank Group during 2007–12. He served in President George W. Bush's cabinet as US Trade Representative from 2001 to 2005 and as Deputy Secretary of State from 2005 to 2006. From 1985 to 1993, he worked at the Treasury and State departments in various capacities, including as Counselor to the Secretary of the Treasury and Under Secretary of State. He is a member of the Institute’s Executive Committee of its Board of Directors.


Undedited Transcript

Adam Posen: Good morning, ladies and gentlemen. Welcome back to the Peterson Institute for International Economics. I'm Adam Posen, President of the Institute. And we're counter-programming the debate tonight with substance. And we're counter-programming the election with reminding the US there's something beyond the border. And we're hoping that both of those bits of counter-programming have a salutary effect on what's to come after.

In that spirit, we could not ask for a better speaker today than Arminio Fraga. And of course, he's infinitely long-detailed biography I left upstairs. Let me just come back to him and Bob in a moment while my brain does its Google search. We're very delighted to have Arminio Fraga and Robert Zoellick here to speak this morning on the outlook for Brazil and then thinking about how the US has to start worrying about these things, Brazil and its neighbors.

Let me just say a brief word that the Institute has a long history, of course, working on Brazil and Latin American issues starting, of course, with John Williamson long ago. And we have continued to rebuild that effort now with Monica de Bolle here covering Brazil with José De Gregorio as non-resident fellow, and to have the benefit of friends like Arminio like Robert like Mack McLarty and others here who helped us following our way through this.

Just to emphasize, what has been striking to me is if you say what haven't the presidential candidate spoken about at least in the international economic sphere that's important. One, of course, can come up with a list. And it's a list that gets buried in the many other lists of things the candidates have not spoken about. But we saw a potential real turning point in Latin America beginning to become evident.

You think of the overture in Cuba and the change coming there. You look at the instability, unfortunately so sad, in Venezuela. You look at the change of government first in Argentina then in Brazil. There is a potential, I would like to think, if we can take a slightly longer view for a virtuous cycle reinforcing among the neighbors.

But, of course, with the difficulties particularly Venezuela, but also Brazil face, there is the potential for a downward cycle as we're seeing the spillovers from Venezuela into Colombia, the backlash, the frustration in Brazil somewhat dragging down the best efforts in Argentina and so on. And so, this is up to the people on the leadership of Latin American economies. But there has to be a role for the US to do something positive.

And it's in that spirit we're starting this set of programming. We'll continue next week with Federico Sturzenegger from the Central Bank of Argentina ahead of the IMF meetings, as well as Mr. Garcia from the Central Bank of the Republic of Chile, and presentations by our own José De Gregorio, Monica de Bolle, and Chad Bown.

Let me now briefly introduce Arminio Fraga who needs no introduction as they say. There's no infinite number of people who need no introduction. He's one of a few dozen. Arminio, of course, had a distinguished career MIT PhD, I believe. What? Princeton? Oh dear, I was trying to upgrade you and you didn't let me. Princeton PhD. Distinguished service as the Governor of the Central Bank of Brazil in a previous effort, then leadership in the private sectors, the founder of Gávea Investments, a leading long-term investor in Brazil. He continues to be a member of the Group of Thirty and a leader in the discussion around central banking as well as Latin America. And we're delighted to have him with us today.

After his remarks, former USTR Ambassador, former World Bank President, I'm delighted to say current member of the Institute's Board and Executive Committee, Robert Zoellick will speak. Robert, as you all know, is uniquely able and principled about combining his commitment to freer trade and sound economics with the diplomatic vision. And that is why we hope to have Robert follow on Arminio and help us understand whether the US should be paying attention and what it might do.

Without any more, please let me turn to Arminio. Thank you so much for joining us at the Institute.

Arminio Fraga: Good morning. Thank you. Thank you, Adam, for having me here. Great to share the discussion space here with Bob that will certainly not only help me with my own country but also with this connection with the US that is so important for us in Brazil.

We're going through quite a lot, and I am going to try to summarize my views. Just to get you going, we are hopefully at the end of a gigantic recession. There's a drop of 7 points in GDP over a 2-1/2-year period. So it's a 10 percent drop in GDP per capita roughly, maybe a tad less. It happened very fast. It's something that doesn't happen in the sort of standard business cycle. And there is a second track to this that's equally amazing, if not more, that comes from the political side of things where we've had a president just impeached. And in parallel to that, we're going through the largest, most amazing corruption scandals plural that are connected. And I'll try to convince you briefly that these things are all part of something that there are common roots to all of these.

So let me let me start with the economic track where I'm more comfortable speaking. Adam, I'm not sure what sort of the rules or press or any of that thing or stuff here. But, anyway, I tend to be careful, but I won't hold anything back, which I usually don't, anyway.

So here's the story and I won't go back too far, but it might help. President Cardoso got rid of hyperinflation. This was like mid-1990s. And, I believe, kind of found a good path to kind of say to develop Brazil. It was fairly standard and fairly simple, but it seemed to be working. It entailed a substantial reform of the state that was to be directed to kind of the more basic and more important things like education, health, proper regulatory environment, respect for the rule of law, this kind of thing. Next to sort of reasonable kind of macroeconomic policies to avoid the classic cycle we see all over Latin America over decades of booms and busts and crises and so on.

We had the good fortune of seeing President Cardoso be followed by President Lula. And it was quite surprising, I must say, at the time because most people in Brazil thought that someday he or someone with his background would win and that would be a real problem not politically necessarily, probably not, but certainly from an economic standpoint. And to his eternal credit, he came in and pretty much threw away his party program and did quite well in his first term and also, in a way, got lucky too. The commodities boom, the really spectacular commodities boom kind of China connected started right as he came in. I'm sure he thinks he created that too. And so he rode that quite well.

Trouble looking back is he took care of the demand side pretty well. It was also the beginning of a credit boom. The supply side never [inaudible 0:09:34] in a meaningful way. So investment didn't do much and even the stuff that would generate productivity gains was modest. It was there for about three years and then slipped.

And the slippage actually happened with the departure of his former Finance Minister, Mr. Palocci—by the way, was just arrested this morning in case you haven't heard—who despite other aspects of his life turned out to be a fine finance minister. But the whole package evidently had a lot of problems.

Once that started to happen, we saw Brazil deviate back on the economic front to a model that we had tried in the well-known 30 years of growth from the 1952 to 1980. But that really didn't take us all the way. And if you recall in 1950 or maybe you're someone who may not know—in 1950, Brazil's GDP per capita was about 12 percent of the US's. And at the end of this, it was double that. It was about a quarter of the US, give or take. So it was a good run.

Trouble was it was the wrong model. So it was a closed economy. No focus on education on productivity. No focus on equality of opportunity, the distribution of income, poverty, none of that. And it basically blew up and led us into hyperinflation and what-not.

Strangely enough, halfway into the Lula years, we saw. It became clear that this was beginning to happen in Brazil. And we saw it, in fact, early on with former President Dilma Rousseff who was in charge of the energy sector. We saw it very clearly in power and in oil where she, basically, ruined whatever attempt at a proper framework for these sectors to grow and to deliver what they ought to deliver and so intervening very heavily and led to massive problems in both cases and not just economic.

The government also made other movements or moves in other areas such as credit and was a beginning of massive presence of the government in lending. The share of government banks in the economy rose from around 40 percent to almost 2/3; so 2/3 or 60-some percent of the assets. And our banking system are now in the books of government banks that as you can imagine with all the stuff that's going on in the political world we're not making wise sort of capital allocation or credit allocation decisions during these years.

In parallel to all these, we saw the first glimpses of the kind of political monster that is now completely visible in a scandal—it was the first big one—in Portuguese we call it the big monthly. There was an operation to generate cash to pay a very large number of people in Congress through kickbacks and the like. This was uncovered and a lot of people were tried. And at that point, President Lula started to lose. He's lost an enormous number of people. They've been tried and convicted including his Chief of Staff who was like his Prime Minister, his number two. Mack McLarty is here. He knows how this works better than anyone. He was very important needless to say -- and many others. I think three or four of the party treasurers are jailed and so on. So that was one, anyway.

That was there kind of was put to rest. It seemed like a good moment for Brazil. But the politics still felt kind of complicated. In order to understand that, there are some things that you must keep in mind. We have in Brazil over 30 parties. So it makes working based on principles and long-term ideas for the country nearly impossible. So the system became like a bazaar of small coalitions based on small ideas and money. So it's very complicated.

Besides this system wasn't put in place totally by Lula. I don't want be unfair. But he really took it to a new level. There were also some other strange things happening. It's worth mentioning. Most people don't know. But the Lula government twice tried to pass through Congress laws that would have given them significant control over the press and media in general, but the press in particular.

I happen to think that things for a free press including kind of 21st century press, internet and so on. A lot of these things we're seeing how, people being exposed, tried, judged favorably or unfavorably probably wouldn't have happened, I think everything is happening in sort of very broad daylight and really puts a lot of pressure on all the institutions. They are now doing their job. So the public prosecutors, the judiciary, the federal police, they're doing well and they're completely exposed, which is a wonderful thing. So it's a plus.

So during Lula's second term to continue with my Lula story, he maintained macro-discipline. It became a little weaker on the budgetary side. You saw the appearance of accounting tricks of all sorts. But it's hard to say that they lost control. The trouble is then Lula ended up managing to elect his successor, now former President Dilma Rousseff. And from then on, things started to get more complicated.

She, at first, kept on slipping but gradually but came in triple strong on the—call it the intervention is heavy-handed side. So that was point number 1. At the time, with great fanfare, they called their model the new economic matrix. It was if they thought they had invented something new. And it basically entailed the following:

They had huge amounts of credit provided by the government; a good chunk of that subsidized particularly the BNDES part, but also from the kind of government saving loan. Tax breaks that were provided with, trust me, no economic logic whatsoever and, quite frankly, no social logic either. So there's no logic, I guess, just private and party interest basically. There was a growing protection against foreign competition. Brazil was not a very open economy, but it didn't move in any way in any good direction and then cozy contracts with the government. So just to list them; cheap credit, subsidized protection, tax breaks, cozy contracts. And they called this the new economic matrix. So this was a revolutionary thing. It is what it is.

And of course it didn't work. And instead of trying to deal with it in a reasonably rational way and even within the kind of framework that they have, it seemed to me at the time that every moment of trouble, every problem that arose, was met with a bad response. So the reaction function of particularly the Dilma government was really tragic.

And while all of that was happening, much to the surprise of most people, another gigantic scandal appeared; this one at Petrobras, which, by the way, Dilma Rousseff had been Chairperson of the Board for a good number of years during the Lula administration. This one was bigger and amazing. And it happened in a company that is probably not really a true company in the way we think of Ford Motor Company that is here today or Google. But it was a very structured disciplined organization that had non-economic objectives, but was well organized and so on and very proud of being quite meritocratic even. The people had their careers and so on.

And all of a sudden, Petrobras, they take it over some spots where the money was as sort of the old story here in the state of they ask someone why they rob banks, right? So it's where the money is. And Petrobras has a lot of money. And we now know also that was another one of these operations. So it's pretty amazing the paint had barely dried from the first scandal and now we bumped into this one.

My conclusion, by the way, was if this happened at Petrobras, it has to be everywhere. And that's still what I think. Everywhere in different degrees. So it's a sign. It's a symptom of a deeper disease that has to do with their cultural elements. It has to do with this notion of what the state is supposed to do. A lot of it comes from our Portuguese roots with all due respect to anyone from Portugal present. Portugal has its own problems too. And I think that's kind of the underlying fight that we're going to have to continue to work on for, I think, decades.

So then now moving towards my conclusion, I'm going to go to the present. Into this come two things. One is talk of impeachment. And impeachment in Brazil, according to our Constitution, requires the existence of some kind of felony or crime. If the President is to be found guilty of a crime, he or she can then be taken to an impeachment trial. And both the people in the world of politics in Brazil then think the crime is a kind of the entry door to a broader discussion and that's exactly what happened.

A lot of detail that I won't bore you with that might have weakened the case a little bit, but I really believe there were plenty of crimes and if the thing was done well. Many of my younger friends including my children, all those are saying, "Well, this is also very bad because she's being impeached by a bunch of politicians who themselves are also being investigated and so on." So there's this general feeling in Brazil about the system as a whole that leads to these notions that this might have been a coup or something like that. It wasn't. But it is true that the system is kind of the way I'm describing here is pretty bad.

But there's a side track on this. It was there on the ground also pretty amazing. And that was what then Vice-President Temer did. And here you have to remember. He was, for years, the president of the largest party in Brazil. It was the PMDB, which by the way has 13 percent of the votes in the House. So it's a highly fragmented political system. He was President of the PMDB that has been the party in government forever type of operation. And to most people's surprise so he's like the co-controlling shareholder of this enterprise, of PMDB and they had satellite partners—many probably 20 or 20 plus as well. But they were in charge.

And he then kind of blew the whistle to most people's surprise including mine and went public saying, "Look, this this can't continue. This is a disaster. I'm the Vice-President. I just want to let you know that I understand what's going on. And here are my proposals." And he put on paper some proposals that were unbelievable. They're really in this sort of populist environment of ours. I think it's very bold talking about social security reform. Now, there's on the table proposal to cap the growth in government expenditures and more.

It was a collection of things that many of us on the ground have been proposing for quite some time and particularly after the 2014 elections, which were also another kind of winning moment for populism with kind of consequences for the quality of the debates as you would expect.

So, anyway, so she takes over. And we see the reaction function is explosive. If a problem comes, she creates two more. The need for the more macro-discipline becomes obvious. She doubles up the bet in the wrong direction and so on. So this is a world that's totally different than actually what we're seeing in most parts of the world at this point.

Amazingly, as we approached the end of her first term and election, she in particular blew a massive hole in the budget. And this has happened over two or three years. But there was a deterioration of about 6 points of GDP, which is big considering we have a debt-to-GDP ratio of close to 70 percent, very high interest rates, 6 percent real terms. Well, low growth for a while now. So we're hopefully at the end of a depression. So the government's credit or the debt dynamics became a major issue. And you don't need to be from MIT to understand that if you have 70 percent debt-to-GDP ratio, 6 percent primary, 6 percent real rates, and no growth. It's going to grow fast, I mean, really fast.

And the trouble with this, by the way, is that even if you take a longer view, the growth engine is broke. We have very low investment rates in Brazil. And as we stood at the time of Presidency Dilma's impeachment, no hope that the investment is going to jump in. It's just you didn't have to think very hard about that. So, the macro size, that's kind of where we are. They had also been fighting inflation with the classic tools of freezing some prices and fudging things not quite as bad as we saw with our neighbors in the South. They were just using the eraser. You erase the number and write another one, but pretty bad.

So here we are. The impeachment happened and in comes President Temer trying to do something about this with his background with the political system we have and so on. Very complicated. So here's how I see the news recently. I think it's mostly good against this pretty hard-to-manage backdrop. So just to say it one last time because it's very bad I don't want you to forget it. But I'm going to say some more positive things in a minute.

70 percent debt-to-GDP ratio exploding, a growth engine that is broke, kind of the micro-economy of Brazil is a disaster. That's bad news. But it means that there's a lot to do also. And a political system that is fragmented and mostly thinking about how to stay out of jail for the most part. This is just starting, by the way.

I think another side story here, the private sector business people that were tried and many have been convicted are already behind bars. And this is probably 80 or 90 percent done. On the political side, it goes to the Supreme Court. And we're probably going to have, I would bet, over a hundred people being tried, politicians being tried. They have this privilege of just being judged by the Supreme Court, which by the way, will have to beef up its staff to handle this. It would be quite a big project. And this hasn't happened yet. So that's kind of where we are. President Temer has a little over two years to go. He tabled his proposals.

And so just looking at it, here's the sequence the way I see it. Impeachment, I think for an economic standpoint for sure fantastic it's never good for any country to go through this. But I think it's eminently fair and her departure, crucial. I think we would have blown up. I think because she had this tendency of taking everything as a personal injury as a personal offense, I was really terrified. She seems to be the kind of person that takes a red light in traffic as a personal offense. So that was very scary. So she's gone. Good news.

President Temer, a year ago, made these proposals that sounded kind of crazy at the time. I had about a month earlier put my ideas on paper and published in the newspapers. Those are the things that I couldn't say during the campaign of 2014 where I was involved with a PSDB candidate. I said quite a bit, but in code just for Monica and a half a dozen others. But I said it in a more colorful way at that time. But me saying it didn't matter President Temer saying it, matters.

So he comes in with this behind him. Then he picks an excellent team; very strong people at the Central Bank, Finance Ministry, the Foreign Affairs Ministry, the BNDES, Petrobras, Education, ministry of cities urban matters, a young ministry quite good, and then a whole bunch of others that I still don't know even who they are. But there's a core there that is quite strong. I think all that is very good news.

So the question now that stands before us is, will they be able to execute? Will they be able to get these reforms done? And will they be approved in in a way that helps stop the debt dynamics and so on? That remains to be seen. I'm cautiously optimistic they get the ceiling on government expenditures done. It is a very good idea. It's very radical. It doesn't impose too many constraints in the near term, which, I think, is an issue. I would rather have seen some of the effort done now.

I don't quite like proposals that say here are changes that will make future governments go through significant austerity. It would probably be better to lead by example like most things in life. But besides that, I think that's good. They're also proposing some social security changes that are crucial. Without the social security reform, the ceiling on the growth of government expenditures doesn't work because about half of the expenditures come from our very extravagant social security system. So we need that as well. That part is being negotiated more at the retail level, which is always very dangerous because you do sense kind of what your final objective is.

And so, anyway, that's where we are. We have local elections coming up soon. And I think after that, we're going to see. I'm pretty confident they're going to vote the ceiling, and social security will be a coming attraction for next year. Parallel to this, the noises from the kind of the bottom upside the macro-side are good. A natural frontier of investment in Brazil would be, at this point, infrastructure. The gaps in our infrastructure are monumental. And so, I think you could attract a lot of capital. It just needed a lot more regulatory overall certainty to kick in.

Manufacturing is more complicated. There's a lot of excess capacity. It's very hard to convince anyone to invest when you have that much excess capacity. Consumers are somewhat burdened also because interest rates are very, very high, so not easy. Most people are skeptical of a strong bounce because you would expect to see it with the kind of recession we had.

I'm not sure where I stand on this. I think we could see some bounce if they can start. They can continue to deliver. I think they are delivering. If they continue to do a bit more, it would be good. So that's kind of where we are. Just in Argentina, you're going to see the President of the Central Bank next week, right? So you'll hear from him.

But I think what's happening in Brazil and in Argentina is very, very important. It is, I think, something maybe Bob will discuss. I think this is a window of opportunity for the US to get close, to engage. It's been a long time. Brazil and Argentina were just kind of on the fence. You had Chile, Peru, Colombia, and Mexico doing well. And then you had Venezuela, Ecuador, Bolivia a disaster, Argentina sort of a disaster as well, and Brazil I think also a disaster quite frankly.

And so if the two largest of the kind of disaster camp move out, it's a phenomenal opportunity. And so I would hope at this point that the incoming US government can kind of rebuild some bridges and do some things hopefully on trade that would require, I think, the US to, at least from the standpoint of Brazil, to talk about some things that really never went very far, agriculture.

Actually, the US has done some things unilaterally there that are quite positive, anti-dumping stuff like that. So I think there's a chance we can do really meaningful things at this point. And I hope the next government here is up to that. They can kind of look over the wall if that turns out to be the case and do something more constructive, but not in the literal sense. Anyway, thank you.

Adam Posen: Thank you so much, Arminio. Yes, worrying about presidents who view red lights as personal offense is a problem we all share. But thank you for that brilliant summary of the Brazilian situation. I'm going to turn now to Bob Zoellick for a few brief remarks responding to Arminio, but also as we said, putting this in the context of the future for the US in the region.

I should also note that Bob just published last week a super piece in Harvard Business Review, I believe, online before the printed edition on trade and the interests of corporates around the world to really line up and stand up for trade as well as the policy interest. And I read it over the weekend. I thought it was great. And I'm proud to say, I think, our report last week on the presidential trade policies complements it nicely. But let me turn to Bob for today's topic.

Robert Zoellick: Okay. Well, first, it's a privilege to be here with Arminio who was both a superb public servant, but also investor. And so I thank Adam for that and the Peterson Institute's focus on Latin America.

And just also to highlight some of the work that's been done, I had an opportunity to read Monica de Bolle's piece, I think, in a briefing that you did at the start of the year. It's a very good sort of comment on sort of the conditions in Brazil. I want to try to complement Arminio's excellent presentation by making four quick points on Latin America and then concluding with some observations on Brazil and US policy. Maybe this can give some guidance for future topics for the Peterson Institute.

First, as Arminio mentioned at the end, of course, there's different Latin Americas. The Pacific Alliance of Mexico, Colombia, Peru, and Chile have been more open to trade and investment. They've had better performance. But they also face some risk today too. And Chile is an interesting example of that.

Then there's the ALBA countries; Bolivia, Ecuador, Venezuela, generally populist authoritarian tendencies, large indigenous populations that have been weakly integrated, in general heavy reliance on energy or mineral production, and they also face a range of troubles.

Then there's Central America which, of course, is small and varied. Some are fragile states and risk being overwhelmed by criminal and drug networks, actually some risks of state takeover. Then there's Panama and the Caribbean, which are really special cases requiring special attention.

Then as Arminio mentioned, there's Mercosur which is really especially Brazil and Argentina, but also Paraguay and Uruguay. But just keep in mind, Brazil is 40 percent of Latin America's GDP. So you can see the significance of that. And as you've heard, the policies previously have been described as more interventionist state nature.

Second point, useful to recall the historical patterns of Latin America, and Arminio touched on some of this. Boom-and-bust economies driven heavily by commodity markets, weak macro policies, a political history of [inaudible 0:38:44] and strongman governments, which had led to weak rule of law, corruption, instability, a wide gap between rich and poor, populist temptation, and in a global comparison, very weak intra-regional trade. It increased from about 13 to 20 percent. But as a comparison in Asia that number is 40 percent. In Europe, it's 60 percent.

So as a result, Latin America has had smaller markets, very limited regional production change, and limited participation in global change, something I'll come back to. Nevertheless, and Arminio is part of this, the debt crisis of the 1980s and late 1990s led to some very important reforms; Stronger macro policies, independent central banks, flexible exchange rates, stronger institutions and financial systems, greater trade openness. What people used to refer to as the Washington Consensus until that fell afoul of the new matrix and other appealing concepts until they're no longer appealing.

The greater trade openness drove micro-economic and institutional reforms and some. And the US was part of this with NAFTA and the US free trade agreements with Colombia, Peru, Chile, Central America, Dominican Republic, and Panama. And just to give you a reference point, those free trade agreements cover about 50 percent of the non-US GDP in the hemisphere actually a little bit more. But the Free Trade Area of the Americas, something that Mack and President Clinton launched, really was a step too far in part because of challenges of Brazil and Argentina, but other issues as well.

Third, this progress in the 1980s and 1990s laid a foundation for what is seen in the region as the golden decade of 2003 to 2011. And, of course, this was helped by the commodity boom and China's growth. There was an innovative use of conditional cash transfers and which drove down poverty rates.

So they started it in Mexico. But actually when President Lula came in and had a generalized hunger program, he worked with the World Bank based on the Mexico experience to develop the Bolsa Familia Program, which was quite successful dealing with poverty at the bottom 15-20 percent for about 0.5 percent of GDP. In combination, this led to a rising middle class. So if you define this at between about $10 and $53 a day, the percentage increase in Latin America are from 21 percent to about 35 percent between 2003 and 2011.

There were some structural reforms often driven by trade. Region weathered the global financial crisis relatively well, but—and there were two big buts—one, it didn't rebuild fiscal cushions, and in summary of what Armenia said, politicians began to believe their own press releases, which is always risky.

So fourth, today's challenges, let me highlight three. One, the continuation of the cyclical issues, the commodity cycle, great deceleration, fiscal and external imbalances and, of course, some uncertainty about the Fed's rate of increases and particularly for dollar borrowers. Two, longer-term, keep in mind. This is the most urbanized developing region, about 80 percent urbanization. So issues of transport, housing, sprawl, basic public services, those drive politics and life in many Latin American countries. The share of the working-age population has peaked. And in some countries, they will face difficult adjustments from climate change.

The third challenge is one that any government has to factor in although it's hard to predict. And that is the disruptions of life; El Nino, the Zika outbreak, natural disasters which especially can overwhelm the small states, Caribbean Central American; it can just wipe out five years of good work, suggesting the need for greater risk management and insurance policies.

The needs which Arminio touched on, on the microeconomic side, are really the factors of productivity; education, infrastructure, integration, health services, labor markets, capital markets, better targeting to social subsidies, and reduction of energy subsidies, which has been a costly production of carbon, but also budget waste in really every country.

There's another challenge developing, which is the expectations of good performance. And here I hope PIIE has a chance to look a little bit at Chile because there's an interesting case. If you look at what's happening in the pension system and education system where after an economy that's done very well over decades, the public starts to want more. And we'll see whether the system can hold, and also as Arminio mentioned the after-effects of the Venezuelan crisis, which is soon to come if not already upon us.

A few comments on Brazil: This may surprise you. But in some, I am relatively bullish if the country makes it through the downturn into the 2018 elections. And let me add to what Arminio said with a bit of a political economy analysis.

He was modest. If you look at the President Cardoso team, Arminio, Pedro Milan, Celso Lafer; this was an extraordinary group. And I know Mack has the same experience. This is where there's always a question among historians about, do figures in history, do individuals matter? I personally believe if Celso Lafer had stayed as Foreign Minister and Trade Minister we would have had a Doha Round and perhaps a Free Trade Area of the Americas. And it would have been a very different picture going forward.

As he mentioned for Lula and Dilma and the PT, you need to put this in historical context. These were people that came out of the military junta era. They were Marxist. To their credit, unlike much of the rest of the Latin American left, they stayed in the Democratic system. Lula fought election after election, lost time after time. They stayed in the Democratic process. And you can see in Colombia and other countries where that didn't happen. But no doubt their economics were very statist and that created this dangerous opportunity for corruption.

And just to connect us again internationally, Ottaviano who worked with me at the World Bank is aware of this. We had the first chief economist for the developing world, Justin Lin from China. He developed a new theory of what he called the new structural economics. Some of us reminded him of the old structural economics of Latin America. And I used to say to Justin, "You have to talk to Ottaviano because maybe the strong state works for a while in China, but discuss with the Latin Americans their experience of a very powerful state and some of the dangers that it provides."

And I mentioned this in part because while I was making a slight joke about the Washington Consensus, I think some of these ideas about overall structures of the economy should be debated. There is kind of this dismissing of the Washington Consensus. And obviously, you can always improve on it. But some of the ideas that were seen as current and the commodity boom with China, we'll see how those survive over time. And I saw this directly in the case of Brazil.

A very big positive that Arminio just touched on is the strength of the legal judicial prosecutorial system. This is an unbelievably impressive performance, which you do not see in many other systems. And you can see actually the connectivity of these people with other countries including the United States and what they learned about political impunity and dealing with rule of law and institutions.

I would add to that. When I was at the World Bank, we worked very closely with the state governors because some of the federal government systems were pretty well-developed, but the states were still quite weak. And what I found was the next generation of leaders were generally practical, pragmatic, believed in market reforms with inclusive economics. One of the real tragedies of life was the one who I found best, the man named Eduardo Campos who was the Governor of Pernambuco, died in an airplane crash in the last election.

So I look to 2018 and beyond as a real possibility for Brazil. Now, in the near-term, it's going to be very painful with political stress. The external imbalances have moderated. But as he mentioned, the fiscal balance is quite high and potentially dangerous. And frankly as someone who also watched markets, I'm not sure that the spreads have factored all this in. Foreign investment has come down a little bit. But if you look at the numbers, they remain quite high. And country is vulnerable to a sell-off of this debt.

With the big deficits, of course, they have to be financed. And if you look at what's happened in Brazil, they've been financed by reallocations of public pensions. And they're almost totally already in government bonds. The banks have also shifted a lot to financing the government, but they're hit by bad debts and they've got some capital problems. So they've got limited ability to finance. The government's short-term debt is generally short term. It needs about 50 percent of GDP for debt to cover the rollover and the deficit numbers.

So in an environment where unemployment is high, you have excess capacity, collapse in corporate profits, and inflation is persistent because of the devaluation. This is a very tricky period. And that's why I'll come back to the point that Arminio closed with, which is much of Brazil's spending is mandated by the Constitution. This is different than other systems. And so, primary government expenditures rose from 22 percent of GDP in 1991 to 36 percent in 2014.

And so, these two steps that President Temer has talked about which the first one is for 20 years nominal annual increases in public expenditures including at the sub-national level are not supposed to exceed the inflation rate of the prior year and the pension issue. If he can deliver on those, then I think that Brazil is in a position to really be quite a surprise performer after 2018.

Now, the last point on this is bring it back to the political economy and the shift in the next generation. Look, no self-respecting Brazilian can say we're going to follow the Pacific Alliance countries, these small little countries like Chile and Peru and Colombia or Mexico. God knows. Brazil can't follow Mexico. But if you actually talked to many next-generation Brazilians or people thinking about the future, they've kept a very close eye on what happened in the Pacific Alliance countries.

And Foreign Minister Serra who's often been quite outspoken on a number of topics is already saying this. So frankly, it's quite important that the Pacific Alliance countries don't blow it, so message to Chile whose president thought that she should follow the Brazilian model for some reason.

So let me conclude with the US policy and maybe Mack McLarty, I hope, will have a chance to implement this. I think there's a totally overlooked opportunity for the United States to work with Brazil and perhaps Argentina through the Pacific Alliance countries if US trade policy isn't paralyzed and that's a very big IF. The fiscal decisions that we've discussed today have to be Brazil's. But there are interesting structure institutional issues where the US could be of help.

And I mentioned Ottaviano as I come in in that he wrote a piece recently that highlighted one of these, which is human capital. It turns out that private companies invest less in HR training in Brazil than those companies in other countries with similar per capita incomes. And Ottaviano pointed that the tax incentives and the disincentives that lead to this. Arminio mentioned infrastructure. And I continue to believe in many parts of the world the multilaterals could work with the private sector to try to create the right incentive structures and best practical design and then I mentioned the issues of disease and insurance.

So what I've observed over the course of 20 or 30 years is structural reforms can be very actively linked to trade policies. This is certainly the lesson of Mexico and NAFTA. And I think if the next Brazilian government is elected on a reform message and this would be a reform of corruption and institutions building on what the Temer government does, you have an entrepreneurial country with extraordinary talent. Frankly, I think private equity investors could find a lot of interesting opportunities there. And the institutions and political reforms are the key juncture.

So here is the strategic aim that the US should have. For well over a century, much of Latin America has looked at the US in a north-south relationship. If you look at US policy with Mexico, it was not only to connect it to North America, but was to give East-West and global perspective. So shortly after NAFTA, the US government worked to try to draw Mexico into APEC, into the OECD process, it's part of the TPP process. And, I think, this is absolutely critical. And it's part of the whole logic of the Pacific Alliance countries, which is the benchmark and comparisons should not just be with the gringos to the north. They should be with what's happening in Asia, what's happening in Europe, what's happening in Africa and the rest of the world.

During my time in government and at the World Bank, much of the attitude you could see a debate in Brazil. But many of the leaders still had a G-77 north-south outlook and frankly that hurt on trade policy. I think that's behind the times. But I think this is now an interesting moment because when you have a big break like this what controls is a shift in ideas and thinking of men and women. And I think that's the moment that offers the greatest opportunity.

So I hope that the United States works closely not only with Brazil but the other countries in the region because I think it could have a global effect at a time that people like Larry Summers are talking about secular stagnation. I see a lot of potential demand in the developing world if we create some of the fundamentals right. But that will be a question for 2017.

Adam Posen: Thank you very much, Bob. As always, you just knit things together along with the real world in a way that's so valuable. Arminio, is there anything you'd like to say in response to Bob to add at this point or should we move to questions?

Arminio Fraga: I think we should move to questions. There's a lot going on down there, but I'd rather address issues that people may have in their mind.

Adam Posen: Right. Thank you for your offering to do that. So as usual, this is on the record. We have a traveling mic in front in Jessica's hand. We have a standing mic in the back. Please either stand at the mic or wave your hand to be recognized. Please identify yourself when you speak. If the gentleman at the back could go to the mic please. And then the more you make it a question instead of an opinion statement, the more time you get. If you could give to the lady in front and then we'll go to the standing mic. Jessica. The lady in front first. No, it's not.

Teresa Ter-Minassian: Okay. Teresa Ter-Minassian, I'm formerly from the IMF. Very interesting presentations from both. Congratulations. My question is basically, to Arminio and I have two questions. I have many more, but I mean let's limit it to two.

One is, how do you see the role of monetary policy and also credit policy in promoting now a revival of activity in Brazil? The second is, are you at all concerned with the potential for the judiciary to be somewhat muzzled by the forces in Congress that are against this important role? I mean we have seen the pronouncements of some important politicians saying that this has gone too far.

Arminio Fraga: Okay. So monetary policy is facing, I think, a real challenge. Inflation this year will probably end up being around 7 percent, give or take, probably a little higher. And they have committed to hitting the target of 4-1/2. So it's a major effort. I don't believe they're going to count on much support from the fiscal authorities in the near term. I think credit will—I guess it's going to be neutral.

So this is an improvement from the standpoint of the Central Bank from what you had in the recent years past where except for the year [inaudible 0:57:03] I should say. But before him with the previous group, macro policy was completely schizophrenic. So you have the Central Bank trying to keep inflation reasonably under control and the other side kind of pumping hard. So it was difficult.

My guess is that they'll make an effort to get inflation down up until—and this is what I read from their statements, not my imagination. But there is a point where the lag effects of monetary policy move us into 2018. And once you reach that, then I think the forecasts are actually quite good. And so, they may be able to cut. The recession is very deep. So the sort of Phillips curve component is kicking in strongly, but there's a lot of inertia so this battle.

So I think they're in a bit of a tight spot for a little while. I think they're already beginning to look through next year gently because they don't want to kind of lose their credibility. So it's a bit of a balancing act. On the Judiciary, I think the main issue is the financing of campaigns in particular what we call down there the [inaudible 0:58:32] the unofficial monies.

And my understanding is the use of that kind of money was widespread. And it ranges from providing a room for a political meeting to paying for a poll and sharing it with a candidate or even taking instructions from a candidate to more -- just piles of cash or deposits in some banking centers that are not so careful, et cetera. So there's a whole range. And no one knows for sure how far they're going to go. And I think there's a general feeling amongst citizens of Brazil, myself included, that they should do their job.

And so it means we're going into a crucial political moment where we expect Congress to deliver on some of these reforms including political reform that I forgot to mention. But there are two very basic proposals on the table that I think are very important; one, limiting the number of parties. And so, I think that's a major issue.

But I think for the most part, the judiciary will work and they'll work according to the law. And Congress is in this delicate position of considering some changes with the people of Brazil in sort of a lynching mold. So I don't know. I think you put your finger on two very, as you always do, very important and difficult topics.

I'm a more optimistic on what the Central Bank is going to do. I think we have a superb team in place. And I think they're going to be reasonable and kind of find the right path down. And the inflation is going to be down enough and expectations are likely to be okay assuming the politics don't misbehave too badly.

Adam Posen: Thank you. Lorenzo, thank you for your patience.

Lorenzo Giorgianni:  Thank you, Adam. Lorenzo Giorgianni from Tudor Investment Corporation. First for Arminio, we all look at 2018 elections as a positive turning point. As investors, how do we appraise the risk of actually a negative turning point? We have a populist candidate, maybe not a Lula type, but someone that is now going to embrace the type of reforms that we all look forward to. And the second question for both, if you want to win on trade side, are there any quick wins, low-hanging fruits, from trade opening in Latin America that could help growth in the not-too far distant period ahead? Thank you.

Adam Posen: Thank you very much. Before our colleagues reply or guests rather I should say, I just want to mention that our colleague, Chad Bown, had a very nice recent short piece on Mercosur being trade opening in reverse that we have up on the website that I would suggest you look at, which fits with some of the things Bob was mentioning earlier. But, anyway, please on the --

Arminio Fraga: So 2018 is close. But for us down there, it feels like ages away kind of hard to predict. I think that there is still room for a different kind of populist to win the day basically saying the problem with these people was the corruption and make all kinds of promises based on that. So it's hard to tell.

For now, it looks difficult for the PT and for former President Lula to make a comeback. He is a political giant. He's done some things that are terribly disappointing and sadly so. So I think the odds of either Lula himself or someone coming from the populist side winning are non-negligible. I think you're still in the tail risk, but a very tail though, very fat.

So on trade, Mercosur is complicated with the presence of Venezuela. Mercosur has always been very tough. When I was in government, I was kind of engaged. But I must say over time—one time, we were doing well. Another time, Argentina was doing well. And it was easy then because we didn't have Venezuela to deal with. So I don't know about that one.

I think for us, Brazil, it's probably positioning to move ahead with the deal with Europe. That one's on the table and to open up some kind of avenue of discussion with the US. That's what I think. I think internally there are—I think a lot of things we could do unilaterally and I belong to a minority camp on that one that would be very helpful.

And I didn't mention a bunch of other things. But I also think in terms of integration, Brazil needs to integrate inside as well because our tax code and infrastructure, trading inside Brazil is impossible. It's probably easier for someone in Canada to trade with France than it is for a business in the state of São Paulo to trade with Rio. So if we could do tax reform, we could also take care of that and start beefing up our infrastructure. I think there would be tremendous gains from internal trade as well not just external.

Robert Zoellick: Just to add to that, the first point, which Arminio has stressed is countries can act on trade policy unilaterally. So if they removed some of their own barriers, they don't need agreements. But agreements often helped create a political context.

Second, in a modern economy, there's a lot of behind border barriers, licensing, regulation. And I would think that these barriers could be connected with the anti-corruption efforts because a lot of those steps are the types of things that officials used to get a little money on the side. And so I would start by focusing on those including to take full advantage, as Arminio said, of the Continental market.

Third, however, and I think Serra is already trying to do this. I would start to try to work with the Pacific Alliance countries just to sort of get the politics to say, "Look at what these countries have done," as opposed to be antagonistic or what can we learn or what can we work together so on and so forth.

And the last piece would be this really does depend on US politics would be, look. If you get through the 2018 period and you have a new type of government, I think this is one of these great opportunities where the United States working with all the free trade area partners in the region could approach Brazil and try to say, "What could we do of our free trade area?" And we'll see whether Argentina is there. This could be one of these historic moves.

And I'll close with this point. I'm writing something actually for the FT now about kind of what to think about new administrations and their policy. And in trade, obviously, who knows with Donald Trump, it probably didn't look good.

But if Hillary Clinton is elected, one of the sort of under-recognized post to watch would be US Trade Representative because she could go one or two ways. She obviously is in a political hole on this given her statements and the politics of her party. She could have somebody like we've seen in the past who basically is a placeholder or she could find people and they're there in the Democratic Party that are kind of activists creative trying to figure out a way to re-posture trade policy.

And there are things possibly with the TPP. But I might also actually start–this is something Jeff Schott and I have a slight disagreement about with Great Britain because Congress is very interested in doing something with free trade with Great Britain. But you move the dial and who knows maybe something with Latin America with a broader Hispanic community. So watch that appointment if Hillary is elected. That will be very important for the future of these topics.

Adam Posen: Thank you very much.

Arminio Fraga: I agree on the Pacific Alliance. I just forgot that. For us in Brazil, Chile, Peru, Ecuador, Colombia, it's almost like they're in Asia because between us and them, you have a lot of jungle and the Andes. But they are doing well. There's no reason why we shouldn't be close to them. I agree completely.

Adam Posen: Great. I'm afraid that ends our time for today. Thank you so much to Bob for coming and giving your unique perspective and a bit of a preview of what you'll be telling the FT and the world. But thanks especially to Arminio Fraga who gave us his usual frank, analytic, and comprehensive view. As Bob said, your public service previously was of enormous importance. And I hope you continue to contribute to the public debate as you did here today. Thank you very much.