Academic Paper Brazil

7/27/2019 Academic Paper Brazil

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C E P A L R E V I E W 1 0 6 A P R I L 2 0 1 2 151

The economics of demand-led growth. Theoryand evidence for BrazilJos Lus OreirOy Luciano Nakabashi, Guilherme Jonas Costada Silva and Gustavo Jos Guimares e Souza

This article describes the theory of demand-led growth and provides evidence that ademand-led growth regime exists in the Brazilian economy. Based on the methodologydeveloped by Atesoglu (2002), econometric tests of this hypothesis show that almost85% of the growth rate of real gdp in the period 1990-2005 is explained by demand-sidevariables, mainly exports and government consumption. As the current fiscal crisis rulesout fiscal expansion, Brazil's only option is to adopt an export-led growth model. Thearticle also shows that the maintenance of undervalued real exchange rate is a majordeterminant of export growth in developing countries such as Brazil.

JEL CLASSIFICATION

Economic g rowth, development models, supply and demand, exchangemacroeconomics, Brazil rates, exports, econometric models.

E12, Cl , F43

Jos Lus Oreiro, Associate Professor of Economics at the University of Brasilia and Researcher at theNational Council for Scientific and Technological Development, [email protected] dan o Nakabashi, Associate Professor of Economics at the Univeisit}' of Sao Paulo, FEA-RP/USP and Researcherat the National Council on Scientific and Technological Development, [email protected] Jonas Costa da Silva, Associate Professor of Economics at Universidade Federal de Uberlndia(uFu). guilhermejonas@)'ahoo.com.brGustavo Jos Guimares e Souza, PhD Candidate at the University of Brasilia and Professor at the Catholic


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152 C E P A L R E V I E W 1 0 6 A P R I L 2 0 1 2

IIntroduction

Over the last 25 years, the Brazilian econom y has grownat an average rate of 2.6% per year considerably lessthan in the period 1950-1980 and lower than averagegrowth rates in other em erging economies such as Russia,India and China. As Brazil's population is growing bynearly 1.5% per year, GD P per-capita is rising by almost1 % annually. At this rate, it will take nearly 70 years forper-capita GD P to reach the current levels of Spain orPortugal. In this respect, the Brazilian economy is nowin a situation of near-stagnation.

In the late 1980s and early 1990s, this situationwas seen as the result of the persistent high inflationprevailing in the Brazilian economy. ]n March 1990,the last month of President Sarney's term of office, thisdeveloped into hyperinflation as prices rose at a monthlyrate of 72%. Annual inflation rates were brought downto below 10% by the successful implem entation of RealPlan during President Fernando Henrique Cardoso's firstterm. This process involved anchoring inflation on theexchange rate, under the crawling-peg exchange rateregime implemented from 1995 to 1998.Stabilization was not followed by a sustainedacceleration of growth, however. The faster growthrecorded in the first two years of Real Plan withaverage rates of almost 5% per year was broughtto an end due to contagion from the external crises inMexico, East Asia and R ussia.In early 1999, following a massive loss ofintemationai reserves caused by a sudden stop in capitalflows to the Brazilian economy, as confidence in thesustainability of the Brazilian exchange-rate regimeevaporated, the cou ntry's m onetary authorities adopteda flexible exchange-rate regime.The new macroeconom ic model was completed in1999 with the adoption of inflation-targeting enhancedby a fiscal policy that aimed to generate substantialprimary surpluses to prevent the public-debt/GDP ratiofrom exploding.The new macroeconomic model allowed for sharplylower real interest rates they fell from almost 25%

D The authors are grateful for helpful commsnts by Luiz CarlosBresser-Pereira, Malcon Sawyer. Guisepe Fcniana. Jos Gabriel

per year in the period 1994-1998 to nearly 10% in thperiod 1999-2005 and for a devaluation of the reexchange rate, which was crucial for eliminating thcurrent-account deficits recorded in the period 1994-199which reached a level of almost 4% of GDP. Moreover,fiscal policy that generated significant primary surplusmade it possible to reduce the public-debt/GDP frompeak of 63 % in 2002 to its current level of around 45Despite lower real interest rates, less externfragility and stabilization ofthe public debt, the grow

performance ofthe Brazilian economy rem ains very weaAverage annual growth in the period 1999-2005 wonly 2.3% compared to 3.22% in the period 1994-199Against this backdrop, the key problem is how produce a persistent increase in the growth rate in thBrazilian economy.There are two answers to this. The first, based oneoclassical growth m odels and the grow th-accountinmethodology, argues that the reason for the Braziliaeconomy's weak growth performance over the last 2years is to be found on the supply side of the economMore specifically, the reasons for the low GD P growrate were a low level of domestic savings owing the negative contribution of the public sector and weaincentives for private savings and lack of technologicdynamism reflected in a very low total-factor-productivi

(TFP) growth rate. On this view, a sustained rise in tgrowth rate would require reform ofth e social securisystem to increase government saving, supported bymore open economy to stimulate higher productiviin Brazilian firm s.The second approach to this issue is based on thidea that the macroeconomic model adopted in Brazil the last decade has undermined aggregate demand anis hampering the real GD P growth rate. This is becauthe combination of still high real interest rates and thgeneration of significant (and, in recent years, increasinprimary surpluses i s depressing demand.According to tview, the solution forthe near-stagnation o fthe Braziliaeconomy would be to replace the current macroeconommodel which is based on inflation-targeting under flexiexchange rates and the generation of primary surpluseIn the belief that both of these views are mistakethis article adopts a Keynesian approach in which th


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side. Nonethe less, the naive Keynesian view that growthcan be stimulated by any policy that increases aggregatedemand is rejected. The fiscal crisis in Brazil imposesclear constraints on growth policies based on increasinggovernment consumption. A sustained increase in thegrowth rate of the Brazilian economy requires theadoption of a new growth model, in which exportsdrive aggregate demand and thus serve as the engine oflong-run growth. Adopting this growth model, however,requires an exchange-rate regim e that can keep the realexchange rate undervalued.This article is organized in five sections, includingthe introduction. Section II describes the theory ofdemand-led growth in which the long-run growth-rateof real GDP is a weighted average of the growth rates of

government consumption and exports. Section III, based

on the methodology developed by Atesoglu (2002), reportseconometric tests of the hypothesis that the Brazilianeconomy is in a demand-led growth regim e. The resultsof the tests showed that nearly 85% of GDP growth inthe period 1990-2005 is explained by demand-sidevariables. Moreover, tests based on the methodologydeveloped by Ledesma and Thirlwall (2002) show that theBrazilian econ omy 's natural growth rate is endogenous,and considerably higher in boom period s. These resultsshow that there are no supply-side constraints preventinga sustained increase in the growth rate of the Brazilianeconomy. Section IV provides an empirical analysisof the relation between the real exchange rate and theincome-elasticity of exports, to show that an export-ledgrowth model requires a comp etitive real exchange ratelevels. Section V summ arizes the conclusions.

IIThe theory of demand-led growth: theKeynesian view

1. Long-run endogeneity of the supply offactors of productionNeoclassical growth models assume that the fundamentallimit to long-run growth is the supply of factors ofproduction. Aggregate demand is relevant only fordetermining the degree of capacity utilization, but hasno direct influence over the rate of growth of productivecapacity. In the long-run. Say's law is assumed to hold:supply creates its own demand.

But is the supply of factors of production reallyindependent of demand? This question, originallyraised by Kaldor (1988), gave rise to the theory ofdemand-led growth, premised on the notion that thatthe means of production in a modem capitalist economyare themselves goods produced within the system. The"supp ly" of means of production should never be takenas given and independent of the demand for them. Inthis theoretical framework, the fundamental economicproblem is not to allocate a given am ount of resourcesbetween alternative uses; but to determine of the rate atwhich those resources are created.The long-run endogeneity of factors of productioncan be understood by starting with the supply of

in time or the productive capacity that exists in theeconomy is the outcome of past investment decisions.Thus the stock of capital is not a quantity determined by"natu re", but depends on the rate at which en trepreneurswish to increase it.This means that investment decisions are thefundamental determinants of the "capital stock".Investment, in turn, is determined by two sets of variables:(i) the opportunity cost of capital (mainly determinedby the short-term interest rate set by the central bank);and (ii) expectations for the future growth of sales andproduction. In this context, if entrepreneurs foresee astrong and sustainable increase in demand for the goodsthey produce as would be expected in an economywith a persistently high growth rate they will makelarge investment expenditures.In other words, investment is an endogenous variablethat is aligned with the expected growth of aggregatedemand, provided one fundamental condition is satisfied:the expected rate of return on capital m ust be higher thanthe cost of capital. If this condition is met, the "supply

of capital" should not be considered as a constraint onlong-run growth.Although production in the short and medium


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of the economy, long-run productive capacity must beincreased through investment expenditures to satisfythe increase in aggregate demand.The second focus is the "supply of labour", whichthis theory also does not see as limiting productiongrowth in the long run.Firstly, the number of hours w orked can easily beincreased to raise the level of output.Secondly, the participation rate the labour forceas a proportion of the total working-age population canincrease in response to a strong increase in labour demand(Thirlwall, 2002, p.86). In fact, during boom periods,the opportunity cost of leisure increases, stimulatinga vigorous increase in the participation rate. Thus thelabour force may grow faster during boom periods as

individuals decide to enter the labour force in responseto the incentives created by a boom ing labour market.It should be noted that population and the labourforce are notfixedfor the econom y as a whole. A shortageof labour even of skilled w orkers can be solved byimmigration from other countries. For example, countriessuch as Germany and France were able to sustain highgrowth rates during the 1950s and 1960s by employingimmigrant workers from the European periphery (Spain,Portugal, Greece, Turkey and southern Italy).Lastly, it is worth considering whether the rate

of technological progress acts as a constraint on long-run growth. Growth will be limited by the pace atwhich knowledge of information and communicationstechnologies (ICTS) expands if technological progress isexogenous to the economic system; but that is not the case.Firstly, the pace at which firms innovate is largelydetermined by their rate of capital accumulation; since alarge proportion of technological innovations is embodiedin new machinery and equipment.'Secondly, even the small part of technical progressthat is disembodied is determined by dynamic economiesof scale such as leaming-by-doing. A structural relationshiptherefore exists between the rate of growth of labourproductivity and the rate of growth of output, known

' This idea was originally expressed by Kaldor (1957) through the'"technical progress hjnc lion". w hich posits the existence of a structuralrelationship between the growth rate of output per-worker and thegrowth rate of capital per worker. According to Kaldor, it is impossibleto isolate the increase in labour productivity caused by the introduciionof new technologies from that caused by an increase in capital per-worker. The reason is that neariy all technological innovations that

as the "Kaldor-Verdoom Law".-- ^ In this frameworan increase in aggregate demand will cause labouproductivity to grow faster, since output growth wiaccelerate in the wake of stronger demand growth.From this standpoint there is no such a thing along-run potential or full-employment output, sincthe supply of factors of production and the rate otechnological progress are both demand-determine"Full-employment" is essentially a short-run concepthat ignores that endogeneity of the long-run "naturgrowth rate".

2. The determinants of long-run growthIf the supply of factors of production cannot be considerea constraint on long-run growth, what are the determinanof economic growth in the long run? From the Keynesiastandpoint, the ultimate determinant of economic growtis aggregate demand. Firm s raise their production levein response to an increase in aggregate dem and, providetwo conditions are satisfied: (i) profit margins are higenough to give to enu^epreneurs the desired rate of retum(ii) the actual profit rate m ust be higher than the cost ocapital. If these two conditions are met, then the rate ogrowth of real output will be determined by the rate ogrowth of "autonomous dem and" the part of aggregademand that is independent of the level of output anincome, variations therein, or both.

In the case of open economies, autonomoudemand has two components: exports and govemmeconsumption expenditure (Park, 2000). Investment is na component of autonomous demand, since decisions invest in capital assets are basically determined by thexpectations entrepreneurs hold for the future growof production and sales, according to the "acceleratoinvestment model (Harrod, 1939). In other wordinvestment is not an exogenous variable in the grow

- Econometric evidence on the validity of the "Kaldor-Verdoom Lafor the United States can be found in McCom bie and De Ridder {198^ Ledesma (2002) estimates a demand-led growth model for 17 countrthat are members of the Organization for Economic Cooperation aDevelopment (OECD) (Australia, Austria. Belgium, Canada. DenmarFinland, France, Germany. Italy, Japan. Netherlands, Norway, PortugSpain. Sweden . United Kingdom and U nited States) in the period 1961994. Based on this econometric evidence, a structural relationship cbe identified between the grow th rate of labour productivity and a sof other variables including the rale of output growth. The estimatstructural equation is:

r = -0.015 + 0.642>' + 0.0002(//O) + 0.61 IK + 0.021GA P,where r is the growth rate of labour p roductivity: y is the growth raof real output; (I/O) is investment as a proportion of real GDP; K


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process, since it is actually driven by output growth. Thelong-run growth rate of real output is thus a weightedaverage of the rate of growth of expo rts and the rate ofgrowth of govemment consumption expenditure.For a small open economy that does not haveits own convertible currency, export growth is theexogenous variable in the growth process. If governmentconsumption grows faster than export growth, then realoutput and income will outpace expo rts. Assuming theincom e-elasticity of imports is greater than 1 (as isusually the case in open ec onom ies), then im ports willgrow faster than exports, generating a ever larger tradedeficit (assuming constant terms of trade), which willbe unsustainable in the long-run.*

'' It is importan t to note that export growth that outpaces the growth ofgovemment consumption is not a sufficient condition for a sustainablegrowth pro cess in the long-run; balance of paymen ts equilibrium is alsorequired. For open economies with zero-capital mobility this meansthat the long-run growth rate will be equal to the ratio between the

The rate of growth of exports is calculated as theproduct of the incom e-elasticity of exports (E) and therate of growth of world income (z). Thus the long-runrate of growth of real output (g*) in the demand-ledgrowth model is given by:(1)

In other words, the growth rate of real output isequal to the product of the income-elasticity of exportsand the rate of growth of world incom e.

income-elasticity of exports and the income-elasticity of imports, withthis ratio being multiplied by the growth rate of world income knownas "Thirlwall's Law" (Thirlwall, 1997). The introduction of capitalflows does not significantly alter the long-run equilibrium growthrate (McCombie and Roberts, 2002, pp.95-96). The present articleis not concerned with balance of payments constraints on Brazilianeconomic growth, but aims to show the existence of a demand-ledgrowth regime in Brazil. The econom etric tests will therefore not use"Thirlwall's L aw" .

I l lDemand-led growth in Brazii?Some empirical tests

This section reports econometric tests ofth e hypothesisthat growth is driven by aggregate demand in the Brazilianeconom y. It firstly shows that certain aggregate dem andvariables play a key role in explaining the growth ofthe Brazilian economy in the period 1991-2005.^ Inparticular, exports and govemment current consumptionare exogenous variables in long-run growth, thuscorroborating the demand-led growth model describedin Section II. It is also shown that the natural growth rateofth e Brazilian economy is endogenous, and determinedby the dynamics of the current growth rate driven byaggregate demand. This means that supply conditionsdo not impose a binding constraint on economic growth.The estimates m ade for this article based on quarterlydata on unemploym ent and the growth of the Brazilianeconomy in the period 1980-2002 show that the

^ The Brazilian Geographical and Statistical Institute (IBGE) replicatedGDP calculations for the years 1995- 2006. As the analyzed series isquarterly and the period of analysis of this study spans from 1991

natural growth rate can vary from 5.2% per year to 8%in boom periods.1. Testing the hypothesis of demand-led growthThis subsection uses the Atesoglu (2002) methodology totest the hypothesis that growth in the Brazilian economyis driven by aggregate dem and . This involves measuringthe relationship between real GDP (Y) and the followingvariables: real level of exports (X); the real level ofinvestment (I);^ real govemm ent consum ption (G); andthe real money supply (M2 deflated).^

* Public and private.' The reason for using a money -supply variab le instead of a long-terminterest rate as a proxy for the effects of monetary policy on long-rungrowth in Brazil needs to be explained. Firstly, the implementationof mon etary policy by setting the short-term interest rate only beganin 1999 after the establishment of an inflation-targeting regime. Priorto 1999, the Central Bank of Brazil used other operational targets formonetary policy, such as money-supply growth (1994-1995) and the


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156 C E P A L R E V I E W 1 0 6 A P R I L 2 0 1 2The data on real GDP, real exports, real investmentsand real government consumption w ere obtained from theSystem of National Accounts provided by the BrazilianGeographical and Statistical Institute (BGE/SNA). Themoney-supply series was obtained from the CentralBank of Brazil. All series were deflated by the generalprice index (IGP-DI) calculated by the Getlio VargasFoundation (FGV). All variables were transformed to settheir 1991 values equal to 100 (1991 = 100), and naturallogarithms^ were applied to these rates. As a result, theestimated coefficients represent the elasticities between

Financeiras do Tesouro) -are indexed to ihe shon-term interest rate.This eliminates the possibility of capital losses caused by an increasein the short-term interest rale, which means that the duration {thesensitivity of bond prices to changes in the inlerest rate) of suchbonds is zero, making them perfect substitutes for bank reserves.This specific institutional feature of the Brazilian economy resultsin a "contaminalion" of monetary policy by public debt, creatinga horizontal yield cur\>e\ in other words, a situation where debts ofdifferent maturities have the same interest rale, namely the interestrate on loans in the inter-bank market (see Barbosa, 2006).^ An L placed before the name of each variable indicates its logarithmicform while DL denotes the first difference of the logarithms.

the variables in question. The study period spans 6quarters, from the first quarter of 1991 to the fourtquarter of 2005.The following unit-root tests were used to check fostochastic trends in the variables: augmented DickeyFuller (ADF, t-test), Phillips-Perron (PP, z-test) and thtrend-adjusted Dickey-Fuller (DF-GLS test), along with thKPSS stationarity tes'., proposed by Kwiatkowski, PhillipSchmidt and Shin (1992).^ The decision on whetheto include the constant or trend, or both, in additioto the number of lags for each series, was made usinthe Schwarz (se) and Newey-West (NW) informatiocriteria, supported by the statistical significance of thestimated parameters and the usual diagnostic testalways starting with the general model and moving tthe particular (initial lag = I.O). The results, set out itable 1, show that all variables are integrated of ordeone, or 1(1), and are therefore are not stationary.^ Following M addala (2001), confirmatory analysis was used andsignificance level of 10% was adopted. In the event of conflictinresults, the unit-root test was preferred.

Unit-root and stationarity tests

VariableLYD(LY)LXD(LX)LID(LI)LGD(LG)LM 2D(LM2)VariableLYD(LY)LXD(LX)LID ( U )LGD(LG)LM 2D(LM2)

Def.I021004301

Def.1021004301

Set termsNNNNNNNNCTN

Set termsCCTCTCTCTCTCTCTCTC

ADFTest0.70-10.781.64-9.520.59-7.770.82-3.21-2.31-3.02

DF-CLSTest

-0.59-7.74-1.46-8.60-2.44-5.62-1.78-2.21-1.14-2.61

Critical value 10%-------

.61.61.61.61.61.61.61.61-3.17-1.61

Critical value 10%-1.61-2.87-2.87-2.87-2.86-2.87-2.88-2.88-2.86-1.61

Def.21118215757152802

Def.54851855851563

Set termsCTNNNNNNNCTN

Set termsCTCCTCCTCTCTCCTC

ppTest-3.15-11.761.56-8.451.25-12.88I.4I-15.62-2.31-6.42

KPSSTest0.200.390.230.150.220.500.210.140.230.42

Critical value 10%-3.17------

.61.61.61.61.61.61-I.6I-3.17-1.61

Critical value0.120.350.120.350.120.120.120.350.120.35

Source: Prepared by the authors using data from the System of National Accounts provided by the Brazilian Geographical and StatisticaInstitute (IBCE/SNA) and "Boletim do Banco Central do Brasil".Notes: N = None; C = Constant; and CT = Constant and linear trend, ln the ADF and DF-CLS tests, the initial number of lags for each seriis defined according to the Schwarz information criterion. The Newey-West selection was applied for the PP and KPSS tests.


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Long-run (eg)modelDependent variable: LYMethod: Ordinary least squares (OLS)Variable C LX

Static regression

Observations:LI

59 (ADL) and 60 Static regressiLG LM2

CoefficientStandard errort-statStandard error (HAC)t-stat (HAC)Variance inflation factor

0.65990.52071.26740.48641.3569

0.06870.02782.47350.02392.87831.7170

0.31720.11932.65980.08473.74282.3850

0.41340.06806.08050.10673.87583.4210

0.0530.0540.9810.0630.8394.691Autoregressive distributed lag

CoefficientWald test (F-stat) 1.17263.7628 0.03891.55880.07933.1683

0.596610.9340

0.0310.117

Adjusted R-Standard error (eq.)Log-probabilityAkaike criterionSchwarz criterionF-statChow lestRamsey RESET test

0.87430.85130.0468ID2.3642-3.1310-2.778937.88550.20951.9947

Du rb in-WatsonBreusch-GodfreyARCH t e s l

White testBreusch-Pagan testDoomik-Hansen test

Lags: 2Lags: 4Lags: iLags: 2Lags: 4

1.9841.2111.9210.0830.4800.74057.99211.119

14.138Source: Prepared by the authors using data from ihe System of National Accounts provided by the Brazilian Geographical and StatisticInstitute (IBGE/SNA) and "Boletim do Banco Ce:ntral do Brasil".Notes: The diagnostic statistics refer to the ADI model with 1 lag.Durbin-Watson and Breuseb-Godfrey tests detect autocorrelation problems.White and Breusch-Pagan tests detect heteroscfdasticity problems.Ramsey RESET is a diagnostic test performed oa the model specification.ARCH test detects problems of autoregressive conditional heteroscedasticity.Doomik-Hansen test detects autocorrelation and normality problems.Chow test is a diagnostic test on the presence of structural change.ADL: Autoregressive distributed lag model.HAC: Heteroscedasticity and autocorrelation te a (White).C: Constant." EO: Two-stage procedu re developed by Engle-Granger to test cointegration.

autoregressive distributed lag (ADL> model ." Thismodel passes the diagnostic tests. In terms of parametersignificance, LX, LI, LG are still signincant (at least at10%) but LM 2 is not.

To ensure the estimated relationships are not spurious,the variables in question need to co-integrate. The nextstep in the Engle-G ranger procedure is tD check whetherthe residuals in the long-run relationship are stationary,using the adf test. Nonetheless, it is notadvisable to usethe values ofth e traditional tables to tesi this hypo thesis.As these tables are not prepared for the estimated values,we use the adjusted table for estimated values and for

the sample size proposed in MacKinnon (1990). Thstatistical test value (-4.68) rejects the presence of a unroot with 99% confidence, thus pointing to the existenof a long-run relationship between variables.The existence of cointegrated variables means therror correction model (ECM)can be used. This connecshort-run dynamic aspects and long-run ones; in othwords, it make it possible to combine the advantagof modeling with variables expressed as differenceand as levels.As Table 4 shows, the variables under study ardifferentiated, so they are stationary (they originallhad a unit root). For the equation to be balanced ithe sense of being at the same level of integration, th


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160 E P A L R E V I E W 1 0 6 A P R I L 2 0 1 2

CoJntegratJon testsTrace Tesi

Hypothesizedno . of EC{s) Eigenvalue Trace statislics 0.05Critical valuNoneAl most IAt most 2Al most 3Al most 4

0.49690.37800.15230.09030.0025

76.902939.810814.16735.24550.1336

69.818947.856129.797115.49473.8415

Tlie maximum eigenvalue lestHypothesizedno . of EC(s) Eigenvalue Maximum eigenvalue statistic

0.05Critical valuNoneAt most IAt most 2At most 3A l most 4

0.49690.37800.15230.09030.0025

37.092125.64358.92185.11190.1336

33.876927.584321.131614.26463.8415

Source: Prepared by the authors using data fro-ni the System of National Accounts provided by the Brazilian Geographical and StatisticInstitute (tBGE/sNA) and "Boletim do Banco Central do Brasil".

The parameter estimates in equation (2) are thestandard co-integrating coefficients; the values inparentheses are standard errors and ths t-statistics arein brackets. All elasticities have the signs expected inthe theory and are statistically significant (5%), except,once again, LM2 .Table 6 summarizes the results obGained from VEC,including each equ ation's error-correction term and thebasic diagnostics of the model as a whole. The figuresindicate the long-run equilibrium adjustment coefficientsobtained from each of the five VEC multiple equations.The significance of the error correction term in eachequation indicates that the dependent variable adjustsin response to an imbalance between the dependentvariable and the independent variables, thus indicatingendogeneity.The statistics of the VEC test rejec: the presence ofautocorrelation, heteroscedasticity and non-normalityin the residuals. In the adjustment matrix, only theerror correction terms in the Product and Investmentequations are significant (up to 5%), which is evidencefor the (weak) exogeneity of exports and govemmentexpenditures in the mo del. Although the money supplydoes not adjust to long-run disequilibria, i: is not significantin the long-run equation.

The analysis of short run-disequalibria and theirinteraction with the long-run dynamics, provided by

signs suggested by the theory are observed empiricalfor the Brazilian economy in the period examineand the explanatory variables exports, investment, angovem ment expenditure are all significant in the shoand long runs. The money supply is significant only ishort-mn dynamics, so // seems unlikely hat monetapolicy has persistent effects on economic growth in BThis is because monetary chan ges, broadly defined, dnot have a statistical infiuence on the behavior of reGDP in the long run.According to the estimated coefficients of regressioequation (2), for each 1% increase in real govemmenconsumption, real GDP grows by 0.40%. Thus, assuminthat tax revenues in the three spheres of govemmenrepresent approximately 40% of GDP, an increase current consumption by govemment on the order o1% would generate an increase in tax revenues oapproximately 0.16%, thereby worsening the publisector deficit. Given the high tax burden currentlprevailing in the Brazilian economy (about 40%) anthe high public-debt/GDP ratio (also around 40%), undcurrent conditions, the govemment cannot permanentlstimulate economic growth by increasing its curreconsumption. Exports represent the only "autono mousource of demand that could induce a growth acceleratioIn other words, the Brazilian econom y needs adopt aexport-led growth model.


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C E P A L R E V I E W

T A B L E 6Summary of vec^ results

D(LY)

106

D(LX)

A P R I L 2 0 1 2

D(LI) D(LG)

161

D(LM2)EO TStandard errort-statAdjusted R^Standard Error (eq.)

-0.7540(0.2490)-3.0285]0.67570.0405

0.9970(0.5846)[1.7053]0.43610.0952

0.4946(0.2423)[2.0379]0.41210.0411

-0.7177(0.3805)[-1.8858]0.81570.0620

-0.2112(0.2156)[-0.9794]0.46960.0351

LM stat (Autocor.)White (Heterosc.)Lutkepohl (Norm.)24.2728

801.10202.8940Source: Prepared by the authors using data from the System of National Accounts provided by the Brazilian Geographical and StatisticalInstitute (IBGE/SNA) and "Boletim do Banco Central do Brasil"." Vector error correction.

Atesoglu (2002). The causality relations support theKeynesian approach discussed in the previous section, inwhich exports and government consum ption are the keysources of economic growth in the long run. Nonetheless,given the severe fiscal crisis in Brazil, it does not seempossible to boost economic growth through a policyto expand the government's current consumption. Aresumption of rapid growth in the Brazilian economyrequires the adoption of an export-led growth model.2. Is the natural growth rate of the Brazilianeconomy endogenous?Subsection 1 showed that the observed growth rate ofthe Brazilian economy is determined by the growth ofaggregate demand. This subsection takes the reasoning astep further by show ing that the natural rate of grow th'^also adjusts to the economy's actual growth rate in thelong term. This means that aggregate-demand growthdetermines not only the dynamics of the actual growthrate of the Brazilian economy, but also the dynamics ofthe natural growth rate, which is conventionally linkedto technological p rogress and growth of the labour force.This subsection is based on a study by Ledesmaand Thiriwall (2002). Using the concept defined byOkun (1962 cited by Ledesm a and Thiriwall 2002), the

'' In the old neoclassical growth models, represented by Solow(1956),the natural growth rate was exogenous and determined by supplyfactors including the rate of technological progress and growth of thelabour force. In the "new growth theory" w hich originated in seminalpapers by Romer (1986) and Lucas (1988), the natural growth rate ismade an endogenous variable in the sense that the rate of technologicalprogress is determined by the m odel itself. Nonetheless, this is not themeaning of the term "endogenous" as used in this anicle. Here theterm "endogenous natural growth rate" means a real output growthrate that is determined by the rate of growth of aggregate demand in

natural rate of growth (g,,) is what keeps the level ofunemployment constant. Okun ( 1962 cited by Ledesmaand Thiriwall 2002) uses the following specification forthe change in the percentage unemployment rate:

(3 )where U is the level of unemployment, g is the rate ofgrowth of output and a and b are two constants. Fromequation (3), when A %i/ = 0, the natural rate of growthis defined by a/b.

As some people do not seek work when econom icgrowth is subdued, it is possible tha t the coefficient a isunderestimated. In this case, the natural rate of economicgrowth would also be underestimated. Moreover, in periodsof rapid economic growth, part of the additional workneeded to increase production comes from labour thatwas previously underused, and also from overtime. Thus,b is underestimated, which leads to an overestimationof the natural rate of growth. Accordingly the naturalrate of growth may be either under- or overestimateddepending on w hich of two effects predom inates.In an attempt to circumvent these problems a differentapproach to estimating the natural rate of growth wasdeveloped by Thiriwall (1969):

(4 )In equation (4), when the variation in theunemployment rate is zero, we have:

(5)Thus, the natural rate of growth is defined by theintercept of the regression equation. The problem of


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Once the natural rate of growth is estimated, adummy variable can be created that takes the value 1(one) when actual economic growth exceeds the naturalrate estimated by equations (3) or (4), and 0 (zero),otherwise. The introduction of the dumm y variable givesthe following regression equation:(6)

where D is the dumm y variable. In specifying equation(6), two natural rates of growth are estimated. The first sestimated for periods in which the growth rate is abovethe natural rate given by equation (4). In this case, thenatural rate of grow th is equal to ^2 + 2- ^^^ second isestimated for the periods in which the observed growthrate is below the natural rate given by equation (4). Inthis case, the natural rate is aj .

A "natural rate" would be expected not to varywhen the actual growth rate changes. If this is true,the coefficient of the dummy variable should not bestatistically different from zero. Otherwise, the naturalrate of growth (^) is endogenous and responds to changesthat may occur in the actual growth rate (g).The database used to perform the regression analysisin this study contains GD P and unemployment variables.The level of unemployment is taken from the IBGEMonthly Employment Survey (PME), with the originalmonthly figures being transformed into quarterly databy calculating the arithmetic m ean of the three monthsin each quarter.'^ The chain index of GDP is based on the

System of National Accounts obtained from IBGE (IBGSNA). '^ The period of analysis spans the first qua ner o1980 to the last quarter of 2002.'^ As both variablwere transformed into growth rates, the first observatioin each series was lost, leaving 91 observations for thempirical analysis.

Using the quarterly data series, estimates of thnatural rate of growth obtained from equations (3) an(4) are shown in table 7.The growth rates reported by each ofthe equatioare very similar, which suggests that the estimated naturrate of growth (NRG) is robust, despite the potentiproblems mentioned above.A natural rate of growth of around 0.60% pquarter gives an annualized rate close to 2.50%. Thu

the regression equations used, suggest that the growth rathat would have kept Brazilian unemploym ent constabetween 1980 and 2002 was close to 2.50% .Table 8 shows the empirical results obtained froregression equation (6). The symbol MA means ththe GDP growth rate is a three-quarter m oving averagThe results of regression (6) indica te that the naturrate of growth responds to the economy's real growrate. The figures in the first line of table S suggest thin periods of rapid econ omic growth the natural rate around 8%, w hile in periods of weak economic grow

or recession the natural rate is actually negative, around -3.5 %.It should be remembered that the data are quarterso the range of variation is large. One advantage of usinmoving averages is that they smooth the fiuctuations,'' Using the monthly data, each year was divided into four quarters,by adding together the unemploytnent figures for the three monthsand dividing by three. Ist quarter unemployment rale (January +February + March) / 3; 2nd quarter unemployment rate (April +May + June) / 3: 3rd quarter unemployment rate (July + August +September) / 3; 4th quaner unemployment rate (October + November+ December)/ 3.

'^ Seasonally adjusted chained series of the quarterly m obile indaverage 1990= 100.'^ The period of analysis ends in 2002 because a methodologichange was made to the Monthly Employment Survey database 2003, making it impossible to extend the econometric tests to tmost recent period.

Estimation of the natural rate of growth using the Okun and Thirlwalt equationsMethod Intercept Slope R-Aj.

Equation (3)Equation (4)

RK

OLS

i.6I(0.99)0.59***(2.99)

-2.70***(3.49)-0.053***(4.12)

2.321.89

O.I I0.15

0.600.59

Source: Prepared by the authors using data from the System of National Accounts provided by the BraxUian Geographical and StatisticInstitute (IBGE/SNA).Notes: *** Significant at 1 %. "'* OLs: ordinary- least squares: RR is the robust regression method used to correct problems of non-norma


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C E P A L R E V I E W 1 0 6 A P R I L 2 0 1 2 163T A B L E 8

Equation (6)Equation (6) M A

MethodOLS

PWER

Estimation ofand ThirlwallIntercept-0.84***(-4.40)-0.26*(-1.66)

the natural rate of growth using theequations with a dumm y variableD u m m y

coefficient2 . 8 5 * * *(10.40)1.56***(10.26)

Slope0 . 0 3 * * *

(-3.35)0 . 0 1 1 * *

(-2.14)

DW2.281.82

Okun

R^Aj.0.610.54

NRG (gg)2.011.3

Source: Prepared by the authors using data from the System of National Accounts provided by the Brazilian Geographical and StatisticalInstitute (IBGE/SNA).Notes: *** Significant at 1% ; ** Significant at 5%; * Significant at 10% . OLS: ord inary least squar es; PWER is the method of Prais-Wistenwith robust errors to correct problems of autocorrelation and heteroscedasticity; DW is the value of the Durbin-Watson tesl for firsl-orderautocorrelation; R- Aj. is adjusted R-; NRG is the natural rate of growth; and MA is the regression equation using three-quaner moving averages.

can be seen from the results shown in the second row oftable 8. In this case, the natural rate of annual growthin "good times" would be around 5.2%, while in "badtimes" it would be close to - 1%.The tests show that the natural rate of growth ofthe Brazilian economy is an endogenous variable andcan therefore be affected by the demand conditions

prevailing in the economy. Estimates for the naturalrate of growth in "good tim es" vary between 5.2% and8% per year, which suggests that the Brazilian economycould grow at annual rates well above 3.5% withoutgenerating inflationary pressures. The empirical resultsprovide evidence that economic growth in Brazil is notconstrained by supply side, but by demand.

IVAn empirical analysis of the relation betweenthe real exchange rate and the income-elasticityof exports

Section III showed that the observed and natural growthrates in the Brazilian economy are both determined bythe growth of aggregate dem and. It was also noted thataggregate-demand growth is driven by the growth ofexports and government expenditures (since investment isendogenous); but a growth regime led byfiscalexpansionis not feasible in Brazil owing to the fiscal crisis. Thismeans that growth in Brazil can only be driven by acontinuous expansion of exports.What conditions need to be satisfied for a strongand continuous expansion of exports in Brazil, or inother capitalist econom ies? In the long run, the rate ofgrowth of exports in a country or region is determinedby the worldwide income-elasticity of exports multipliedby the rate of growth of income in the rest ofthe world.The income-elasticity of exports captures the influence

of exported products, the degree of differentiationof exported products compared to their competitorson the international market, the value added to theseproducts, and so forth have on the country's externalcompetitiveness. The higher is the income-elasticityof exports, the higher will be a country's growth rateof exports for a given rate of growth of world income.This is the channel through which supply factors caninfluence, but not determine, the growth rate of realoutput in the long r un .' '

" The inclusion of supply factors in the analysis of this article doesnot diminish the role of aggregate demand as the ultimate cause ofeconomic growth. The growth rate of real output in the long termis determined by the growth rate of autonomous demand, which


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Countries on the so-called "technological frontier"should generally have a higher income-elasticity ofexports than less developed countries. That is becausecountries that are closer to the "technological frontier"tend to export prod ucts of higher value-added and withgreater technological content than countries that arefurther from the frontier. Thus the "technological gap"will be an important determinant of the income-elasticityof exports and, hence, of the long-run growth rate ofexports (Do si, Pavitt and Soele, 1990, p. 26).The theoretical and empirical literature on thedeterminants of the income-elasticity of exports has,however, neglected the role of the real exchange rateas one of its determinants. In fact, empirical work onthe variables affecting export performance has been

limited to estimating the price-elasticities of exports;and price-elasticity estimates have either shown theopposite sign to that predicted by the theory or havebeen non-significant.No attempt has been made to assess the existence ofa relationship between the income-elasticity of exportsand the real exchange rate. The literature seems to supportthe hypothesis that the real exchange rate can onlyinfluence long-run economic growth through its effecton the willingness of domestic and foreign consumersto spend their income on domestic or foreign g oods . The

literature neglects the impacts the real exchang e rate canhave on the econo my 's productive structure and, hence,on the income-elasticity of exports.On a purely theoretical level, a relationship can beestablished between the level of real exchange rate andthe income-elasticity of exports, using the Ricardianmodel of intemational trade expounded in Dornbusch,Fischer and Samuelson (1977). Based on this model,the degree of productive specialization of an econom yin othe r words the number of different types of goodsproduced by the domestic econom y is determined bythe ratio between the domestic real wage and real wagespaid worldwide.The higher the real wages paid in the domesticeconomy compared to the rest of the world, the greaterwill be the country's degree of productive specialization,or the smaller the number of different types of goodsproduced in the domestic economy. The greater thedegree of productive specialization, the lower will be

possible lo identify a precise channel through whic h the real exchangerate can influence export grow th in the long run . The conc lusion ofthe analysis, set out in the fo llo win g paragraphs, is that a robust andcontinuous expansion of exports (which is a necessary condition for

the rate of export growth generated by a given rate oworid income growth in other wo rds, the lower wibe the income-elasticity of exports.The real exchange rate affects the degree oproductive specialization in the economy by directimpacting on real wages. An appreciation of the reexchange rate generally causes real wages torise, herebincreasing production costs in the country relatively those prevailing in the rest of the world. This proceforces productive activities undertaken in the domesteconomy to migrate abroad, resulting in deindustrializatioof the domestic economy, with adverse repercussioon its export capacity.To assess whether the income-elasticity of exportsaffected by the real exchang e rate and the technologic

gap,'^ 30 developed and developing countries'^ weanalysed using a two-step regression methodologFirstly the values of the selected countries' incomelasticities of exports were estimated for the perio1995-2005; then the relationship between a countryincome-elasticity of exports and its real exchange ralevel and technological gap was estimated.The equation estimated in thefirststage is as follow(7

where X is the real dollar-value of exports by count/ ', y* is the real dollar-value of the rest of the worldGDP, Q is an index of the real exchange rate, taken an average from the period 1995-2005 (1995 = 100CQ is a constan t, , is the error term, C) represents thexchange-rate elasticity of exports, and C2 representhe income-elasticity of exports, in other words, thresponse of each country's exports to changes in thworld GDP.-^ All series use quarterly data.Estimation of the second-stage equation aimed capture any effects exerted by the real exchange rate antechnological gap on the income-elasticity of exportTo this end, an OLS regression was estimated of thvalues of the income-elasticities of exports estimate

'* The technological gap concept is due to Fagerberg (1988).'^Argent ina, Austral ia, Austria, Brazi l , Canada, Chile. Czech RepubDenmark. France, Germany, Hungary, Indonesia, I taly, MalaysMexico, Nether lands, New Zealand. Norway. Portugal , Republ icKorea, Russian Federation. South Afric a, Sp ain, Sweden, Switze rlanThai land. Turkey, Uni ted King do m and United States.^^ Of the 30 countries review ed, 24 did not present any prob lem in test imat ion o f C2 in level terms. In the cases of Chile, Denmark, NeZealand, Norwa y, Portugal and the United King dom , exports and woCDP do not cointegrate, so it is impossible to estimate the correct lev


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C E P A L R E V I E W 1 0 6 A P R I L 2 0 1 2 165in the first stage against the real-exchange- rate andtechnological gap indices for the selected countries inthe period 1995-2005. The model specification allowsfor an interaction between the real exchange rate and thetechnological gap in determining the income-elasticity ofexports. Introducing this interaction makes it possible toanalyze whether the effect of real-exchange-rate variationson the income-elasticity of exports is affected by thetechnological g ap. Countries with a larger technologicalgap in relation to the United S tates could be expected tooffset their technological disadvantage through currencydepreciation. For countries closer to the technologicalTonfier the opposite result is expected: a higher level of non-price competitiveness allows these countries to maintainan appreciated currency and thus higher real wages.

The real-exchange-rate index was calculated usingquarterly data on the nominal exchange rate and consumerprice indices obtained from International EinancialStatistics (IFS), and normalized to 100 in 1995. Figure 1below shows the dispersion ofth e income-elasticity ofexports and the real-exchange-rate index.Figure 1 reveals the existence of a nonlinearrelationship between the income-elasticity of exportsand the real exchange rate across the selected cou ntries.For lower levels ofthe real exchange rate, there appearsto be a negative relation between the two variables. Athigher levels of the real exchange rate, however, therelation is positive.The results of the econometric model are shownin table 9.

Income-elasticity of exports versus real-exchange-rate index5 0004 5004 000

^ 3 500- 3 000I 2 500^ 2 000

1 50010000 500

80 000 90 00 0 100 000 110 000 120 000Real-exchange-rate index (average from 1995 to 2005) 130 000

Source: Prepared by the authors on the basis of data from Internationa l Fina nce Statistics (iFS).

TABLE 9 Selected coun tries: Results of the econometric modelfor the income-elasticity of exports (1995-2005)VariableRERGAPRERGAPConstantR2Durbin-Watson statProbability (F-statisiioO)

Coefficient0.0277190.203742-0.001963-0.9194430.2261102.1164910.078975

Standard error0.0134310.1124110.0010191.427213

t-statistic2.0637391.812469-1.926045-0.644222

Probability0.04920.08150.06510.5251

Source: Prepared by the authors.Note: (i) White Heleroscedasticity-Consistent Standard Errors & Covariance; (ii) RER is the real-exchange-rate index; (iii) GA P is the ratio


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The real-exchange-rate and technological-gap indiceshave the expected signs and are statistical significant at5% and 10% respectively. This means that a depreciationof the real exchange rate will increase the income-elasticity of exports, thereby raising domestic exportgrowth for a given growth rate of world income. Thisresult is consistent with the notion that an economy'sdegree of productive specialization depends criticallyon the real exchange rate; so the real exchange rate andthe long-run growth rate are linked.

It can also be seen that a reduction in the technologicalgap (represented by a rise in the technological-gap index)will increase the income-elasticity of exports, thusconfirming the hypothesis that a higher technologicallevel is associated with exports of higher technologycontent, thus increasing the country's income-elasticityof exports.

Lastly, there is a small, but statistically significant,negative interaction between the real exchange rate andthe technological gap, which confirms the hypothesisthat the effect of real-exchange-rate variations on theincome-elasticity of exports depends on the size of thetechnological gap. The negative sign of this variable inthe regression estimates is a reflection of the weight ofdeveloped countries in the sample. In these countries.

the technological gap is smaller, so their externcompetiveness enables them to maintain appreciatecurrencies relative to those in developing econom iesThe econometric tests show that countries whicare further from the "technological frontier" cannbase their growth strategy on a low real exchange ratIn these countries, appreciation of the real exchangrate will eliminate their only m eans of competing wideveloped countries, namely an undervalued currencDeveloped countries can compensate for a lower reexchange rate with technologically superior productsThere is also a clear positive relationship betweethe income-elasticity of exports and the level of the reexchange rate for all countries in the sample. This m eathat, regardless the size of the technological gap, a rea

exchange-rate devaluation can raise the long-run growtrate of an economy by increasing its income-elasticiof exports, thereby boosting export growth for a giverate of growth of w orld incom e. The real exchange rais thus a fundamental variable in any country's growstrategy.-'

- ' Forasur\ 'ey of the liieraiureon the real exchange rate and growsee Gala (2008).

VConclusions

This article has used the demand-led grow.th model toaddress two fundamental issues: (i) why the growth rateof the Brazilian econom y slowed in the last two decadesof the period 1950-1980; (ii) what policies are needed tospeed up sustainable growth in the Brazilian economy.The answ er to the first question is based directly ondemand-led growth theory. The econometric tests reportedin section \U show that 85 % of Brazil's real GDP growth inthe period 1990-2005 is explained by aggregate-demandvariables, thus supporting the hypothesis of demand-ledgrowth in the Brazilian econom y. Then the methodologydeveloped by Ledesma and Thiriwall (2002) was usedto show that the natural rate of growth in the Brazilianeconomy is endogenous and rises significantly in boomperiods. Accordingly, there does not seem to be any supply-side constraint preventing more rapid economic growth.

of the pattern of aggregate-demand growth that haprevailed since 1964, namely an expansion of spendinon durable or luxury goods facilitated by the increasinconcentration of income in the middle- and upper-incomgroups. The semi-stagnation of the Brazilian economis thus explained by the current absence of a consistepattern of aggregate-demand expansion.

The econometric tests also showed that the govemmecurrent-consumption m ultiplier is approximately 0.40%so a 1 % increase in the governm ent's current consumptwill generate an increase of 0.37% in Brazil's real GDAssuming an average tax rate of about 40% of GDP,follows that a I % increase in the government's curreconsumption will raise tax revenues by just 0.15% GDP. In the fiscal crisis currently prevailing in Brazwhich involves a combination of a high public debt/GD


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in the Brazilian economy by increasing the governm ent'scurrent consumption. The only alternative is to adoptan export-led growth model.What conditions need to be satisfied for a robustand continuous expansion of exports in Brazil or othercapitalist econom ies? The econom etric tests reported insection in show that countries which are further fromthe "technological frontier" cannot base their growthstrategy on a low real exchange rate. In these countries,appreciation of the real exchange rate will eliminatetheir only means of competing with developed countries,namely an undervalued currency. In contrast, developedcountries can compensate for a lower real exchange ratewith technologically superior products.There is also a clear positive relationship between

the income-elasticity of exports and the level of thereal exchange rate for all countries in the sam ple. This

means that, regardless the size of the technologicalgap, a devaluation of the real exchange rate can raisean economy's long-run growth rate by increasing itsincome-elasticity of exports, thereby boosting exportgrowth for a given rate of world-income growth. Thereal exchange rate is thus a fundamental variable in anycountry 's growth strategy.

As a corollary of these results, developing countries,such as Brazil, may try to offset the international-competitiveness effects of their technological disadvantageby devaluing the real exchange rate against those ofdeveloped countries. This means that the adoption ofan export-led growth model in Brazil a necessarycondition for Brazil to achieve high long-run growth ratesof requires an exchange-rate policy that can sustainan under-valued real exchange rate in the long term.(Original: English)

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