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Lula's Surprise

Author: Kenneth R. Maxwell, Nelson and David Rockefeller Senior Fellow, Council on Foreign Relations
July 3, 2003
New York Review of Books


In the weeks before the election of Luiz Inacio Lula da Silva— "Lula"— as Brazil's president last October, financial experts throughout the world predicted a disaster. The Brazilian C-Bond, the best indicator of foreign investor confidence (or lack thereof), had fallen from eighty to less than fifty cents to the dollar. And Brazil's currency, the real, which had been selling at two to the dollar, had virtually collapsed and was approaching four to one.

Because so much foreign and domestic debt was indexed to the dollar the fear was palpable that Brazil would default on its international obligations and follow Argentina into bankruptcy. Foreign investment dried up; lines of credit evaporated. Some right-wing commentators in Washington expressed worries that if Lula and his leftist Workers Party came to power, Brazilian nuclear bombs and missile delivery systems could reach Florida. [*]

After nine months, Brazil has made the strongest rebound of any "emerging market" economy in the world. The Brazilian real is now valued at less than three to the dollar. Since Lula took office on January 1, 2003, Brazil has received some $5.6 billion in foreign investment and, as of May 23, has accumulated a $7.1 billion surplus on its trade balances. As for the nuclear threat, in fact Brazil has no such bombs and has signed the Non-Proliferation Treaty. The analysts at Goldman Sachs are now saying that the real is undervalued.

More remarkable, Lula, the "leftist" as The New York Times continues to call him, is now, with considerable resentment, being called a "neo-liberal" by many of his old friends in the anti-globalization movement. When I visited Brazil in May, some powerful supporters of the previous government told me that they had to admit that Lula was more cautious than they ever expected. "Continuity," they claimed, had triumphed over change— though Lula had said that the election had been all about change. Officials at the IMF and World Bank in Washington have praised the stringent fiscal orthodoxy imposed by the new government. Even Lula's most dramatic initiative, his Fome Zero program, which pledged that by the end of his four-year term in office no Brazilian would go hungry, has been dismissed by critics as window dressing, a regression to failed "welfare policies." This is an unfair comment since Fome Zero, despite the ineptitude of its bureaucratic beginnings, is slowly taking hold.

The situation is very reminiscent of Disraeli's famous aphorism of 1845, when he said that Sir Robert Peel had "caught the Whigs bathing and walked away with their clothes." A member of the administration of former president Fernando Henrique Cardoso seemed bemused by all this. "The Lula government," he said to me, "has a lot of new ideas and good ideas; but the new ideas aren't good, and the good ideas aren't new." So what happened? Has the deep pessimism on Wall Street of last year been replaced by a false euphoria? If the "experts" were so wrong then, can they be trusted to be right now?

The remarkable shift in attitude toward Lula rests on three tactical victories he achieved soon after taking office. The first was to persuade Brazilians to be patient. After his landslide win, there was concern that the great hopes raised by his election could not be satisfied quickly in view of Brazil's continuing vulnerability to foreign economic pressures and the changing sentiments of domestic and international investors. Any dramatic change in policy was bound to be difficult. In August 2002 the Cardoso government was rescued by an IMF agreement providing for a $30 billion loan. The deal obliged the future government to impose stringent fiscal policies and achieve budget surpluses, which means that very little tax money has been available for discretionary spending.

Yet in the face of these constraints Lula has been able to persuade Brazilian voters that time is needed before they receive any large benefits. So far public opinion has strongly supported him. He remains immensely popular, with 75 percent approval ratings in the opinion polls, and with only 13 percent thinking he is doing a "bad job," a substantial improvement on his negative rating of 25 to 30 percent during the campaign. Many ordinary people I spoke with seemed persuaded that Lula had taken office burdened by a poisonous inheritance, not only of huge debt but also of stubborn inequalities. They know how difficult it will be to deal with these, and how often in the past attempts to do so have foundered. Unlike the experts, they did not see "continuity" in the long term. And they continued to believe in Lula's commitment to fundamental change. The latest polls show that 80 percent of Brazilians "trust" him.

The second tactical victory of the first months was to confront the fear that had taken hold of investors, both foreign and Brazilian. To calm speculation, Lula, in a "letter to the Brazilian people," had committed himself during the campaign to maintaining the budget surpluses required by the IMF. When he took office, he not only did this, but he went further and surprised Wall Street by increasing the budget surplus from 3.5 percent of GDP to 4.6 percent. He appointed to the Finance Ministry a relatively unknown but successful former mayor and physician, Antonio Palocci, who said at once that though he was not an economist, he was a doctor who recognized that Brazil was in "intensive care."

For the critical position of president of the Central Bank, Lula appointed Henrique Meirelles, the former president of global banking at FleetBoston Financial, and well known in US financial circles. Meirelles had returned to Brazil before the last election and won a seat in Congress from Goiás, one of Brazil's interior states, on the ticket of PSDB, the party of Cardoso. He is one of the few bankers anywhere who has been willing to submit to the judgment of voters.

The third tactical victory of these early months was to counteract the claim that for all its experience in local and state politics, Lula's Workers Party, or PT, had never governed nationally or had to deal on a day-to-day basis with Congress or with Brazil's bureaucracy. But Lula had for over twenty years been a successful labor leader and negotiator, and this taught him both toughness and flexibility. Under Brazil's federal system any president needs to negotiate with Congress, and the Workers Party government does not have a majority in either house. Former president Cardoso did have such a majority, but, as he told Bill Clinton, it was an "unorganized" majority, which turned out to be the understatement of the decade. During his second term, President Cardoso could not persuade his coalition to support any major reforms. But President Lula has quickly demonstrated that he can build "majorities of the willing" in Congress, as when he won wide support for a constitutional amendment to give independence to the Central Bank.

Lula has also shown that he can work with state governors, although some of them are leading figures in the opposition parties and may run against him in the presidential election of 2006. Brazil's states, like the federal government, face huge fiscal problems, attributable in large part to enormous deficits in their social security systems. Since reforming the national social security system is also Lula's highest priority, he has been able to persuade them to join with him, which they did in person, carrying his reform proposals from the president's palace, the Planalto, to the Senate chamber, where, with much publicity, a Brazilian president, for the first time, appeared to deliver his message. These reforms will require constitutional amendments, no easy task under the Brazilian system, since changing the constitution requires the support of three fifths of both houses of Congress. Because the state governors in Brazil have immense influence over their states' representatives in the national Congress, their backing is crucial if he is to pass the measures he needs during the next few critical months.

Lula's political advisers have also shown remarkable political pragmatism. Jose Dirceu, in effect his chief of staff, has been called the Karl Rove of the Planalto, but his background could hardly be more different. A radical student leader in Sao Paulo, he was arrested in 1968 by the military regime; he was released in 1969 as part of a hostage exchange for the kidnapped US ambassador to Brazil, and left the country. While in exile, he spent several years in Cuba where he was trained as a guerrilla. His appearance changed by plastic surgery, he returned to Brazil and organized clandestine opposition to the military regime until he was given amnesty in 1979, when he returned to Cuba for further plastic surgery to restore his original features.

Since then Dirceu has been a cen-tral figure in building the PT into a national party. He served as its president, and now leads the moderate majority within it. Dirceu has developed a close working relationship with Jose Sarney, the president of Brazil between 1985 and 1990 and now president of the Senate, hence the head of the Congress and a critical figure in setting congressional agendas, making appointments, and building coalitions. Sarney, a skillful and resilient politician, poet, and novelist, as well as powerful force in his home state of Maranhao, where his daughter is governor, has known the Brazilian political establishment from the inside over many changes of regime and has become a strong ally of Lula's.

Another former guerrilla in Lula's inner circle is Jose Genoino, who succeeded Dirceu as the leader of the PT. He is almost the sole survivor of a virtually unknown guerrilla campaign in the Brazilian jungles in 1977. After it was brutally repressed by the military regime, Genoino was tortured. The full details of this hidden story have only now been revealed in a recently published history based on the secret records of the dictatorship by the Brazilian journalist Elio Gaspari. Genoino has the critical job of keeping the PT rank and file in line— especially as pressures grow to revise or abandon Lula's tough economic policies.

Lula knows time is working against him, which is why he is trying to get the most controversial reforms through Congress this year. The next big electoral test will be in the October 2004 municipal elections, so by January politicians will be making their calculations with this in mind. Lula has maximum political leverage while his public-opinion ratings hold up. This is the time when the notoriously flexible politicians that run the centrist parties are most susceptible to the charms of power. Lula has already, with Sarney's help, exploited the divisions in these parties to his political advantage in Congress. But maintaining discipline within the PT is also crucial: the PT is the solid base on which ad hoc alliances can be constructed. To be sure, the newfound friends from other parties will have to be paid off, perhaps with one or two ministries in the government, most likely those that assure control over major patronage (mines and energy, for example, or national integration, that is, roads, railways, and dam construction and maintenance), or, just as important, federal positions at the regional level within development banks and regulation agencies.

Lula put together an eclectic cabinet, and he has taken to regularly convoking its members for long sessions to report on how well (or not) they are doing. It is a cabinet that does indeed reflect Brazil's diversity, incorporating, for example, Brazil's "chicken king," the successful businessman and exporter Luiz Fernando Furlan, as minister of development, industry, and commerce, as well as Marina Silva, a colleague of the murdered rubber tapper and union leader Chico Mendes, as minister of the environment, and Benedita da Silva, the first black Brazilian senator and governor, who still has her home in a Rio favela, as minister of social development and aid. Lula has already appointed the first black, Joaquim Benedito Barbosa Gomes, to the Brazilian Supreme Court, long overdue in a country where the population of African descent is second only to Nigeria's in number. And his government has moved aggressively to clean up the corruption in the Brazilian soccer establishment, an issue that engages all sectors of the Brazilian population.

Lula's intuitive sense of politics also has been a surprise to many who expected him to be an inflexible, doctrinaire leftist, though much of this surprise reflects a certain condescension among the elite. Who would have thought, some say, that someone of Lula's background could emerge so quickly not only as a popular leader but also as a canny politician within the establishment? Lula after all, as such people never cease to remind you, left school after the fifth grade. But he has consistently been underestimated. Many well-placed observers, including former president Cardoso, told me last October that Lula was a "myth." But as an old friend who has closely observed him for decades told me at the time, anyone who thought he could manipulate Lula soon learned the hard way that this was not possible. He rose by sheer willpower from a poor family in the northeast of Brazil, one of the most backward regions in the world today, where there are few opportunities for education. Making his way to the industrialized megalopolis of Sao Paulo in the south of Brazil, he worked as a shoeshine boy and then, thanks to vocational training programs, as a lathe operator; he soon became a leader of his union. He patiently built a national labor movement and a political party, and ran for president in four elections.

Those who said he was a stooge of the far left or that he would cause a financial catastrophe were often influenced by the demonization of Lula that started in the days of dictatorship. They ignored that he has had to prove again and again that he is not incendiary, not a devil. Unlike almost every other Brazilian politician, he learned about Brazilian society from the bottom up, and not from the top down; he knows what it takes to survive in the streets.

The speed and success of Lula's tactical achievements and his pragmatic deal-making have confounded both the opposition and the left-wing members of his own party. But as with the image of Cardoso's government, always better outside Brazil than within, criticism at home has been growing. The honeymoon in fact ended the week I was in Brasilia. Some of the left-wing members of the PT were openly criticizing him, and the party leaders were threatening the most acerbic critics with expulsion if they voted against the government's reform measures. The movement of landless workers, which had been largely quiet during the election, suddenly reemerged. Some of its members invaded farms in the north and south of the country, occupied highways, and held several hostages. Landowners had already armed themselves in anticipation of takeover attempts, and more violence may erupt from beneath the surface of rural life.

Urban violence is also becoming a major challenge. The new government is constrained in its ability to respond effectively by the constitution which, seeking to avoid the arbitrary powers exercised by the previous military governments, places severe limits on federal action within the states. But tomany I talked with, the real threat to Brazil is that it risks falling into the kind of violence they see in Colombia, especially if Lula fails to stimulate economic growth and social reform. In some of the huge teeming urban areas where most Brazilians now live, especially Rio de Janeiro, this is not an unrealistic fear; the drug lords are in charge, shutting down large sections of the city just to show their power. They fire shots at the tourist hotels in swanky neighborhoods and, during shootouts with the police, they regularly close down the main highway into town from Rio's international airport. The sprawling favelas are no-go areas for most government officials. And the vast flow of narco-money corrupts judges as well as several entire states through which Colombian cocaine passes to the US and Europe.

From within the government itself dissident voices are being heard. The vice-president, Jose Alencar, a prosperous textile-mill owner from Minas Gerais, had been put onto the ticket to reassure the middle class and the entrepreneurs. He has denounced the excessively high interest rates which are suffocating Brazilian industry. Leading figures in Brazil's film industry rose up in fury after the government proposed "social offsets" for its subsidies (such as free access to theaters for youth and the poor). Lula sent his minister of culture, the famous singer and composer Gilberto Gil, to Rio to calm the film industry down. And writers on the Op-Ed pages of the Brazilian press have been denouncing the PT's caution and fiscal orthodoxy. Academic critics who have been complaining for years about the lack of discipline within Brazilian political parties now criticize the PT for the "Leninist" tactics being used to keep party dissidents in line.

The country remains deeply vulnerable. The risks of investing in Brazil are still severe, and Brazil's debt of 380.6 billion reals, about 28 percent of its gross domestic product, and its basic interest rate of 26.5 percent mean that the average Brazilian must pay astronomical rates for credit on consumer purchases. Interest now accounts on average for 14 percent of the cost of production in Brazil and as much as 25 percent in the case of the steel and auto-parts industries. Unemployment in the greater Sao Paulo region, Brazil's industrial and financial heartland, has risen to over 20 percent. Brazil's economic policy makers remain under IMF surveillance, obliged to make payments on the $30 billion of IMF loans that the previous government negotiated, which gives very little space for the economy to grow. The left wing of the PT and leading figures in the industrial sector are united in demanding lower interest rates and more generous government expenditures.

So far the government is standing firm. In April it laid out its arguments in a remarkably frank and detailed document. I discussed it with Finance Minister Palocci and his leading adviser, whom I met in a conference room on the fifth floor of the green, box-shaped building that houses the Finance Ministry, part of Oscar Niemeyer's esplanade of identical ministries lining the center mall of Brasilia. They believe that this year they have no alternative to their current austere policies if they are to break out of the cyclical pattern that has characterized the Brazilian economy for decades. If budget surpluses can be sustained, once growth picks up next year, as they anticipate it will, they believe that they will at last be able to shift surpluses from paying debt and toward social development, education, health, and improving roads and other infrastructure.

All this must happen if Brazil is to mitigate the inequality of income, unchanged for over thirty years, by which 33 percent of the population live in poverty and 15 percent in conditions of extreme destitution. Lula and his ministers are also wary about unexpected external financial shocks of the type that almost sank Brazil at the time of the Asian and Russian economic crises of 1997 and 1998. If Dirceu has become the political boss of Lula's team, Palocci is his economic czar. And like lightning rods, both attract the most criticism of the government by its opponents.

Almost all the people I spoke with in Brazil agree that the hard part of Lula's administration is about to begin. Within the next four to five months it should be clear whether his tactical victories can be transformed into strategic reforms that he can sustain. It will be an intense and probably ugly struggle, with the outcome depending on the fate of two major pieces of legislation that the former government was never able to pass. The first would revise Brazil's grotesque social security system, in which money from poorer workers is used to finance large pensions for a privileged bureaucratic elite. About 40 percent of social security payments go not to workers who are old but to people between the ages of forty-five and sixty, some of them still working at other jobs and accumulating extra pensions. The federal government spends 33 billion reals in pensions for a million specially privileged beneficiaries. For the entire public sector it spends 61.6 billion reals while taking in 7.2 billion reals a year, mainly from taxes.

The legislation reforming the social security system will be debated in Congress between June and August. Opposition will be ferocious and sustained, because the measures will have a direct impact on the pensions of many members of Congress, along with many judges in the court system who may be called on to decide whether the measures are constitutional, as well as the bureaucrats who will have to administer a new pension system.

No less controversial will be the government's plans to reform the tax system. Brazilians are among the highest-taxed people in the world, but like the social security system, its taxes are perverse and regressive, with huge benefits and loopholes for the rich. Again a complicated battle can be expected that will involve not only the federal government but also states and municipalities, as well as powerful businessmen.

In foreign policy Lula has been forced to make major decisions much sooner than he would like. Alarmists in Washington have tried to portray him as part of a new Latin American "axis of evil" with Castro and the Venezuelan caudillo Hugo Chavez. But Chavez quickly overplayed his hand with Lula. In fact, the Brazilians and the US reached a quiet agreement to jointly sponsor a group called "Friends of Venezuela," which is trying to mediate among the parties involved in the bitter political impasse that continues there. Castro's recent arrest of over seventy dissidents and his execution of hijackers has not endeared him to Brazilians. While the government has taken a neutral position toward Cuba, for the first time a debate has broken out within the Brazilian left over the lack of democracy under Castro.

In Argentina Lula made clear his preference for Nestor Kirchner and his deep distrust of the former leader Carlos Menem, the two Peronists seeking the presidency. After Menem withdrew to avoid a humiliating defeat and Kirchner took office, Brazil quickly pledged the equivalent of a billion dollars of assistance to Argentina, a sign of Lula's hopes to reinvigorate Mercosur, the customs union between the two countries and Paraguay and Uruguay, which has been weakened by the Argentine crisis.

In his dealings with Uruguay, Lula, concerned that its leaders were talking of a bilateral free trade deal with the US, brought heavy pressure to bear on the Uruguayan president, Jorge Batlle Ibanez, to accept Brazilian and Argentinian leadership in dealing with the US, thus preparing for the major battle ahead with the Bush administration over a Free Trade Area of the Americas, which the Bush administration hopes to see established by 2005. This is the administration's only serious policy toward South America, apart from its escalating war in Colombia. Lula entered office with Brazil and the United States already chosen to be co-chairs of the negotiations.

Yet Brazil is deeply ambivalent about the whole idea. Brazil has a much more diversified trade with the world than Mexico did at the time of the NAFTA deal. It also has a more substantial domestic market, as well as longstanding ambitions to regional leadership within South America. The Brazilian Foreign Ministry, from which the negotiators come, tends to be the most nationalistic part of the Brazilian bureaucracy. But Palocci's Finance Ministry's strategy calls for greater integration into the global economy, more trade, and greater access to the US market for the output of industries where Brazil is most competitive, especially the products of agribusiness and steel mills. These are precisely the two sectors where Bush has shown himself to be most susceptible to the pressure of US lobbies. And Lula's traditional friends in the United States have been within the protectionist-minded unions and environmental movement. The hastily organized summit between Lula and Bush, scheduled for June 20, will focus on this question.

For both Bush and Lula the stakes are high. And both face divided opinion at home on free trade. Without Brazil, the vision of a Free Trade Area of the Americas will go nowhere. But to get Brazil's agreement, Bush will need to confront powerful domestic lobbies. Lula, to the surprise of many in Washington, wants to be accepted as a new Latin American leader who is playing by the rules of the game; but he will come to the White House as an experienced union negotiator with a tough position, expecting to bargain. And he will, as he said in a statement issued just before the recent G-8 summit in Evian, expect the rich nations to move beyond rhetoric to think imaginatively and constructively about ways to improve living conditions in the developing world. He is wise to broaden the G-8 agenda: trade alone is too limited and contentious to be the only topic of G-8 conferences. Trade is both credited with too many potential benefits and blamed for too many ills and Lula wants Brazil to be fully involved in reconceiving approaches to the dilemmas of global economic and social disparities.

Whether domestically or internationally, the most difficult tests of Lula's leadership are about to begin. The biggest questions of all posed by his victory remain whether a leader with a genuinely egalitarian social vision can succeed in the global economy, and whether the United States will have the good sense to see that it is very much in its own interest to help him.


[*]See my "Brazil: Lula's Prospects," The New York Review, December 5, 2002.

Reprinted with permission from New York Review of Books

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