What will the rise in living costs mean for Brazilian cities?
By Aruba Khalid & Joseph Dana | May 10, 2017
In 2011, Brazilian cities such as Sao Paolo and Rio de Janeiro were more expensive than New York City, Los Angeles, Berlin, Luxembourg, Miami, and Abu Dhabi. The Economist’s Big Mac Index showed similar results _ burgers in Brazil were costlier than anywhere else except in super-rich Norway, Sweden, and Switzerland.
In 2014, the cost of a Jeep Grand Cherokee was approximately $80,000, while you could buy two of these in the US for that amount. So, what explains the high cost of living in the upper-middle income Brazil for the past few years? With booming urban areas, how does the high cost of living transform the urban geography of the country’s major cities?
Upon closer look, Brazil’s living costs are not exceptionally high when compared to other costs. Business costs in Brazil are so high they have merited their own specific institution: Custo. The term Custo Brasil refers to the notably high operational costs of doing business. These costs likely impact living expenses directly. For instance, if a government increases taxes, such as VAT and excise duties, prices of goods and services, and therefore the consumer price index (CPI), will increase. High taxes, poor infrastructure, and low labour productivity contribute to Custo Brasil.
Real vs dollar
In 2002, a US$1 bought R$2.9. Almost a decade later, it bought R$1.7 – the biggest appreciation of the Brazilian currency against the dollar in the last two decades. The shift was huge. Brazil’s inflation rate was much higher – 6.5% in 2011, while in the US it was 3% that year – and, therefore, the real should have become cheaper, not more expensive. Prior to the skyrocketing cost of living, Brazilian officials were concerned their currency appreciation would reduce quantity supply, thereby increasing prices. However, the country’s currency appreciation had very little to do with rising costs.
Exchange Rate vs Brazil’s CPI, 2010-14 (% change)
Source: The Delma Institute, based on OECD data, 2017
As the table above indicates, rising costs in Brazil go beyond currency appreciation. This does not mean Brazil’s exchange rate has no impact on the cost of living, rather it explains a small part. The following section explains the main reason life in Brazil has become so expensive. The focus is on inputs of the Custo Brasil.
Custo Brasil and the loss of competitiveness
Many economists argue that high taxes are one of the main inputs to the Custo Brasil. In 2013, Brazil’s overall taxes equated to roughly 33% of GDP compared to the 21.8% average for Latin America and the Caribbean. Tax rates in Brazil have been so high in the past few years that companies’ total tax rates were approximately 70% of their commercial profits, which until now barely dropped, according to the World Bank.
Furthermore, Brazil’s tax system is quite complex. For instance, EY’s 2017 Worldwide VAT, GST, and Sales Tax Guide notes that companies in the South American powerhouse pay four types of value-added tax by the time consumers receive their final product: State VAT, federal VAT, municipal service tax, and gross receipt contributions. This clearly indicates that not only state and federal but also municipal authorities have the right to collect taxes. And, in addition to the extended tax collection, a 2013 article by Forbes states that Brazil’s tax regulations are quite time-consuming for companies.
Total Tax Revenue, 2010-15 (% of GDP)
Source: OECD, accessed 2017
Total Tax Rate 2010-16 (% of commercial profits)
Source: World Bank, accessed 2017
In the past decade, Brazil’s infrastructure needs have increased as the economy has grown. One might think the high taxes have been used to increase infrastructure stock, but, unfortunately, that is not the case. The government of Brazil barely invested in infrastructure. In fact, according to a McKinsey report, ‘Bridging Global Infrastructure Gaps‘, Brazil is among countries that spend less and have low-quality infrastructure. This adds to high costs for companies in Brazil since they have to pay higher fares for freight.
Infrastructure Quality vs Spending
Source: McKinsey Global Institute, 2016
Apart from these two limitations to doing business in Brazil, low labour productivity is another constraint (or another crucial input to the Custo Brasil). In a 2013 paper titled ‘Brazil: Confronting the Productivity Challenge‘, The Boston Consulting Group argued that about 75% of the country’s growth in the previous 10 years was due to adding workers, and only about 25% came from productivity gains.
In other words, according to Joseph Schumpeter’s theory of innovation, Brazil’s technological change was low, which implies a low human capital. Jonas Prising, CEO of the Manpower Group, states that Brazil is among the hardest places for firms to find the skills they need. This also means that companies pay higher costs for operating in Brazil.
Helen Joyce, from The Economist, and Kenneth Rapoza, from Forbes, argue these three main constraints for doing business in Brazil cause a decrease in supply (or a loss of competitiveness). In economics, a decrease in quantity is strongly associated with an increase in prices. Therefore, this scenario shifts the market price out of balance, leading to higher inflation rates in Brazil. Furthermore, the decrease in Brazil’s quantity supply causes its imports to exceed its exports. Hence, both the high inflation rates and the fact that imports exceed exports explain the big price differences in Brazil over the past few years.
Brazil’s Annual Inflation Rate, 2006-16
Source: Worldwide Inflation Data, accessed 2017
Export and Import of Goods and Services, 2010-15 (% of GDP)
Source: World Bank, accessed 2017
Today, nothing much has changed, except that Dilma Rousseff is no longer the president of Brazil. According to the most updated version of the Big Mac Index, the Big Mac burger in Brazil is still more expensive than anywhere else except the three super-rich European economies mentioned in the introduction. Furthermore, the Jeep Grand Cherokee’s value in Brazil has slightly decreased, however, you could still get approximately two of them in the US for the price of one in Brazil. The last update of the cost of living index by the Economist Intelligence Unit shows the cost of living in the two biggest Brazilian cities _ Sao Paolo and Rio de Janeiro _ has come down when compared to 2011, which might be due to various external factors. In fact, the country’s average CPI for all items, from the OECD database, shows no decrease in Brazil’s standard of living.
Tackling the Custo Brasil is a major challenge, since it has many problems, including the country’s tax system, lack of infrastructure, and low labour productivity. In the near future, it is highly likely the situation will not improve dramatically and Brazilians will still have to cope with high costs of living, despite the country having a new government. The only way to reduce the cost of living is to lower costs for companies by cutting and simplifying taxes, offering successful infrastructure auctions, and implementing technological change _ increasing the efficiency of a product (good or service) or process that results in more output without an increase in input.
Urban slums as unplanned growth
Economic growth has long propelled rapid urbanisation in emerging markets, and Brazil is no exception. Decades of unplanned growth in Sao Paulo and Rio De Janeiro have led to the rampant expansion of urban slums known as favelas. These informal communities that encircle Brazil’s big cities are a physical demonstration of growing levels of income inequality, the rising cost of living, and the harsh reality of unequal urbanism.
A favela situated near Sugarloaf Mountain in Rio de Janeiro, Brazil. dany13/Flickr CC BY 2.0The government is working to rebuild infrastructure and create sustainable housing while militarising its police force to combat rising gang warfare and endemic levels of crime, as favelas have proven to be largely ungovernable over the past two decades. At the same time, wealthy urban residents are barricading themselves in exclusive, gated communities replete with their own public spaces that are off limits to the majority of Brazilians.
In 22 years, from 1990 to 2012, Sao Paulo’s metropolitan population increased by 33% to 20m residents. At the same time, the number of billionaires in the city increased. Today, the economic capital of Brazil ranks 9th for the highest number of billionaires anywhere in the world.
Despite the growing wealth in the city, the majority of its residents are poor. The number of people living in favelas has risen steadily since the 1970s. Exact figures are difficult to come by but Cities Alliance, published by the World Bank, states the number of people living in Sao Paulo’s favelas rose from 14,504 in 1970 to 360,000 in 2007.
Favelas are the physical confirmation of unplanned and reckless urbanism that is now irreversible. When cities are not able to adequately plan living space for their residents, the result is dangerous, overcrowded, informal settlements such as favelas. Some analysts claim favelas reflect a ground-up, and, thus, sustainable response to the problem of overcrowding. But that does not alter their environmental impact. In spaces defined by income inequality, such as these urban areas of Brazil, public space is another problem area.
Privatisation of public space
Catering to wealthy residents, new malls and public spaces are being built in wealthier neighbourhoods throughout the city. For the wealthy, these are public spaces, but for poorer residents they are effectively off-limits due to their geographic isolation from favelas and the ability of mall authorities to establish the difference between paying and non-paying customers.
Urbanists and architects have responded to increasing restrictions on public space by using underutilised and previously abandoned parts of the city for new public space projects. One architect built a platform over the Aricanduva, a section of the river Tiete in the eastern part of the city. Not only did this platform create a unique public space open to all but it also raised awareness of the rising population levels in Sao Paulo’s river systems.
As the cost of living rises across Brazil, so too does crime. This issue received special attention during the FIFA World Cup and Olympic Games that were held in Brazil in 2014 and 2016, respectively. Deploying tactical police units that received assistance and guidance from countries such as Israel and the US, the Brazilian security establishment has turned parts of some cities into war zones.
Wealthier residents will continue to barricade themselves into exclusive enclaves that are effectively off limits to the majority of Brazil’s citizens while the security establishment will use military tactics to police lawless urban slums. Can the state reverse these trends? Efforts to rehabilitate some favelas and upgrade existing infrastructure are under way, but it is unclear if they are too little, too late.
The state’s role in urban challenges
Throughout the world, housing is an important engine for economic growth. Brazil is no different. At the state and federal level, Brazil has refocused efforts to allocate funds to formalise favelas around Sao Paulo. As the World Bank notes (page 32), sizeable investments have been made to upgrade the housing stock to ease overcrowding and address environmental concerns. The city of Sao Paulo has invested more than R$2bn ($628.3m) into growth acceleration programmes that address the needs of the most vulnerable when it comes to infrastructure, health, social vulnerability, and crime.
Across the city, where possible, residents have been resettled from areas that pose a high risk to the environment and the city’s water supply. These projects are being facilitated through government offices such as the Housing and Urban Development Company of the State of Sao Paulo, along with private entities such as the Inter-American Development Bank.
Brazil is not alone in grappling with the rising cost of living. Given the country’s size and its recent political turmoil, however, the way in which the government handles the crisis at both the local and federal level will have ramifications far beyond Brazil’s borders. From reforming the tax system to necessary infrastructure upgrades, it is unclear if there is the political will necessary to force the changes required to ease the rising cost of living for Brazilians, despite a new government being in power.
The results of inaction can already be understood in Brazil’s urban areas. Social tension is reaching a boiling point in cities such as Sao Paulo where income inequality is driving reckless urban practices that physically separate rich from poor. This gives the government extra impetus to reform tax laws, increase technological innovation and push forward with needed infrastructure projects. Such projects will remove some pressure on the urban environments despite the rising cost of living.
Emir Hidovic, a research intern at The Delma Institute, contributed economic research support for this blog.