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Henrique Simonsen Reviewed work(s): Source: Economic Development and Cultural Change, Vol. 13, No. 2 (Jan., 1965), pp. 188-202 Published by: The University of Chicago Press Stable URL: http://www.jstor.org/stable/1152218 . Accessed: 20/06/2012 17:02
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AND TRANSPORTATION INFLATION: IN POLICYMAKING BRAZIL A STUDYOF IRRATIONAL
Werner Baer Yale University Isaac Kerstenetzky Fundacao Getulio Vargas Mario Henrique Simonsen Fundacao Getulio Vargas
Although it has been argued that some aspects of the Brazilian inflation were and that many of the drastic distortions usually favorable to economic development, attributed to inflation were absent, 1 there exists one particular aspect of the BraThis is the zilian inflation which cannot be defended by any school of thought. in policies followed by the government in setting public utility rates, especially In many countries suffering from inflation, rates charged for public transportation. utilities fall so far behind changes in the general price level that an increasingly the transporimportant part of government expenditures are devoted to subsidizing With expenditure commitments for develtation system and other public utilities. opment programs rising faster than revenues that can be supplied by archaic tax increasing subsidies to public utilities worsen government deficits and systems, constantly add to inflationary forces. It has been claimec by "political realists" that a democratic government in this type of situation cannot afford to raise rates, especially transportation rates, It will be one of the purposes of this paper so as to match other price increases. to show, using the Brazilian case, that the economic impact on individuals and firms of adopting a realistic rate will be so slight that the political effects might The second, and more important purpose of this paper will be be made negligible. to show that by estimating both the effects of action and inaction as far as changing rates are concerned, the policy maker will be in a better position to choose and rationalize his policies. Deficits and Subsidies
During the greater part of the 1950's and the early 1960's, the Brazilian A glance at Table 1 federal budget has been characterized by increasing deficits.
See Werner Baer, "Inflation and Economic Growth: An Interpretation of the Brazilian Case, " Economic Development and Cultural Change (October 1962); also "Inflation and Economic Efficiency in Brazil, " Economic Development and Cultural Change (July 1963).
ECONOMIC DEVELOPMENTAND CULTURAL CHANGE will make it clear that there is a very close relationship between changes in the Since in the inflagovernment's budget deficit and the rate of price increases. of financing deficits by issuing tionary milieu of Brazil there exists no possibility domestic bonds, a deficit is usually financed by the issuance of new money.
TABLE 1. Expenditures of the Brazilian Federal Government, Changes in the Money Supply, and the Rate of Inflation
Public Sector Expenditure Government Revenuea Federal Total government
. 93 .78
Federal deficit (in billions of CR$)
Increase of money supply (billions of CR$)
Changes ofwholesale pricesc
1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961
1.00 1.06 1.16 .99 1.15 1.16 1.05 1.13 1.19 1.31 1.18 1.19 1.22 n.a.
.92 1.04 1.19 .88 1.01 1.06 .90 1.08 1.25 1.44 1.15 1.24 1.20 n.a.
2.8 3.3 1.8 9.0 5.5 8.0 27.8 39.8 26.5 53.7 77.7 137.5
7. 6 16.4 34. 5 15. 9 14.7 19.1 22. 1 17.5 22.1 53. 9 21.3 41.7 38.2 51.6
4 6 20 18 9 14 12 12 18 20 19 24 31 28
9.2 4.8 2.3 21.3 12.9 16.8 22.8 19.5 21.9 14.5 14.4 42.8 31.5 40.4 and Centro de
Fundacao Getulio Vargas, Estudos Fiscais. minus transfers
Centro das Contas Nacionais,
and subsidies by dividing the money supply by the index of
Inflation index was obtained real output. Wholesale price index,
Thus, we also find a close relationship in the rate of new money issues.
in the rate of inflation
A large and growing item of the Brazilian federal budget has been expenditures for subsidizing the transportation system, especially the state-owned railroads. The data in Table 2 show the relative magnitude of these subsidies in the
federal The subsidy budget. ment and tend to understate come directly from the federal figures budget docuactual subsidies. This can easily be seen by comparing
AND INFLATION IN BRAZIL TRANSPORTATION
TABLE2. The Federal Budget and Transportation (in CR$ 1,000, 000) Subsidies
Year 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962c a. b.
Balance of fed. budget +2,819 +2, 278 -2,868 -3, 900 -5, 700 -24,400 -41,100 -26, 000 -59, 000 -77, 600 -137, 500 -270,000
Fed. railroad subsidya ( .7) (1.2) ( .8) ( .8) (1.1) 3,115 (2. 9) 2, 993 (2. 5) 10,491 (7.0) 11,828 (6.4) 15, 423 (5.8) 17, 423 (5.8) n. a. 186 346 316 415 728
Aviation subsidya 38 (.5) 30 (.1) 30 (.1) 31 (.1) 31 (.1) 197 (.1) 495 (.4) 490 (.3) 450 (.2) 450 (.2) 859 (.2) n.a.
Merchant marine subsidya b 94 ( .4) 99 ( .3) 120 ( .3) 150 ( .3) 189 ( .3) 1,047 (1.0) 1,125 ( .9) 3, 273 (2. 2) 1,504 ( .8) 2, 522 (1.0) 1,812 ( .4) n. a.
Total subsidies 318 (1. 6) 475 (1. 6) 466 (1.2) 596 (1. 2) 948 (1.5) 359 (4.0) 613 (3. 8) 254 (9. 5) 782 (7.4) 395 (6. 9) 281 (4.8) n.a.
4, 4, 14, 13, 18, 20,
Numbers in parenthesis
proportion of total federal expenditures. to private
Subsidies to aviation and the merchant marine are also partially enterprises which operate in those area. All 1962 figures are official estimates.
Balancos Gerais da Uniao; Commissao Da Marinha Mercante, Diretoria da Aeronautica Civil, Ministerio da Aeronautica.
the official federal subsidy for railroads with the deficits of the railroad system in Table 3. The actual deficit is often twice as much or more as the official subsidy. Since Brazilian railroads don't issue bonds, it can only be assumed that the entire deficit is covered by subsidies from the federal government. Many of these subsidies must, however, be hidden under other items in the federal budget which are not easily identifiable. Considering that the railroad deficit for 1961 was substantially greater than the total subsidies for all transportation systems combined, and that the same understatement of subsidies also exists for aviation and the merchant marine, the impact of subsidies on total government expenditures is stronger than indicated by the total official subsidies as a probably considerably proportion of expenditures as shown in Table 2. Examining the tables presented so far, it becomes obvious that by just elimproportion of inating the railroad deficit or by keeping the receipts/expenditure 1951, the increase of the federal budget would have been kept in check considerably, Thus, up which, in turn, might have controlled the rate of increase of inflation. to 1955, by just eliminating the railroad deficit, the federal budget would have been in surplus or balanced, while in the later 'fifties a similar procedure would have considerably dampened the expansion of the deficit. Looking at it from a
ECONOMIC DEVELOPMENTAND CULTURAL CHANGE slightly different point of view, the federal deficit increased by sixty billion cruzeiros between 1960 and 1961, while the railroad deficit increased by 17 billion. Had policies been followed which would have kept the railroad deficit in check between those two years, or had the deficit been eliminated, the increase of the federal deficit might have been kept to 43 billion or 24 billion cruzeiros, probably cutting the rate of increase of the inflation between those years by a substantial amount.
TABLE3. Consolidated Brazilian Railroad Budget (in millions of CR$)
Year 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 a.
A Receipts 3,218 3,137 3,279 3, 693 5, 513 7, 505 8,863 9, 435 11,269 13, 495 20, 042 n.a.
B Expenditures 4,167 5, 064 6,771 7, 963 10, 953 16,807 18,808 19, 868 25,785 32, 750 56, 465 n.a. official estimate.
C Balance -949 -1, 927 -3,491 -4,270 -5,441 -9, 303 -9, 945 -10, 533 -14, 516 -19, 255 -36, 424 -84,424a
D A:B 77 62 48 46 50 45 47 47 44 41 35 -
The 1962 figure is a preliminary Anuario Estatistico
behind the Railroad Deficit
Assuming that the readers have been satisfied with the above evidence, showing that the transportation subsidies of Brazil have tended to contribute substantially to the excessive type of inflation experienced in the last decade, we would like to examine how these deficits came about and whether their avoidance would have caused any drastic welfare reductions for certain groups within the Since railroads constitute the largest share of the government transporcountry. tation subsidy, and since railroad data are relatively easy to obtain, we shall concentrate on them. We are fairly sure that our analysis would turn out to be quite similar for other transportation systems. Table 4 contains a breakdown of the principal categories of receipts of the railroads. A very large proportion comes from the shipping of merchandise, though there has been a noticeable decline in recent years, and the second largest proSince these two make up the bulk of rei. portion comes cm passenger service. ceipts, our analysis will concentrate on them. In the 1951-61 period, the number
TRANSPORTATION AND INFLATION IN BRAZIL
of passengers serviced by railroads increased by 38 percent, while merchandise This shows that railroads have fallen increased by 20 percent on a quantum basis. considerably behind other means of transportation, trucking and bus especially when one considers that in the same period the real output of industry services, increased by 148 percent and agricultural production by 64 percent. Much of this of the system and lag in the use of railroads was due to the general inefficiency due to the fact that investment in the railroads has not kept up with the requirements of the growing industrial centers. Increased passenger service was about equal to the increase in population during the period covered, although it can be assumed that with a faster growth of urban population, the use of transportation increased faster than natural population growth, and much of this faster increase was absorbed by transportation operations competitive to the railroads, such as suburban and interurban bus services. Railroads have also followed an extremely unrealistic and expensive wage policy, paying workers wages far above the remuneration of workers in similar lines in other industries. The resulting cost increases were extremely high, especially in relation to lagging revenues. 2
This becomes clear when examining changes in wage rates of railroad workers and the proportion of salaries in total expenditures: Rate of change of railroad workers' wages
1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 Source: Anuario Estatistico 31 1 10 15 36 24 35 64 -4 10 25 32 91 of the RFFSA.
Railroad salaries as a proportion of total RRexpenditures
52 57 57 62 60 62 68 67 74 64 64 61 63 69
ECONOMIC DEVELOPMENTAND CULTURAL CHANGE TABLE4. Breakdown of Brazilian Railroad Receiptsa (millions of CR$) Year 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 a. Passenger 766 744 773 898 1,162 1, 542 1,884 2, 095 2,368 2, 939 4,239 (24) (24) (24) (24) (21) (21.) (21) (22) (21) (22) (21) Baggage 151 135 133 169 227 270 279 271 259 294 419 (5) (4) (4) (5) (4) (4) (3) (3) (2) (2) (2) represent Animals 87 90 99 97 141 218 299 347 367 393 887 (3) (3) (3) (2) (3) (3) (3) (4) (3) (3) (4) Merchandise 1,953 1,931 2, 045 2,253 3,433 4, 632 5,382 5,362 6,221 7,635 11,097 (62) (62) (62) (61) (62) (62) (61) (57) (55) (57) (55) Other 260 237 229 275 549 843 1, 019 1,361 2, 054 2, 233 3,399 ( 8) ( 7) ( 7) ( 7) (10) (10) (11) (14) (18) (16) (17)
Total 3, 128 3, 137 3,279 3,693 5,513 7, 505 8,863 9,435 11,269 13,495 20,042
Numbers in parenthesis Anuario Estatistico
proportion of total receipts.
da RFFSA. TABLE 5.
of Brazilian Railroad Rates (in cruzeiros) Tons km. for baggage 1.26 1.22 1.21 1.28 1.60 1.92 2. 01 2.32 2.43 3.23 4.86 Tons km. animals 0.30 0.32 0.30 0.34 0.50 0. 72 0. 91 0.85 1. 01 1.28 3.01 Tons km. merchandise 0.41 0.43 0.44 0.48 0.66 0.87 0.95 0.84 0.87 1.03 1.48
Year 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 Percentage 1951-61 1948-51 Changes Changes
Passenger kilometers 0.10 0. 10 0.09 0.10 0.13 0. 16 0.19 0.18 0. 19 0. 23 0. 30 change 200 11 of Cost of Living (Rio): of Wholesale PricesWith Coffee: Without Coffee: Computed from Anuario
286 4 1948-51: 1948-51: 1948-51: Estatistico
903 25 29%; 1951-61: 49%; 1951-61: 31%; 1951-61: Da RFFSA; 677% 599% 714% Conjuntura
AND INFLATION IN BRAZIL TRANSPORTATION
At In Table 5 are reproduced rates for different types of railroad services.3 the bottom of the table we also compared the estimated changes in rates with changes in the cost of living and wholesale prices in the period 1951-61. The differences While the cost of living increased by 677 percent, railroad rates are quite striking. increased by only 200 percent, and while wholesale prices rose by 714 percent, But we also have merchandise rates on railroads increased by only 261 percent. data to show that even before the 'fifties, rates of transportation substantially lagged behind rises in the general price level.
Effects of Various Corrective
Let us now estimate the burden that would have to be born by various groups in the Brazilian exonomy if action were to be taken to correct the unrealistic rate of the decade under review. We shall assume that the elasticity making policies in view of the fact that due to of demand is zero. This is a realistic assumption, most producers have already switched the Brazilian railroad system's inefficiency, to other means of transport wherever possible. Thus, the present load of the system represents a minimum, i. e., goods which by their nature and/or their location Since other parts of the transport system cannot be transported via other means. and since our proposals would also extend to them, the proare also subsidized, represent a price increase posed increase in railroad fares will not necessarily relative to the other means of transport. We shall begin by taking the extreme case in which rates would be changed in 1961 so as to eliminate the entire deficit. This is done in Table 6. Taking the expenditure figure for 1961, CR$ 56, 465 million, we assumed that revenues for getting this total would be allocated to each type of railroad service in the same proportion as in that year for the actual revenue collected. Thus, for example, since in 1961 passenger revenues were 21percent of total revenue, and since the goal for total revenue is CR$ 56, 465 million instead of CR$ 20, 042 million, the desired passenger revenue would be CR$ 11,858 million. Dividing the latter by the total number of passenger kilometers for 1961, we obtain the desired passenger fare which would contribute towards a balancing of the railroad budget. - The fare is . 85 cruzeiros per passenger mile, instead of the .30 actually charged. Thus, the proportionate increase of passenger fares from 1951 to 1961 which is needed to balance the budget is 750 percent, as compared to the actual increase of 200 If we take into account percent and to the cost of living increase of 677 percent. that passenger rates also lagged behind cost of living changes in the years prior to 1951, the desired fare increases would not be out of line with price increases of other items in the consumer budget. A similar type of analysis was made for obtaining desired merchandise rate This is all summarized in Table 6. changes in order to balance the railroad budget. Another method, less drastic than balancing the railroad budget, would be ratio would again be the same to plan rate increases so that the receipt/expenditure 3. Since the railroads do not keep a yearly record of rates charged, we had to use a roundabout method for estimating rates, and especially changes in rates. For passenger fares, we used the number of passenger kilometers for each year, dividing this into total receipts from passenger services; for merchandise rates, we divided the total yearly tons-kilometers into total merchandise receipts.
ECONOMIC DEVELOPMENTAND CULTURAL CHANGE
as the one holding at the beginning of the period examined, i. e., a change of rates would be aimed at so that revenues would again constitute 77 percent instead of 35 percent of total expenditures. This was also done in Table 6, and the results show that the necessary proportional rate increases to accomplish this would be less than the increase in the cost of living in the 1951-61 period for passenger rates, and less than the increase in the wholesale price index for freight rate increases.
TABLE6. Two Examples for Charging Realistic Passenger and Freight Rates in 1961 I. Balanced Budget Assumption (a) Passenger Service Actual total revenue Planned total revenue (21% of expenditure) Actual rates (passenger km) Planned rates implied by planned total revenue Actual proportional rate increase over 1951 i i t it Planned 11 Increase in cost of living index (1951-61) (b) Freight Service Actual total revenue Planned total revenue (55% of expenditures) Actual rates (ton kilometer) Planned rates implied by planned total revenue Actual proportional rate increase over 1951 if " Planned " " ". Increase in wholesale prices 1951-61 (excl. cof.) II. 1951 Deficit Relationship Assumption (a) Passenger Service Planned total revenue (21% of expenditure) Planned rates (passenger km. ) Planned proportional rate increase over 1951 (b) Freight Planned Planned Planned a. in millions Service total revenue (55% of expenditures) rates (tons km) proportional rate increase over 1951 of CR$. Estatistico da RFFSA and from Conjuntura
CR$ CR$ CR$ CR$ 200% 750% 677%
4, 11, 0. 0.
239a 858a 39pk 85pk
CR$ CR$ CR$ CR$ 261% 912% 714%
11, 097a 31, 056a 1.48 4. 15
CR$ CR$ 430%
9, 130a 0. 53
CR$ CR$ 680%
23, 913a 3. 20
Calculated from Anuario Econom ica.
If we should add to this approach an assumption about what would happen if railroads were more efficiently run, both in their current operations and in their investment policies, thus attracting a larger proportion of increasing traffic, the
TRANSPORTATION AND INFLATION !N BRAZIL
burden of finding increasing revenue might have to lie less on rate increases (we are assuming throughout this paper that increased usage does not result in increasing costs, since there is a lot of idle capacity in the present railroad system of Brazil). Thus, for example, if due to better management freight traffic would have increased on a quantum basis by 100 percent instead of only by 57 percent (we are now using kilometer tons as measurement), which is not unreasonable, considering that real output of industrial production increased by over 148 percent, the revenue from freight in 1961 at the actual price charged would have been CR$ 14. 2 billion instead of CR$ 11. 0 billion; and, using the price obtained for the 1951 deficit revenue from freight would have been CR$ 30. 4 billion. relationship, Since, however, we are more interested in rate-making in this paper instead of a complete analysis of the railroad system, we shall not pursue this matter at length. The Burden of Rational Rate-Making We shall now briefly examine how burdensome a realistic adjustment of rates would be to various groups within the Brazilian economy. First of all, if we refer back to Table 6, and if we look at changes in the cost of living index, we find that in the period examined it has increased by 677 percent, whereas passenger rates increased only by 200 percent. The rate increase under one assumption is less than the cost of living, and under the balanced budget assumption it would be only slightly higher, though considering that transportation rates in 1951 were already out of line, the relative burden of railroad rates would not really have increased very much. Secondly, looking at the weights used for the consumer price Of the latter, 2. 3 perindex, we find that public services take up 10. 5 percent.4 cent goes for urban bus services, 1. 3 percent for streetcars, and 1. 3 percent for a sort of semi-bus service (lotacao). The weight for railroad transport is so small that this item isn't even used by the price division of the Fundacao Getulio Vargas Since the same was true in in constructing Rio de Janeiro's cost of living index. 1951, it would seem that even if passenger rates were to increase by the same amount as the general cost of living since that time, it would still be too small a weight to be included in the cost of living index.5 A third, though not entirely satisfactory, indicator of what the burden of the above discussed passenger rate increase would be is a comparison to changes in the minimum wage legislation.6 From January 1952 to October 1961 the minimum an increase considerably superior to wage increase amounted to 1,020 percent, even the rate of increase implied by the balanced budget assumption. It is of interest to mention, in passing, that from 1951 to 1961 the average wage of railway employees increased by 1, 326 percent. Although there is no doubt that these
4. Conjuntura Economica (January 1963), p. 84.
A more concrete indication of the low weight of passenger fares is the example of suburban
Rio de Janeiro workers who use the suburban trains to get to work. Until March 1963, the fare for a thirty to forty-five minute ride was still only two cruzeiros (it was changed to ten in March for the first time in 20 years). Thus, the worker paid four cruzeiros a day or, The minimum assuming a 25-day work month, 100 cruzeiros a month for transportation. salary for these worker was already over 20, 000 cruzeiros in March 1963. satisfactory indicator about who is actually is that there exists no data covered by minimum wage
The reason for calling this a not entirely on average wages paid and no indication legislation.
ECONOMIC DEVELOPMENTAND CULTURAL CHANGE increases also reflected productivity changes and necessary distributional equity shifts for the working classes, they do serve to show that realistic rate increases would be relatively burdenless.
TABLE7. Examples of Transport Coefficients for the United States and Brazil
Brazil Non-metallic mineral industries Machine industry Furniture Paper products Rubber industry Chemicals and pharmaceuticals Foodstuffs Tobacco Printing Sources: 3. 0 1.0 2.0 3.0 .5 2. 0 2.0 .6 .8
United States 4. 7 1. 6 3. 3 4.5 1.5 3. 0; 6. 7 2.8 1.5 1.4
The Brazilian coefficients were derived from the Brazilian Industrial come from the 1947 input-output Census of 1950; U.S. coefficients table.
The matter gets to be more complicated when trying to estimate the cost increase to firms as a result of freight increases. Since the latest Brazilian census it was only possible to compare the 1950 census figures are not yet available, evidence with estimates for the United States based on the 1947 input-output table. We are aware that the differences in location of manufacturing in both countries limit to some extent the comparison. But, as in practically all groups of industries the Brazilian coefficients were smaller than the United States coit would seem that the cost of transportation in 1950 in most Brazilian efficients, industries was substantially smaller than it was in the United States. But since the glaring lag of transportation rates occurred only in the 1950's, we can probwere considerably lower in the ably assume that these transport cost coefficients early 1960's.
The evidence presented in this paper suggests that a more realistic rate the railroads, can have substanpolicy for the transportation system, especially tial dampening effects on the rate of inflation which has prevailed in Brazil. We have also shown that the burden of higher transportation rates on passengers would be extremely small, while the cost increases for industry would probably just move the cost structure into more normal lines, possibly resulting in some price increases, nature. Let us illustrate this latter though these would be of a once-and-for-all point a little more.
AND INFLATION IN BRAZIL TRANSPORTATION
The elimination of subsidies, just as an increase of indirect taxes, usually increase in the price level, which, in the short run, results in an instantaneous This sudden increase in the would not occur if such subsidies were maintained. price level can be called a "corrective inflation, " since it is followed by a substantial reduction of public expenditures on subsidies which will result in a noticeable lowering of the subsequent rate of inflation. Figure 1 summarizes this clearly showing that after a short period of time the increase in the price process, level will have been much smaller without than with a continued government subsidy of public utility rates. That the elimination of subsidies (or an increase of indirect taxes) should rise in the price level (a corrective rise AB, as depicted result in an instantaneous The in the graph) is an obvious matter which does not need much explanation. Their natural reaction.of producers is to transfer increased costs to the consumer. success is doing this depends, of course, on whether demand conditions are such A small time will have as to absorb the entire output sold before at higher prices. to pass, however, until the producers can decide whether or not further price The immediate reaction, however, is to transfer to changes will be convenient. the buyers the burden of the subsidy cuts. (I) Price increases
B Price Level A'
(II) Price increases assuming subsidy elimination at Point A
Time Figure 1. Finally, that a slower long-run rate of inflation resulting from subsidy cuts The direct will be more advantageous to the mass of the public is fairly obvious. increase of transportation costs on the public has been shown to be a tiny burden. On the other hand, since the mass of the workers have, on the whole, suffered by an inflation, i. e., since during most of the Brazilian inflationary experience they a slower rate have fallen behind in the struggle to keep up with price increases, can only benefit them.
Sources of Irrational Behavior in Policy Making Although the mechanism of a corrective inflation should be fairly obvious to a majority of the population and its leaders in countries like a trained economist,
ECONOMIC DEVELOPMENTAND CULTURAL CHANGE
What is Brazil have shown a complete lack of understanding of such a mechanism. generally understood is only that subsidy cuts, like increases in indirect taxes, The lack of understanding is due to three raise prices and are thus inflationary. reasons: lacking any elementary (1) The people and many of their representatives, understanding of economic theory, find it difficult to identify causal relationships over time, which is necessary in order to understand the disinflationary effect of cutting subsidies. They (2) Many persons explain an inflation from a distorted point of view. can easily identify the causes of a. rise of prices when they are transmitted from the bottom to the top through cost increases. But they are completely perplexed when prices are pulled up from the top through excess demand. They usually attribute such a phenomenon to speculation and to the greed of businessmen. Such persons will naturally believe that a cut of subsidies is inflationary. (3) The Brazilian experience will not help the layman to understand the mechanism of corrective inflation. Actually, the subsidy cuts (and increases in indirect taxes) which did occur in the last few years have probably helped to But since keep the inflation from becoming even higher than it actually has been. most major subsidies have continued, and since other factors in the Brazilian economy also contributed to the inflation, there has never existed a clearcut result of subsidy elimination. enough situation to clarify the non-inflationary Thus, the average person is still convinced that subsidy cuts are inflationary. The difficulty laymen have in understanding the above relationships seem to be the principal reason for the lack of a rational policy of the Brazilian government towards subsidies. The government's policies were not only restricted towards railroads and other means of transportation, but extended also to various other areas where prices are more or less subject to government control (e. g., for policy exchange subsidies for certain imports). Many persons responsible making have yet to understand the relationship between a cut of subsidies and a slowing down of the rate of inflation; and many policy makers who do understand it fear that the electorate would not be able to.
APPENDIX CORRECTIVEINFLATION: A MODEL
Let us assume
= Gross domestic product at current market prices at time t (in this model a time period means the interval between earning and spending). = Gross expenditure = Government ex-ante in time t. in time t (except subsidy).
AND INFLATION IN BRAZIL TRANSPORTATION
T(d) t T( t C
= Direct taxes = Indirect taxes
paid during time t. minus subsidies in period t.
= Credit expansion
= G = Y
in the private sector in period t.
deficit during t. period t.
- T(d) - T(i) = government
- T (i)
of the model are: in open-
There would be no difficulty (a) We are dealing with a closed economy. ing the economy, but this would not affect the results.
(b) There are no sales of government bonds to cover a deficit, i. e., there is no public debt in terms of outstanding government bonds; again, there would be no difficulty in introducing this variable into the model, but it would complicate it unnecessarily; also, this assumption is closer to the Brazilian case. (c) In each period the private sector spends all the income of the previous period, minus direct taxes paid, plus resources which are obtained through credit this will mean that: expansion; increasing government expenditures,
T(d) + G t t
This Say-type hypothesis seems to be adequate enough for the case of Brazil. For a country which suffers from an extremely high rate of inflation and whose potential for investment is very great, it would seem correct to assume that the the financial resources. private sector spends all its disposable Implicitly, above equation assumes that the demand for money is limited to transactions demand. There would, however, be no difficulty in introducing a precautionary demand function for money without changing the import of the model. (d) In each period, credit expansion to the private sector is a certain proportion of the government deficit of the previous period. This is augmented by a portion of autonomous credit, a function of rediscount policies.
This hypothesis corresponds to the usual mechanism of expansion of the means of payments by the banking system. The deficits force the government to issue paper money. This paper money flows through the banking system in the form of deposits; the banks, having excess reserves, expand credit to the banking system. (e) The market supply of and demand for the gross national in all periods; on an ex-ante basis: product art, the same
ECONOMIC DEVELOPMENTAND CULTURAL CHANGE These are the assumptions it can be stated that: (4) Y = Y t t-1 +B of the model. Making certain transformations,
+ mB A + T t t -T(i) t-1 t-1 +tThis equation makes it possible to determine the evolution of the gross domestic product at current prices. Let us suppose, and this is quite realistic in the case of Brazil, that the nominal value of the gross product increases at a rate considerably higher than the rate of growth of the real product. Let us also assume that the productive capacity of the country is fully utilized, and that in the short run the real product of each period is given. Under those conditions, a reduction of the rate of growth of the gross product at current prices will have to be interpreted as a diminution of the rate of inflation, and vice versa. t Given equation (4), and assuming that the government deficit, the autonomous credit expansion to the private sector, and direct taxes minus subsidies corresto fractions b, a, t, of the gross national product at current pond, respectively, prices, we have:
A = aY t t
The latter equation shows that, ceteris paribus, the rate inflation is a function of the government deficit/national product ratio. This is an obvious
We can see now what happens when indirect taxes increase or when subsidies are cut. Assuming that the proportion of indirect taxes rises from ti to ti + At and results in a lowering of the deficit from b to b- At, the final effect of this increase of indirect taxes (or cut of subsidies) will be a reduction in the rate of inflation, which can easily be inferred from equation (8). There exists, however, a time lag problem. If the subsidies cut become effective at the beginning of period to , during this period aggregate demand for goods and services will grow exactly in the same proportion as the subsidies which have not been cut.8 Only from period t1 on will the rate of expansion of demand diminish. This conclusion can easily be drawn from equation (4). The disinflationary
7. Less obvious is the conclusion that given the same government deficit proportion, the rate of inflation will be greater with a greater degree of indirect taxes. This, however, has nothing to do with our model, since we shall assume that the proportion of government exwe are penditures does not change. Thus, when the proportion of indirect taxes increases, assuming that the proportion of the deficit decreases by the same amount. This happens because of the component (T() - T(i) ) in equation (4) which, t-1 t would offset the disinflationary effect of the lowering of the deficit. for that period,
TRANSPORTATION AND INFLATION IN BRAZIL in indirect taxes) will only be felt, how-
effect of the subsidy cuts (or increase ever, with a time lag.
The above mechanism can also be described graphically. In the graph below, the rectangular areas represent aggregate demand in each period (the ordinate is measured on a logarithmic scale, according to the assumptions made). Discounting the growth of the real product, the solid line represents the path of the price level compatible with our model.
To Moment of Subsidy Cut
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