Dissolving corruption in Brazil: painful transition presages long-term benefits

Brazil's judicial investigation into widespread government corruption has unveiled an expansive network of illicit relationships between small clusters of private firms, public sector officials and politicians.

Several high-level businessmen and politicians have been convicted. The short-term economic implications have been dire, as private groups and corresponding value chains faced a sudden freeze of client demand, operations and finance. However, these investigations may have a far-reaching positive impact on the interaction between the public and private sectors in Brazil and, thereby, on the country's economic performance.

As a result of these investigations and changing popular sentiment, the consequences of being caught behaving corruptly have never been tougher. Brazilian firms are overhauling their compliance functions in what some are calling a 'corporate governance revolution'.

The harmful economic effects of abuse of public sector positions for private gain are manifold. Public expenditure and economic resources tend to be allocated in ways that maximize opportunities for 'corruption rewards' rather than economic efficiency. In this system, conferring privileges on corrupt bodies eliminates the functioning of a competitive marketplace.

As a consequence of Brazil's corruption purge, there is potential for change in at least three economic dimensions. First, the cost effectiveness of public spending can improve substantially. The selection of projects, regulatory decisions, choices between suppliers and other public sector choices will be optimized for the public good, rather than for the benefit of corrupt bodies. Second, the investigation is likely to lead to extensive change in those sectors of the economy where there is significant interaction with the public sector. The system of 'organized creation and distribution' of public sector demand among a few privileged private sector actors has been broken. Third, there will be an improvement in the perception of Brazil's 'rule of law', a boon for attracting foreign investors.

Brazil must complete an economically painful transition before reaping the long-term benefits. In the private sector, large domestic companies involved in the investigation face a financing drought. This is in addition to rising doubt about their asset values and net worth, operational challenges and shrinking client demand. Many external companies have, in turn, adopted a wait-and-see attitude, evaluating the possibility of acquiring Brazilian assets which are being liquidated. Confidence in a new regime of public-private relations can only rise gradually, as risks of reversal fade out. A fine-tuning of regulation, agencies and state companies will have to take place.

The investigations into corruption should be just the beginning if Brazil wants to enjoy the benefits of a broad 'governance revolution'. The judicial proceedings need to be supported by the implementation of a microeconomic reform that eliminates aspects of Brazil's business environment which are a haven for corrupt practices. Accountability should be improved in all spheres of government.

The prevalence of crony relationships between public and private agents is neither new to Brazil nor singular to the country. The dissolution of this framework, even if painful in the short term, has great potential to create economic, political, and social gains in Brazil, and may provide an example for other countries around the world.

Otaviano Canuto is an Executive Director at the World Bank. All opinions expressed here are his own and do not represent those of the World Bank or of those governments Mr. Canuto represents at its Board.

Follow Otaviano Canuto on @ocanuto

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