Global Management Practice Reflection Paper

Tackling the Custo

Brasil: a policy approach
REBECCA RYAN TOMMASO STORARI

FGV-EAESP, CEMS MIM

17/03/2015

1. Custo Brasil: facts and components

The Custo Brasil refers to the additional cost of doing business in Brazil that companies have to bear due to
inefficiencies and peculiar factors of the country. The many drivers can be grouped in four main categories,
namely a) taxes and corruption b) labor market issues c) management practices d) weak infrastructure.
These issues contribute to increased costs and consequently prices in the country; a study from Gerncia
de Estudos Econmicos da Firjan (Gerncia de Economia e Estatstica, 2013) showed that unitary costs
increased by 40% in the period 2008-2012, while prices of industrial products show a markup of 20% to 30%
relative to Developed Economies and China respectively. Another study from the Boston Consulting Group
shows that production is now 23% more expensive in Brazil than in the United States, despite the fact that
in 2004 it was 3% cheaper(The Boston Consulting Group, 2013). These issues have remarkable social,
economic and political implications. On one side, Brazil became an ever more expensive place to live in,
exacerbating the social tension among population groups and between the citizens and the government.
On the other hand, rising production costs reduced Brazils attractiveness as far as FDI and manufacturing
are concerned, weakening the countrys position in the international industrial forum.
This paper will focus on two drivers of Custo Brasil, corruption and labor market issues. In the following
pages, their size and economic impact will be evaluated, and subsequently policy implications will be drawn
and a scope for action will be proposed. A tentative comparative approach will be used to understand which
intervention will lead to the most significant short-term gains and improvements. The main aim of the paper
is to demonstrate how severely these two topical areas affect Brazils economy and business environment.
Subsequently, it will be argued that effective and targeted policies to improve the labor market can yield
immediate and tangible gains that can boost output in a short-run horizon, while tackling the corruption
problem will require a different, more extensive approach that will display results in a more long-term
horizon.

2. Corruption
Corruption is captivating the headlines in Brazil and the world over with the recent Petrobras scandal that
has emerged, deemed the most daring and outrageous corruption scheme and embezzlement of public
funds ever seen in Brazil. (Antunes, 2013) This controversy has shed light on an embedded and integral
part of Brazilian culture and how business is done in Brazil. The state owned Oil Company, Petrobras was
illegally diverting 3% of its value to slush accounts for political parties (The Economist, 2015). The outrage
across the country was heard with people expressing their disappointment with a failed and corrupt
government when pots were banged throughout at least five major cities in the country during President
Dilma Rousseffs speech, proposing belt-tightening, fiscal austerity policies to get the country back on its
feet (Merco Press, 2015). What the Brazilians may find even more disheartening about this case however,
is the involvement of President Rousseff. A President that promised change for her country, one that fought
aggressively against such dishonesty, one that defended her role to bring about change all conditions
upon which she was elected (Antunes, 2013). Her failure therefore is not only to the nation she fought so
courageously for, it is also a failure of the fight against corruption in the country. This unfortunately, is just
another corruption scandal in Brazil, a country with a long history of bribery. The Mensalo Scandal that
emerged in 2005 was another such case. Political figures organized a vote-buying scheme whereby quick
congressional approval was ensured in a diverse coalition government where consensus was difficult. In
2012, allegations were made against thirty-nine politicians of which twenty-five were sentenced for
criminal charges. (De Salles Brasil, 2013)
These corruption cases are more detrimental to the economy than the image of Ms Rousseff and fellow
politicians alone. To put into perspective, if the money in the Petrobras case had been invested in Brazils
education system, the number of Brazilian students enrolled in elementary school could be improved from
its current 34.5 million to 51 million (Antunes, 2013). Such an investment would allocate precious resources

that would contribute to lifting people out of poverty by improving their qualification and chances of finding
a source of remuneration. Instead, the impact of corruption and lost funds is counter-productive to the
whole economy. Following the controversy surrounding the Petrobras case, the real tumbled by 5% against
the dollar amid the political uncertainty surrounding the Janot list (where politicians where named for
investigation). Inflation reached 7.7% in February, the highest in a decade (pushed up in part by long
overdue hikes in regulated prices for fuel and electricity). The central bank raised interest rates last week
at 12.75%, meaning that they are now back to where they were just after Ms Rousseff first took office in
2011, and up from 7.25% in 2012-13 (The Economist, 2015). These are all indicators of an economy that is
struggling to emerge, and with Brazil being the poorest performing BRIC country in terms of GDP growth in
recent years, people are now starting to question its merit as an emerging BRIC economy (Pereira, 2013).
Austerity measures following such scandals seems too little too late in terms of recovering a prosperous
GDP growth for 2015.
Where does this corruption stem from and why does it seem to be archetypal of emerging economies? The
nature of social practices in a country can be seen as a reflection of the long-term development and
organization of its social and political system. These countries particularistic and personalized social
structures remained in place as financially poor and administratively inefficient central states in the past
were forced to rely on regional brokers at local level and were seen as an important social mechanism.
The existence of these strong clientelistic networks may contribute to the development of a path
dependency, in which it becomes almost impossible to escape from what Donatella Della Porta has
described as the vicious circles of clientelism-corruption-clientelism and poor administration-corruptionpoor administration. Another view is that corruption is the product of growing state intervention, where an
increasing amount of decisions is left in the hands of a few with greater financial resources (Heywood,
1997). The jeitinho in Brazil is a case in point. It rests on the use of personalistic ties to temporarily bypass
formal rules, for example, moving to the front of the line because of personal connections. People are aware
that the formal systems often produce inefficient results and are prepared to make exceptions, leading to
a cordial and informal social style (Holanda, 1996).Thus, the administrative order is temporarily inverted in
order to consolidate the interpersonal order (Islam, 2010). The transitions toward democracy and market
economies have not yet overcome this culture of corruption. Furthermore, setting up institutions that
monitor corruption often appears more a publicity and marketing ploy to boost a governments public
image, a way to create a pretense that action is being taken whereby people no longer protest. It seems
unrealistic to believe that those who benefit from corruption will be the ones who will eradicate it (Salas,
2014). National power is simply not enough to tackle such an issue that is so embedded in the culture.
International Organizations that provide transparency to the people of their government needs to happen
for even a hope that corruption will cease to exist in Brazils future.
Corruption - comprising all kinds of is the improper use of resources, such as bribery, nepotism, extortion,
use of privileged information, fraud, and others for non-official purposes (Houaiss and Villar, 2001)
appears to be a dominant feature of an emerging economy, and yet it is also a severe hindrance to its
chances of development to an advanced stage. Brazilian stockholders have become aware of the risks
involved in unethical procedures and are adopting the Best Practices of Corporate Governance initiative.
International agencies have intensively supported organizations and governments in an effort to define
policies that inhibit illegal or corrupt cultural habits throughout the world, but despite this, Brazilian
practitioners show insufficient response (Halter, et al., 2009).
Globalization and democratization are two important transparency promoters. Transparency is no longer a
choice. The society is demanding and pressuring governments and organizations to implement it (Halter, et
al., 2009). Such an organization has to be international in order to ensure a non-biased source. Transparency
International, together with Social Accountability International (SAI) developed the Business Principles for
Countering Bribery (BPCP) and together are one such organization that seeks to empower anti-corrupt

movements in countries. Its 2009 edition brings recommendations of greater emphasis on public reporting
of anti-bribery systems and enterprises commission external verification or assurance of their anti-bribery
program (Halter, et al., 2009).
These initiatives are gaining momentum and result surely positive, as they stimulate thinking and awareness
on the problem and promote honest and fair practices throughout companies. However, their direct effect
on the Custo Brasil issue is uncertain. In her article, Rita Ramalho challenges the effectiveness of anticorruption campaigns (Ramalho, 2004). Furthermore, given the informal and voluntary nature of such
measures, the impact on Custo Brasil will be related to the speed and capillarity with which such practices
are adopted and implemented, and on their accurate enforcement. Finally, as argued by Athanasouli &
Giroud (Athanasouli & Goujard, 2012), high corruption levels are associated with poor management
practices, and this can lead to a vicious circle whereby conflicted managers avoid adopting such business
practices, perpetrating unfair and dishonest behavior.

3. The labor market issues

The other determinant of Custo Brasil analyzed here is the inefficient Labor market. The unemployment
level of Brazil has been low and declining in recent years. Yet this result may convey unjustified optimism
and conceal thorny issues. Particularly when put into the context of the last years sluggish GDP growth,
such low unemployment level may be connected to rigid labor laws and low labor productivity, and
eventually lead to unjustified high cost for firms and inefficiencies in the market. Truly, part of the fall in
unemployment is attributable to a decrease in the labor force. Although this could bring about the issue of
discouraged workers (which do not figure out as unemployed but still represent a social issue), there is
evidence that part of such decline is due to an increase in schooling, and this is good news.
As mentioned before, Brazil is not a low-cost country when it comes to manufacturing. As shown in Figures
1 to 3, Brazil regulation is pretty generous in terms of minimum wage compared to other countries,
especially in relation to the value added produced by a worker. This affected its relative cost
competitiveness vis--vis other countries up to -15%, as depicted in Figure 4. The contrast is even more
striking in Figure 5, where Brazil displays a manufacturing cost index in line or even higher than most
developed economies. The index score for Brazil was 123, compared to 100 for the U.S.A., 96 for China, 91
for Mexico. Not surprisingly, the biggest share of this score is labor-related. High labor cost per se is not a
problem. However, it becomes critical when coupled with disappointing productivity levels. As displayed in
Figures 6 to 8, Brazil performed poorly on this dimension. Data of the Total Economic Database show GDP
per hour worked remain flat in a decade; total factor productivity, as calculated by The Economist (The
Economist , 2013) , declined significantly.
This mismatch between wages and productivity is in part regulatory-originated. It is argued that labor
market laws are excessively protective of employees (for example in terms of benefits, pension funds and
minimum wages), rigid in terms of workers deployment and onerous in terms of taxes
(Knowledge@Wharton, 2007). This increases the cost for firms, but this high cost does not find justification
in productivity gains. Furthermore, the low productivity of labor may even reinforce the problem, as firms
need to hire more workers, ceteris paribus. Not surprisingly, The Boston Consulting Group (BCG) estimated
that approximately 74% of GDP growth over the past decade was due to increase in the number of people
working and only about 26% can be attributed to productivity gains (The Boston Consulting Group, 2013).
Add to this the decline in supply for labor, driven by increased schooling and demographic changes, and the
room of maneuver for companies to further narrow down, exacerbating the issue. This may imply additional

increases in costs, time lost for bureaucracy or in tribunal to deal with labor law issues and the infamous
yet frequent recourse to informal employment.
A final mention is due to skills and competency level. The above-mentioned report by BCG also uncovered
issues related to a shortage of skilled and high-qualified labor among companies. This scarcity negatively
affects companies not only because it raises labor costs further (due to high bargaining power of skilled
workers), but also because it somehow limits the extent to which firms can find talented and trained
personnel to grow and compete. The issues appears to be connected to the quality of education and training
rather than its quantity. Indeed, government spending on education is among the highest among OECD and
most developing countries (OECD, 2012). The issue is rather in the allocation. As The Economist illustrates,
most funding is concentrated to higher education, and less to primary and secondary school education (The
Economist, 2013). This creates a bias, in the sense that those who have access to high-quality university
education are children of rich people who could attend private school. This not only has implications in
terms of fairness and equality, but it is also economically inefficient, as investing more resources in primary
and secondary school would benefit a larger fraction of the youth population and increase chances of
university attendance and development of qualified labor force. Besides this, spending also lacks in training
and educational programs targeted at people who would like to pursue off-university preparation and
workers willing to update and learn new skills.

4. Policy implications
As mentioned in the beginning, our analysis of these two key drivers of Custo Brazil has a pragmatic aim in
terms of policies and possible medidas. We already stated our argument that tackling the Labor Market
problem would be a more viable option, conducting to possible short-term quick wins which could
contribute to a boost of the current economic situation. A more detailed and data-driven analysis of the
relative impact of the two issues could be insightful to understand which measures would yield the greatest
results. Unfortunately, this calls for extensive analysis that is beyond the scope of this work. Still, a
qualitative approach can be embraced that support our claim.
Labor market issues have been identified in three main categories: productivity, costs (connected to
regulation) and skills. Although such problems cannot be solved overnight, there is scope for government
to implement measures that have significant and relatively fast effects. For example, reallocating the
investment in schooling to primary and secondary education would have sizable effects in terms of number
of students impacted and their chances to pursue a higher degree, with positive spillovers on productivity
as well. Investment in technology can further boost specialized labor and development of valuable skills
sought by companies. The development of training and updating programs for workers can promote
updating of skills and fulfillment of qualified job requirements from companies, thus expanding the supply
of qualified labor.
For what concerns labor market flexibility, measures can be embraced to simplify tax laws, address the
issue of pension spending and rethink the benefits systems. Although these are sensitive topics, the
government shall find clever solutions to relax and simplify the regulations without necessarily reducing or
affecting the well-being of workers. According to Mrs. Fabiola Marques, professor of labor law at the
Pontifical Catholic University in So Paulo, crucial labor reforms are needed. Suggested ones include the
reform of the taxation system, the change of Trade Union law to prevent that workers are obligated to
make payments to Trade Unions that do not fight on their behalf and changes in the norms that regulate
the relationship between companies and employees conductive to a more flexible and company-tailored

approach (Knowledge@Wharton, 2007). Such measures shall be aimed not at reducing the well-being or
wages of workers, but rather increase the room of maneuver of firms in terms of hiring policies, tax
spending and benefits spending. One suggestion by Mrs. Marques in this sense would be to allow company
to classify bonuses paid to works differently than salary, so to have a lower tax payable on those amounts.
Many OECD countries underwent significant reforms in both the education system and the labor market,
which in turn affected productivity, efficiency and costs. One famous and praised case is Germany in 2005
(Krebs & Scheffel, 2013). The ambitious reform plan encompassed most of the aforementioned elements,
and led to significant reduction in labor costs and unemployment in less than 2 years, originating a true
labor market miracle. Clearly, such measures are not easy to replicate and promulgate, the context is
different and often they bear the risk of being unpopular and controversial. Yet, we are convinced that to
improve the wage-cost-productivity issue underpinning the Custo Brasil, such reforms are of paramount
importance. Moreover, by working at the same time on both components of the problem (the numerator:
wages/costs, and denominator: productivity), the overall net benefit will be amplified. If properly designed
and implemented in a timely manner, such measures could yield significant changes within a moderate
period of 12-24 months, generating visible effects in terms of reduction of the Custo Brasil, positive impact
on companies and attractiveness for FDIs.
On the other hand, it was discussed above how corruption-related issues appear to be deeply connected
with Brazils historical and cultural development. This is due in part to a past characterized by inefficient
institutions and congested regulation, whereby people relied on networks to get things done and
circumvent the suffocating state intervention in the country. The corruption cases that have emerged in
the country are becoming more and more scandalous as political figures take advantage of their role in
society. In order for this to change, non-biased institutions need to intervene to change the mentality of
the system and provide transparency to the institutions. MNCs located in Brazil have a crucial role to play
here by enacting OECD Guidelines for Multinational Enterprises which provide recommendations for
responsible corporate behavior, in particular in such areas as transparency and anticorruption (OECD,
2003). MNCs have the power to implement these guidelines and influence the government to improve
public relations whilst improving the economic environment in the country that they intend to operate in.
This concerted action is needed to tackle corruption, but such process will be inevitably is a more complex
and lengthy one.

5. Counter-Argument
An alternative approach is also foreseeable. The Labor Market is undoubtedly one of the most complex
policy topics, and some could well argue that it would be too complex to design and pass the necessary
measures to adequately tackle these problems. Instead, it could be argued that policymakers attention shall
be directed more towards fighting corruption with more stringent laws on bribery, closer monitoring and
checks, tighter expenses and budgets to encourage appropriate spending, investments in transparency for
the public administration and publicly available information.
Furthermore, one could well claim that the Custo Brasil shall be addressed primarily by solving the
infrastructural problem, and hence concentrate the spending on this area. There is plenty of available
evidence on the obsolete and precarious condition of roads and ports, as well as on the weak investment
stock in infrastructure if compared with other developed countries. (Loman, 2014)
With respect to the first one, we believe that tighter restrictions and regulation on corruption may prove
useful, but could as well exacerbate the formal-informal conflict mentioned above, with the undesired

result of further nurturing the jeitinho practice. We stress again our perspective of effectively addressing
the corruption issue, the country shall embrace a broader mindset challenge to fight the problem out of
the regulatory scope. Government measures and initiatives can help, but they work insofar as they support
a more substantial and comprehensive practice review conducted by companies, managers, workers and
citizens in general. Hence, in this sense policy attention would be more fruitful if addressed to labor market
reforms that, if properly drafted, can improve the playground upon which business is conducted.
Regarding the second argument, it is undeniable that infrastructures deficiencies cannot be left unsolved,
especially in a country that aspires to restore to fast and sustained economic growth. Here as well, however,
we believe that the government action shall be mostly supportive. Experiences in developed economies
showed how often government-backed projects often present inefficiencies and delays, while more and
more often large infrastructural projects are carried out mostly or entirely thanks to private investors under
the supervision of public bodies. As an investment priority, we are convinced that the government shall
maintain a key focus on improving the spending and allocation on the education system and on the training
programs to promote a positive productivity shock, and at the same time, work to decrease the costs
associated with the ineffective labor market. If this plan succeeds, significant progresses in terms of Custo
Brasil reduction can be realized quickly, and this would stimulate FDIs in the country possibly conductive to
new infrastructural development.

6. Conclusion
The paper uncovered the facets of two important components of the Custo Brasil, labor market
inefficiencies and corruption. An historical perspective was followed in order to trace back the corruption
problem to the countrys institutional development. The current state of government action was found to
be remarkable misaligned with the urgency and delicacy that the issue demands. Indeed, the recent
corruption scandals revealed how institutions lay right at the heart of the matter, uncovering a rooted and
idiosyncratic inclination towards such practices. Such behavior is a result of the turbulent and irregular
pattern of democratization and institutional development of Brazil, which was characterized by a formalinformal dichotomy and the reliance on clientelistic stratagems to cope with the overly rigid institutional
framework. This led to a gradual blending of the borderline between the licit and the illicit practice which
distinguishes the jeitinho approach. While policymakers actions to curb bribery, corruption and illegal
practices are desired and important, the real key to wrestle this issue is, in our view, a mindset change. In
order to tackle the most controversial aspect of the jeitinho, it is necessary to bring about a common
reflection on the jeitinho itself and on its grounds, to discern the good practices from the bad and borderline
ones. This long process shall be fostered by a plethora of actors including companies, international
organizations, administrations and the people calling for leading figures, inspirational examples,
widespread practices, public opinion sensibility and social awareness.
On the labor market side, the problems examined encompass productivity of labor and rigidities in labor
market laws, which in turn lead to high labor costs and low flexibility for companies. A comparison with
other countries was helpful to highlight such critical areas. It was argued that government action could
prove effective in addressing this issue, mostly through targeted and well-designed reforms. Relaxing the
labor market and reducing unjustifiably high labor costs on one side, while working to improve labor
productivity through education and trainings on the other side, may represent the appropriate recipe to
combat the disappointing cost-to-productivity ratio in companies. In our view, policymakers efforts
notoriously subject to time and scope constraints- would be best deployed when addressing this
component of the Custo Brasil.

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8. Appendix

Figure 1. Source: The World Bank database

Figure 2. Source: the World Bank database

Figure 3. Source: The Economist

Figure 4. Source: The Boston Consulting Group

Figure 5.Figure
Source:
5. Source:
The Boston
The Consulting
Boston Consulting
Group Group

Figure 6. Source: The Economist

Figure 7. Source: Total Economic Database

Figure 8. Source: The Boston Consulting Group

Figure 9. Source: The Boston Consulting Group

Figure 10. Source: Education at a Glance: OECD Indicators 2012, OECD