Persio Arida, Opportunity
Now at Opportunity Asset Management, economist Persio Arida has
been a central figure in Brazil’s attempts to kill inflation.
Together with colleagues from the Catholic University in Rio de
Janeiro-including Gustavo Franco, Edmar Bacha, Andre Lara Resende,
Pedro Malan and Winston Fritsch-Arida played a major role in
creating the Real Plan. Below, he talks about why the Real Plan
succeeded while the Cruzado Plan, and the stabilization programs in
between, failed.

On why previous anti-inflation plans failed…
It’s very important to understand that the Brazilian inflation
problem was not the same. When the Cruzado Plan was launched, we
had a pattern of inflation that was similar to the Real pattern of
inflation, but in between, the pattern changed. The Real Plan was
based on a paper published by Andre Lara Resende and I in 1984,
which addressed the problems of stabilizing inertial chronic
inflation, and this pattern of inertial chronic inflation was
pretty much the same for the Real and the Cruzado. With the demise
of the Cruzado Plan, we had a different dynamic in which inflation
was driven by expectations of the next price freeze. So people
would anticipate that with the demise of one program inflation
would go rampant, and sooner or later the government would impose
price controls. So everybody wanted to be in a good position when
price controls came, and that would speed up the process. And of
course, when the process sped up, the government validated
expectations by imposing a new price freeze. That’s why we had one
stabilization program after another, with intervals of a year or a
year and a half, because they all tried to repeat the structure of
the Cruzado Plan. But the Cruzado Plan addressed inertial
inflation, not this particular sort of expectation-driven
inflation, in which inflation is accelerated because market agents
anticipate that at some point the government would impose a price
control. This particular dynamic disappeared in 1992. Why? Because
we had a major confiscation of assets in 1990, which was something
different than the traditional price freeze. That didn’t work. Then
we had a new attempt at a price freeze in 1991, and finally in
1992, the country could not stand another cycle of price freezes.
So there was a general consensus against price freezes that
actually stopped the previous cycle and returned inflation to what
it was in the early 1980s. That’s why the Real Plan in 1993/1994
could be based on a paper written in the early 1980s, precisely
because the pattern of inflation came back around.The second aspect
of the story is the social learning curve. For the Cruzado program,
I remember when I would speak about privatization, people would
think that it was something invented by Thatcher and the
conservatives in Britain and that it didn’t deserve much
consideration. When we would insist on eliminating the public
sector deficit, people would say, “Yes, of course,” but they didn’t
really understand what that meant. When we would say, “You should
not allow for nominal wage increases,” they would say, “Yes, but
you should take into account that the workers are very poor.” The
country was not mature enough to understand that fiscal discipline
and wage restraint and reforms are very important. The climate was
very different then. It was the beginning of the democratization
process, a moment when popular pressure became more and more
important, so that was an important difference in the two
situations. The country as a whole, because of a series of ill
fated attempts, became more mature.Obviously another difference is
that the right things to do became much more obvious after the fall
of the Berlin Wall, from the viewpoint of the population as a
whole. Another important difference was trade liberalization and
the resumption of capital flows. The Cruzado Plan was done under
absolute constraints from the viewpoint of finance. Brazil was
still technically in a moratorium situation, and several attempts
to get together with the IMF had failed, so that crisis was not
over in 1986. External constraints were a major factor, and the
economy was a closed economy as a consequence.

On why the Real Plan worked…
With the Real Plan, the external situation was much more favorable,
first because between 1990 and 1992 capital flows resumed. The
external debt agreement was already reached and trade opening had
already happened. When the Real Plan was launched the external
trade tariff had already declined, the economy was much more open,
so in a sense, the power of the exchange rate as a stabilization
anchor was all the more enhanced with the real vis-à-vis the
cruzado, because you may keep the exchange rate stable, but if the
economy is a closed one with few imports over GDP ratios, that
doesn’t mean much in terms of keeping inflation low. But when the
economy is open, that makes all the difference.As a group-we were
all teachers at the Catholic University in Rio-we developed two
theories to deal with chronic inflation. One was a theory based on
the heterodox shock, a temporary price freeze, and the other one
was this superindexation of the economy, creating an alternative
standard unit of value. One was associated with Francisco Lopez,
who is now at the central bank, and the other with Andre Lara
Resende and myself. So we discussed two alternative therapies for
the problem. The second one proved to be more effective, for sure.
But you should not underestimate the differences in the
preconditions-much better with the Real than with the
Cruzado.People who have not experienced directly what it is to
prepare a stabilization package certainly underestimate the
complexity of the process, because it requires coordination of
social agendas, political agendas, economic agendas. It’s a very
complex operation that can derail very easily. Obviously, maturity
and understanding the problem is very important from the viewpoint
of the economic team. We were much more mature in 1994 than in
1986, in terms of personal experience, direct observation, previous
mistakes, knowledge of other countries’ experiences. The Cruzado
program was very similar to the Israeli program in 1985. It worked
in Israel, it didn’t in Brazil, which shows there’s nothing
intrinsically wrong with it, but the implementation of the Cruzado
was faulty in the sense of the major political problems we faced.
The Real was much better in terms of political support. Creating a
stabilization package requires balanced judgement of the situation,
and to a considerable extent, taking risks. It’s much more similar
to fund management than people think, in terms of control of risks,
willingness to take risks, intuition, perception of the markets,
and obviously you have to be grounded in fundamental value.The plan
was subject to constant revision. The impression one has from the
outside is that it’s a very complex puzzle and that one day you
look at the puzzle and get it right. But it’s much more like a
chess game in the sense that it takes time, and you have to
establish a strategy depending on how the markets and political
forces react.If you look at the situation now, you say, “The
reforms should have been done more quickly.” But actually, if you
asked people before the launch of the program to draw the rosiest,
brightest scenario that they could ever possibly draw in 1993, I
would bet no one in the country would ever imagine being in such a
situation in 1998. So in a sense it’s beyond the wildest
expectations of the country.I would be the first one to say that we
have problems. Obviously I would be much happier if we had done
more reforms, but my sincere feeling is that Brazil did what could
be done. It’s a fragile democracy. Unfortunately you have a
constitution that’s very populist-it’s the only stabilization
program that I can think of that actually associated economic
reform with constitutional change. You have no single party running
the scene and there is a fully independent judiciary-so it’s a full
democracy, and democracies tend to take time to respond. It takes
time to discuss, it takes time to get reforms approved, but that’s
the price of democracy, and it’s a price that is worth paying. If
you take all of that into account, what has happened up to now is
close to a miracle, in the sense of being in the best possible
situation.