Why Brazil Could Be the New Britain

Over the last few days, I've been talking with our Rio correspondent, Mac Margolis, about the future of Brazil, which has been one of the winners in the global financial crisis. As Mac reports for an upcoming Scope item in the international magazine, the country has weathered the downturn much better than most: not a single bank went under, its debt is low and is predicted to fall rather than rise significantly in coming years, and the Treasury is still sitting on $208 billion in hard currency reserves. While the Dow, the DAX, and the Nikkei have tanked, the São Paulo stock exchange is up 31 percent since January and most economists are expecting Brazilian GDP growth to grow strongly again by next year.

But the fact that Brazil is so flush is also a risk. Mac says that President Lula has become something of a cult figure, with 80 percent approval ratings. That has given him license to start spending money like there's no tomorrow. True, Brazil needs to beef up its social safety net and public infrastructure. But instead, Lula is jacking up civil-servant salaries, rolling over state debt, and easing consumer lending rates—all things that are tough to reverse should the economy weaken. Spending on schools, roads, and bridges, meanwhile, has taken a hit, down from 2.6 percent of GDP to 0.7 percent in the last couple of decades.

All this reminds me of a story I wrote in 2004 on Gordon Brown, then the U.K.'s chancellor of the Exchequer. A super-strong global economy combined with the popularity of New Labour had given Brown license to spend the country into oblivion (with much of the money going to increased salaries), creating a bloated public sector and undermining the government's welfare-state reform. I argued that at current spending levels, Britain was on track to have a public sector that resembled continental Europe. Brown argued vehemently that we were wrong, but in fact, the only thing NEWSWEEK was wrong about was the size of the problem, which turned out to be much bigger than we had predicted. Between 2006 and 2010, the IMF estimates that Britain's government debt will have risen faster than that of any other major rich country, ramping up nearly 59 percent, to a whopping 68.7 percent of GDP. That's one reason that the U.K. will face some of the most serious social and economic fallout from this recession.

Note to Lula: Learn from this lesson, and don't overspend just because your star is rising. As Mr. Brown has discovered, fortunes—and finances—can change very quickly.