How Brazil Broke Loose

CAMBRIDGE – Brazilian President Dilma Rousseff’s visit last week to Washington, DC, offers an occasion to consider how some once-poor countries have broken out of poverty, as Brazil has. Development institutions like the World Bank have advocated improving business law as being essential to success. Are they right?

Such thinking goes back at least as far as Max Weber’s argument that an effective business environment requires a legal structure as predictable as a clock. Investors, it is thought, need clear rules and effective courts. Security of contract and strong mechanisms that protect investors are, in this view, foundational for finance, which in turn fuels economic growth. If a potential financier is unsure of being repaid, he or she will not invest, firms will not grow, and economic development will stall. Rules and institutions come first; real economic development follows.

But, compelling as this logic seems, Brazil’s rise does not confirm it: financial and economic growth was not preceded by – or even accompanied by – fundamental improvements in courts and contracts.

Growth is unmistakable: Brazil’s financial markets have expanded robustly, with stock-market capitalization rising from 35% of GDP in 2000 to 74% in 2010. In the eight years prior to 2004, only six companies went public; in the eight years since, 138 have. Last year, Brazil overtook the United Kingdom – often seen as an exemplar of contractual security – as the world’s sixth-largest economy.