Brics in crisis and new middle classes will bear the greatest costs

By Jan Hofmeyr

These are trying times for Brazil and South Africa, the southern members of the Brics grouping of emerging nations that also include China, Russia and India. After years of robust growth their economies are in the doldrums, and their governments lack latitude in the options to revive them. It is not only the erosion of macro-level gains that should concern policy makers in Brasilia and Pretoria; increasingly they also need to worry about the backlash of citizenries, particularly the new, vulnerable middle classes, against the abruptness with which the brakes have been put on the wheels of progress.

Less than a decade ago these commodity-rich economies raced ahead with seemingly unstoppable momentum. Buoyed by what at the time appeared to be the insatiable resource demand from a rapidly growing China and the steady flow of cheap money from the developed north, they racked up growth rates that made them believe that a permanent change in their developmental trajectories was within reach. Tied together by shared domestic realities of high poverty and inequality levels, Brazil and South Africa aspired to eradicate these and to convert their windfall into a stable middle class that would become the dynamo of future growth.

And crucial gains were made. Brazil in particular became a textbook example to other developing economies on how to lift millions of destitute citizens out of poverty into the middle class. Since it came to power in 2003, the Workers’ Party (it redirected the surge in government revenues towards ground-breaking anti-poverty initiatives, such as the conditional cash transfer programme Bolsa Familia). According to World Bank data, the percentage of Brazilians living under the country’s poverty line was halved from 17.5% in 2006 to 8.9% in 2013. Inequality, as measured by the Gini coefficient, shrunk from 0.61 in the early 2000s to about 0.52 in 2010. It is estimated that between 30 and 40 million Brazilians joined the ranks of the middle classes since 2003.

South Africa was less successful in extracting mileage from the commodity super cycle. As the Bertelsmann Stiftung’s Transformation Index (BTI) shows, the country created its own hurdles through policy inconsistency and internal political fragmentation. But it did attain some significant achievements of it is own nevertheless. Under Thabo Mbeki’s ANC-led government millions of marginalised South Africans for the first time gained access to basic services like sanitation, electricity, and healthcare. The percentage of citizens living under the national poverty line decreased from 66% in 2006 to 54% in 2011, due to an expansion in the coverage of its social welfare net, which grew from 2.4 million recipients in 1998 to close to 17 million in 2014.

While this reprieve to the poor did subdue growth in the country’s exceptionally high income inequality levels, it was not sufficient to arrest the direction of the broader trend. As a result class differences are becoming an ever more pronounced feature of present-day South Africa. Although more modest, the country also recorded gains in the growth of its middle class with expendable income. According to the Cape Town-based Unilever Institute, the South African middle class grew by about 1.5 million between 2004 and 2012. With the size of the white middle class remaining virtually unchanged, the new emerging black middle accounted for almost all of the growth in this category.

Investors jitter about emerging markets
But the boom times are gone. Since the global economic crisis of 2008/9 things have just not been the same for emerging markets. The Chinese economy has cooled down and, as a consequence, commodity prices have tanked. Its recent stock market scare has further added to investor jitters about emerging markets, which saw their currencies plunge and the stream of portfolio flows to these countries being reduced to a trickle. Although spared by the decision of the Federal Reserve in September not to raise US interest rates, Fed chairwomen, Janet Yellen, recently made it clear that the inevitable will happen before the year is out.

For Brazil and South Africa it would add insult to injury. During the second half of 2015, Brazil slipped into recession and the credit ratings agency, Standard & Poor’s, has become the first to downgrade the country’s credit rating to junk after it failed to meet key targets. Others may follow. In the meantime policy makers in Pretoria are looking on anxiously. Hampered by a debilitating energy crisis, an ineffective state, and dysfunctional state enterprises that fail the neediest citizens, South Africa’s economy is also in a funk. In August Statistics South Africa, the country’s official statistics bureau, announced that it contracted by 1.3% during the second quarter of this year.

Citizens in both countries are feeling the pain. Government revenue, derived from personal income taxes, is declining; the weight of fiscal and monetary burdens is increasing. The cash that has financed countercyclical policies have all but evaporated and, given their large current account deficits, it would be risky to further raise already growing debt levels to soften the impact. In Brazil the capital gains tax rate had to be increased to 30%, and in South Africa the marginal tax rate for top earners has been raised by 1 percentage point to 41%.

But the consequences of the deteriorating climate in both societies will be felt most acutely by the poor and lower middle classes. The Brazilian inflation rate has surged to 9.25%, and in an attempt to rein it in the Brazilian Central Bank was forced to hike interest rates by a half a point to 14.25%. Unemployment is up by 3 percentage points from a year ago to 7.5%, and according to the Institute of Applied Economic Research, the government think tank, the number of Brazilians in extreme poverty had risen in 2013 for the first time since 2003.

In South Africa policy makers have succeeded in containing inflation within the targeted 3% to 6% band, but the country’s Reserve Bank has raised its prime lending rate in any case with 25 basis points. Unemployment remains stubbornly high at 25%, while lay-offs, particularly in the mining sector, continue unabatedly. If the government is to stick to it targets for 2015, it will have to rein in its ballooning public wage bill — something that will be particularly unpopular and politically risky less than year before the country’s local government elections.

Body politic in Brazil and South Africa might become more fragmented
It is the short-term success of both countries — the rapid momentum of change — that may, ironically, come back to haunt them. The pace and trajectory of progress to date, marked by pronounced changes in access to services and altered consumption patterns, especially among those that have entered the lower end of the middle class, will have raised expectations about the pace and trajectory of progress in the future. These expectations are unlikely to be met and when this realisation dawns — as it has already done amongst many — expectation will first turn into frustration and then into anger.

Combine this with a growing awareness of the scale of corruption by governing elites at the expense of vulnerable citizens — Petrobras in the case of Brazil and mounting discontent with the culture of patronage around the person of South Africa’s president, Jacob Zuma — and the net result may be a body politic that is less cohesive and more volatile. This may elicit more violent state responses to the protests of desperate people, as so crudely demonstrated by the Marikana massacre where the South African police mowed down 34 protesting mineworkers.

Their long-term failure — unproductive investment in economic infrastructure — will stunt the much-needed growth of their respective middle class in the absence of supply side tools to stimulate consumption. Brazil’s is lacking, South Africa’s is crumbling. Their manufacturing sectors are both in decline. Both countries have woken up too late to this reality and will now have to make difficult choices in contexts where foreign funding will be both more difficult and expensive to obtain. While these pressures will be exerted from above, citizens will do so with increasing forcefulness from below.

Jan Hofmeyr heads the Policy and Analysis Programme at the Institute for Justice and Reconciliation (IJR) in Cape Town. Hofmeyr is one of 250 country experts who are currently working on the forthcoming edition of the Bertelsmann Stiftung’s Transformation Index, BTI 2016. He writes in his private capacity.