BRAZIL’S PETROBRAS SCANDAL: A CASE STUDY OF EXTRACTIVE ECONOMICS

By Evan Carlo
Staff Writer

Once hailed as “an extraordinary triumph for Brazil’s achievement,” the Brazilian energy giant Petrobras is now caught in a corruption scandal that could lead to the very top of the country’s political establishment. For months corruption investigators have dug into Petrobras’ records and discovered illegally diverted funds going out of the company and into the pockets of politicians and party activists. Given that the Brazilian government owns 51 percent of the company’s stock, Petrobras essentially operates as a state-owned enterprise. The government uses Petrobras’ revenue and profits to aid in the country’s social development by requiring the company to invest part of its business in local development. Because of this, many Brazilian citizens are angry over the fact that public funds are being used to enrich the political and economic elite.

The scandal kicked off when authorities arrested Paulo Roberto Costa, Petrobras’ chief of refining from 2004 to 2012, in March of last year on money laundering charges. He confessed that construction companies in his division won contracts by diverting over $3.7 billion dollars to slush funds for politicians, making this the largest corruption scandal in Brazil’s history. His testimony led the indiction of over 30 people, many of whom were members of the ruling Worker’s Party. Recently, the scandal reached new heights with the April 14 arrest of the party’s treasurer Joao Vaccari. Authorities charged him with handling $200 million of funds that were obtained from engineering and construction firms that over-charged Petrobras for their services and used their inflated profits to bribe the company and political officials to accept these contracts.

Given President Dilma Rousseff’s status as head of the Worker’s Party and her former role chairing Petrobras’ board of directors during its years under investigation, she has become increasingly connected to the scandal. President Rousseff has repeatedly denied involvement but that has not stopped calls for her impeachment and declines in her approval ratings. Politically this scandal may bring down her presidency and cost the Worker’s Party and its coalition many seats. But a new ruling coalition will unlikely change the political and economic structure that allowed and incentivized corruption.

This is a problem that we see time and time again in developing countries that operate under an extractive economic system. Political economists Daren Acemoglu and James Robinson extensively developed the idea of extractive economies. An economy is extractive when the ruling political elite exploits whatever economic rents they can from their existing economy to maintain their hold on to their power. This contrasts with an inclusive economic system that diversifies the economy and promotes inclusive growth from other sectors. In an inclusive economy, corruption is less widespread since the rule of law and property rights are strongly enforced. Policy examples of extractive economics include: monopolizing industries, excluding entry into the market, using political power to give an advantage to favored industries over new startups, corruption, the alignment of private and public interests, and more. The point of an extractive economic system is to keep political and economic elites in power and extract excess rents from the population. This system is easier to establish in commodity-based economies that focus mainly on extracting and exporting a basic commodity, which is exactly what is happening in the case of Petrobras.

Now it is a little unfair to call Brazil an extractive economy. Brazil, unlike say Russia or Kuwait, does not fully depend on the petroleum industry for its economic survival. Even in the areas of corruption and the rule of law, Brazil ranks higher than many Latin American countries on The World Bank’s Governance Indicators. Since the democratization of Brazil in the 1970s, the Worker’s Party has tried to develop an inclusive political and economic system to reduce inequality and oligarchy. While conditions in Brazil have improved since the 1970s, Brazil problems with income inequality and corruption persist.

The scandal with Petrobras demonstrates that aspects of the Brazilian economy still operate under an extractive system. Petrobras controls enough of the economy and suffers from enough corruption and inefficiencies to pose an economic threat. Economist Samuel Pessoa estimated that Petrobras and its various subcontractors are responsible for a tenth of Brazil’s economic output. Another study by the FGV Business School predicts that the scandal will cause Petrobras and its subcontractors to decrease spending and investment by $30 billion. The world economy is already beginning to slow down due to slower growth in East Asian and European countries. This poses a severe risk to Brazil, which operates mainly as a commodity exports economy. A slowdown in the petroleum industry combined with exogenous shocks can throw Brazil into a recession.

Even when Petrobras and the Worker’s Party try to pursue inclusive policies by using Petrobras to develop impoverished regions, it is executed in a way that makes Petrobras inefficient. Petrobras has a domestic content requirement to contract a certain percent of the goods and services from local businesses. This prevents Petrobras from contracting more experienced and efficient international companies, raising the cost of business. In addition, the government subsidizes fuel consumption through Petrobras by keeping prices artificially low. These two effects keep costs too high and prices too low for Petrobras to remain profitable. Therefore Petrobras is unable to finance its operations and expand its business without going into debt. Petrobras is now one of the most in debt businesses in the world because of how the government crafts their business strategy. The culmination of these policies turned one of the most promising companies in the world to an economic basket case.

The Brazilian government needs to loosen control over Petrobras and allow it to operate more as a private business. The Worker’s Party can create inclusive economic policies through the government and public policy instead of through a state-owned business. These policies not only make Petrobras inefficient but also incentivize corruption. If Petrobras operates more as a private business there will be a disincentive to accept inflated contracts in exchange for bribes since it must make a profit. Having the government divest more from Petrobras will keep the government out of the decision-making process at Petrobras, preventing private and public interests from aligning.

By allowing more competition in the bidding for Petrobras contracts, the Worker’s Party can fight corruption while still developing a more inclusive economic system. If they don’t reform Petrobras, corruption will continue and the emerging economy will suffer for it. The high debt and economic inefficiencies of Petrobras are preventing it from fully exploiting Brazil’s promising off-shore oil reserves that are estimated to hold 50 billion barrels of oil. With the scandal forcing Petrobras to cut back on investment spending, the company is unable to procure the equipment and skilled labor necessary to develop these oil sources. Because Petrobras is a large part of the economy, if it doesn’t recover quickly from the scandal it can weigh down Brazil’s already weak economic growth. Without these reforms, Brazil’s economy will stagnate for the foreseeable years to come.

Image by Agência Brasil

IS BRICS THE NEW “GAME OF THRONES” FOR INDIA AND CHINA ?

PROSPECT Journal is collaborating with China Focus, a blog focusing China’s role in the world and U.S.-China relations. As part of this collaboration, PROSPECT will be intermittently publishing articles by the China Focus bloggers. Our journal is excited to bring a wider range of expert analysis of Chinese politics, economics and culture to our readers.

By Amrita Jash
Contributing Writer

Multilateralism has become the new behavioral response of the international system. Global leaders have joined the nexus to create ‘absolute gains for all’ over the ‘relative gains of a zero-sum game.’ This mode of diplomacy has become the new jargon of international politics- whereby the mantra is that of “all for one and one for all.” The emerging Asian powers- India and China, have taken a proactive multilateral approach to widen their spheres of power and influence. In this marathon for great power status, BRICS has emerged as the new locus for jockeying for power between India and China.

With its first summit in Yekaterinburg-Russia in June 2009, BRICS as an association of the five major emerging economies (Brazil, Russia, India, China and South Africa) has successively surfaced as an alternative for the rising economies against the western-dominated economic order. During the 6th BRICS Summit held in Fortaleza, Brazil from July 15th-16th of this year, the regional forum called for the creation of a $100 billion BRICS New Development Bank (NDB) and a BRICS Contingent Reserve Arrangement (CRA) – an emergency reserve fund of over $100 billion. This is a tremendous step in reshaping the western-controlled international financial system, currently dominated by the International Monetary Fund and the World Bank. The BRICS bank aims to provide funding for infrastructure projects in developing countries with its headquarters in Shanghai and is to be headed by India. The Contingent Reserve will act as an emergency economic cushion for the BRICS countries when met with a financial debacle.

In this configuration of the NDB, where China gets the headquarters and India gets the command, the question that needs immediate deliberation is who takes the lead in this initiative? While India gets the first presidency of the bank for a term of six years, followed by Brazil and Russia for the successive terms of five years each, China is left with technically no command for almost two decades. This unparalleled hierarchy creates discord in the organization’s power politics. The NDB was likely designed this way in a deliberated attempt by the second-tier BRICS countries to keep China’s ambitions at bay.

With this change in BRICS power dynamics, the competition between India and China is taking a new form. This new level of complexity is the result of parallel aspirations of these two rising Asian giants. Although India will lead the initial shaping of the BRICS economic pillars in its role as head of the BRICS bank, it is likely to be more challenging for India to prove its mettle in the presence of China as the world’s second largest economy. China has already set several norms in global politics, where as India is just now emerging as a geopolitical trendsetter. There are wider concerns that an ambitious and powerful China might try to maneuver the norms of the NDB to expand its own political and economic clout. Thus, the NDB could be called the new “game of thrones” between India and China. India and China are the biggest beneficiaries of this development project as both are the largest rapidly emerging economies, and both are embroiled in high-stakes games to ascend through the international order.

Though India has been a pioneer in other regional networks such as NAM (Non-Aligned Movement) and SAARC (South Asian Association of Regional Cooperation), BRICS offers a new kind of multilateral dynamic for India. Although India holds a commanding position, it must still take a pragmatic approach. BRICS provides India and China an equitable platform; however, the power disparity between them remains a big challenge. In this vein, the new BRICS framework with the NDB adds an unknown dimension to India-China relations. The full impact of BRICS will only be visible in time. However, based on their parallel ambitions to gain power and influence on the global stage, with certainty, BRICS is the new platform of power projection between India and China.

Image by Blog do Planalto

PLAYING HOST TO THE WORLD CUP: PROMISED LOCAL BENEFITS TAKE A DIVE?

By Andrew Muse-Fisher
Staff Writer

Over the next eight years, the world will watch as Brazil, Russia and Qatar respectively host the World Cup. Though the money and labor that goes into the preparation of the world’s most viewed sporting event is ultimately used as a show of the strength and vitality of these nations, the efforts of these nations have exposed the individual issues that hinder their establishment or re-establishment of a positive global image. And as this trio works to rid themselves of the domestic problems within their own borders, they are also working towards the goals of the Fédération Internationale de Football Association. A closer look into the relationships of the host governments with its people and with FIFA reveals how the spirit of the World Cup is being pushed out by the search for profit and growth at the expense of the citizens of these countries.

In June of this year, the World Cup will commence in the country with a history of zeal for the sport. Brazil, whose five World Cup wins are the most by any country, began preparing in 2007 after its bid to host was approved by FIFA.[1] Naturally, the Brazilians celebrated this opportunity to develop infrastructure, increase health and education and reduce poverty within the country, just as the government promised in its campaign to win the bid. [2] The government, too, saw potential to reinforce Brazil’s developing economy. After two decades of economic growth that allowed Brazil to develop a strong economy, it has done little to sustain continued growth. [3] Brazil has relied on increased internal consumption in recent years, while simultaneously losing prospective outside investors. [4] This has slowed economic growth and has created a need to draw attention from the outside world to their potential for further development and possible investment. [5]

It is hardly surprising that they pursued the 2014 bid, but since they started preparing, they have put their need to attract foreign investment and global recognition before the needs of the Brazilian people, especially those living in the favelas. During the initial planning stages in 2010, the costs of building and renovating stadiums was estimated to cost 5.4 billion Brazilian Reais, or $2.3 billion. However, by 2013, the cost reached BRL 8 billion– $3.4 billion. [6] The total cost of the Cup stood at BRL 25.6 billion, or $10.8 billion. Unfortunately for Brazilian taxpayers, investors will cover only 15% of the total cost. [7] These costs only cover the expenses of staging the cup, and do nothing to fund improvements to healthcare, education or the reduction of poverty as Brazil promised to do in its winning bid. [8] This places the burden of the Cup largely on the citizens of Brazil, while they are receiving very little of what they were promised at the outset. In some cases, the government’s actions have directly contradicted their pledge to share the benefits of the World Cup with all Brazilians.

Though the country has experienced growth in recent years, a large amount of the Brazilian population still lives in slums or favelas. In order to construct roads necessary to connect the host cities, some residents of favelas were evicted with little notice and their homes were then demolished to make way for the infrastructure. [9] To follow this, the government raised public transportation prices. In response, 1.5 million Brazilians protested outside the last game of the Confederation Cup, a small-scale version of the World Cup, in June 2013. [10] Initial protests centered on the destruction of favelas and the price hike; they soon grew to include calls for greater urban mobility, and investment in health and education. [11] The protestors were met with tear gas and rubber bullets, and two protestors died in the chaos. [12] Shortly thereafter, the government announced promises to increase spending on urban mobility, while several cities retracted the increased transportation prices. [13] Though the government acted quickly to pacify the protestors, the question remains on whether they will act on their promises or if the government is simply trying to calm down dissatisfied Brazilians until the World Cup passes. If some of the most avid soccer fans in the world are too busy protesting to cheer on their team and country, Brazil will have a difficult time attracting positive attention.

On top of the obstacles Brazil has faced in allocating funds, it also has had trouble meeting deadlines, especially in terms of stadium construction. Though twelve stadiums were supposed to be built or renovated completely by 2012 in order to meet FIFA regulations, three of the stadiums were still under construction at the beginning of 2014. [14] These last-minute preparations have done little to alleviate the atmosphere of chaos in Brazil. Regardless of the amount of progress Brazil has made in the time allotted, they still had to restructure regulations in order to cut corners and meet deadlines set by FIFA. [15] That is, early on in the process, Brazil passed legislation that allows them to ignore certain environmental regulations in construction, while their debt limit was raised. [16] Both of these shortcuts suggest long term problems if Brazil does not take action to reverse the environmental and economic effects these might incur once the games are over. In other words, by putting FIFA’s guidelines before the demands of the public, while simultaneously searching for the support of investors, Brazil is potentially wasting an opportunity to ensure a strong future for both the economy and its people.

Four years after having hosted the winter Olympic games in Sochi, Russia will host the 2018 World Cup. Russia won the bid on the grounds that they do not currently have the infrastructure in place to hold the games, but do have the economic resources to establish this infrastructure. The decision was further sealed by the fact that Russia has experience in planning an event on such a large scale, partly because of their preparations for Sochi. It is indeed a win-win for both FIFA and Russia in that FIFA can have confidence in Russia’s ability to prepare, while Russia will get the much needed opportunity to strengthen its infrastructure. [17] Currently, Russia is constructing high-speed rails to connect cities with stadiums. While the government is paying 70% of the cost for the rails, it sees it as an endeavor with great potential to help create jobs and help the economy overall. [18] Even if the railways are not going to pay for themselves, the government is confident it will help to better connect the country. [19]

In addition to stitching the country together, Russia is also hoping to boost GDP from tourism from 2% to 7%. [20] The World Cup is, of course, a perfect opportunity to augment their tourism industry, but it also provides another chance for Russia to brush off the remaining parts of its image reminiscent of its communist days. By further opening itself to the world’s view, it can portray itself as a modern democracy and not a backwards regime, an image from which Russia is trying distance itself. [21] So far, Russia’s 15 billion Euro venture is remaining more or less free of complications, at least when compared to Brazil’s effort. [22]

That is not to say, however, that Russia has remained free of the drama that is typical of these processes. Similar to the discussions of Russian homophobia that were hot button issues before Sochi, there have been accusations of racism within the Russian soccer fan base. Black players playing for and against Russian teams have been subjected to racist chants and banners from the crowd. [23] Manchester city player, Yaya Toure, has gone so far as to call a protest within potential participants against the Russian World Cup. [24] Though Russia has ample time to recover from such incidents of racism, a protest by high-profile players could be detrimental to the success of Russia’s Cup and all it is trying to achieve by hosting it. [25]

At the same time, Russia is dealing with allegations of corruption in regards to its bid for the World Cup. While the country has denied these accusations, they have opened themselves up to an investigation. [26] This investigation was hindered as Michael Garcia, a representative of the FIFA ethics department, was denied access to the country for unrelated reasons. [27] Though these allegations may just be standard procedure, they stand to show the potential for corruption in an event where there is so much to be gained. If Russia continues steadily on its course to the 2018 World Cup, the games should go off without any major snags, and ultimately help Russia’s economy and image as intended. Russia, however, is not new to accusations of corruption or misconduct so there are no guarantees it will be able to emerge unscathed in the court of world opinion.

Beyond the horizon of Brazil and Russia lies the Qatar World Cup. Like Brazil and Russia, Qatar sees the World Cup as a prospect for increased economic activity and as a way to show the world its strength as a developing nation. The latter is especially important for the tiny oil rich country, as they strive to make a name for themselves that Brazil and especially Russia earned years ago. [28] In order to guarantee a successful Cup, Qatar has allocated around $100 billion for the games. [29] Regardless of this large sum of money, the country has been quick to cut costs, particularly when it comes to labor. Qatar has recruited migrant workers from several South East Asian countries to work on stadiums and infrastructure projects. [30] During the summer of 2013, nearly one worker died per day. [31] If workers continue dying at this rate, then around four thousand workers will be dead before the games start. [32] These deaths are largely attributed to the high temperatures, and minimal access to water and food in some cases. [33] The workers are also subjected to cramped living conditions, and job mobility is almost nonexistent because of contracts the workers agreed to in order to work in Qatar. [34] Though the majority of workers report decent working conditions, these extreme cases cannot be ignored. [35] Labor groups outside and within Qatar have called for FIFA to push the Qatari government to amend labor laws to prevent further instances of abuse, though it ultimately comes down to the government’s discretion on whether or not to do so. [36]

Simultaneously, the U.S. Treasury Department has released accusations that former members of the Qatar Football Association may have ties to Al Qaeda and Hamas. [37] Others closely tied to the selection process have been accused of anti-Semitic speech. [38] Though these may be a political smear campaigns on behalf of the United States, they may also represent racial and ethnic tensions that might form a roadblock later on in Qatar’s preparations. [39] A more prevalent issue facing Qatar’s hold on the World Cup is the possibility of corruption in the bidding process. [40] The FBI is currently investigating whether or not a member of FIFA accepted money from a Qatari company in order to secure the bid for Qatar. [41] Between abuse of the labor force, possible links to terror and corruption, and the fact that the Qatar is relatively far off, it is conceivable that the bid might be revoked from Qatar. This holds especially true if the corruption allegations are found to be legitimate. Though it is the farthest away of the three World Cups to come, the Qatar World Cup is already encountering complications that make it stand out as the most worrisome. Indeed, it not only highlights internal issues that Qatar must deal with or ignore, but it also implies either a weakness or neglectful attitude that allows such abuse and scandal to occur under the umbrella of FIFA.

Brazil, Russia and Qatar are three very different nations, but each stand to receive similar gains by hosting the World Cup. In order to host the games effectively, they need infrastructure to sustain such large crowds and the development of infrastructure can act as a boost to their growth. And if they pull off the games successfully, then the trio will be able to show the world their strength in resources and organization. While the individual governments know what they want to gain from hosting the World Cup, their populations also have wants and expectations from the process. Unfortunately, the motives of FIFA, the group that runs the games, trump the desires of citizens in hosting countries. Moreover, FIFA and host governments have more in common in what they are trying to achieve. This has in part caused the marginalization of the people that, ideally, should be receiving the benefits. Brazil has forgone attempts to increase access to education, healthcare and overall quality of life, especially to those with lower incomes, while construction and consulting firms are getting paid regardless of their slow pace. In Qatar, the benefits are not making their way down to those at the core of the process: laborers risk dying only to end up a statistic of the poorly planned preparations.

Of course, if these governments are successful in using the World Cup to strengthen their economies as planned, then the people will experience at least some of the profits. However, the long term benefits are not likely to be as direct or as effective as what they have demanded. If this holds true, then these countries are not utilizing the potential of the World Cup to the extent that they could to greatly aid those of all income levels, not just elite segments of society. And if it is the case that the gains of the World Cup are not distributed efficiently, then this raises questions about corruption in the sense that those in charge of the planning of the Cups can manipulate the effects in the favor of a select few. But there are questions that remain. Is this corruption caused, at least in part, by the demands set out by FIFA? And furthermore, does this corruption exist in these countries normally, or is it something that is only brought out in the spirit of the Cup? Regardless, as Brazil, Russia and Qatar each take the spotlight, they have the opportunity to show the world their strengths as a nation and to prove that they are above corruption, while simultaneously reinvigorating the spirit of the cup for both their underserved communities and avid soccer fans.

Photo by Catalytic Communities

Notes

[1] Carrión, Maria. “Brazil’s Poor Pay World Cup Penalty.” Progressive 77.7 (2013): 26. Master File Premier. Web. 5 Apr. 2014.
[2] Ibid.
[3] Taberer, Vivienne. “Brazil’s Economy Could Be Primed For A Comeback Going Into The World Cup.” Institutional Investor-International Edition (2013): 244. Business Source Complete. Web. 5 Apr. 2014.
[4] Ibid.
[5] Ibid.
[6] Conti, Juan Pablo. “Brazil 2014 The Last-Minute World Cup.” Engineering & Technology (17509637) 9.2 (2014): 50-53. Academic Search Complete. Web. 5 Apr. 201 4.
[7] Ibid.
[8] Wahl, Grant. “The Two Brazils?” Sports Illustrated 120.9 (2014): 60. Master File Premier. Web. 5 Apr. 2014.
[9] Amaral, Marina and Natalia Viana. “Brazil Vs. The World Cup.” Nation 297.3/4 (2013): 6-8. Academic Search Complete. Web. 5 Apr. 2014.
[10] Ibid.
[11] Ibid.
[12] Ibid.
[13] Ibid.
[14] Conti, Juan Pablo. “Brazil 2014 The Last-Minute World Cup.” Engineering & Technology (17509637) 9.2 (2014): 50-53. Academic Search Complete. Web. 5 Apr. 201 4.
[15] Amaral, Marina and Natalia Viana. “Brazil Vs. The World Cup.” Nation 297.3/4 (2013): 6-8. Academic Search Complete. Web. 5 Apr. 2014.
[16] Ibid.
[17] “From Russia With Love.” New African 501 (2010): 66. Master File Premier. Web. 6 Apr. 2014.
[18] “High Speed To The Urals.” Railway Gazette International 168.9 (2012): 39. Business Source Complete. Web. 6 Apr. 2014.
[19] Ibid.
[20] “From Russia With Love.” New African 501 (2010): 66. Master File Premier. Web. 6 Apr. 2014.
[21] Ibid.
[22] “Russia’s World Cup Set To Cost €15 Billion.” Construction Europe 24.7 (2013): 4. Business Source Complete. Web. 6 Apr. 2014.
[23] “From Russia With Love.” New African 501 (2010): 66. Master File Premier. Web. 6 Apr. 2014.
[24] “Yaya Toure Suggests Black Players Could Boycott 2018 Russia World Cup.” International Business Times 25 Oct. 2013: Regional Business News. Web. 6 Apr. 2014.
[25] Ibid.
[26] Interfax. “Russia Says Will Assist FIFA in Probing Bidding Campaign to Host 2018, 2022 World Cups.” Russia & FSU General News 07 Oct. 2013: 1. Regional Business News. Web. 6 Apr. 2014.
[27] Ibid.
[28] Rawlings, Nate. “Qatar Gets Scolded Yet Again For Migrant Worker Abuses.” Time.Com (2013): 1. Business Source Complete. Web. 6 Apr. 2014.
[29] Ibid.
[30] Ibid.
[31] Ibid.
[32] Ibid.
[33] Ibid.
[34] Ibid.
[35] Ibid.
[36] Ibid.
[37] “The World Cup Hosts in Bed with Terrorists.” Daily Mail 19 Mar. 2014: 72. Regional Business News. Web. 6 Apr. 2014.
[38] Ibid
[39] Ibid.
[40] “Call to Take World Cup off Qatar if Votes Were Bought.” Daily Mail 19 Mar. 2014: 73. Regional Business News. Web. 6 Apr. 2014.
[41] Ibid.