As in other Latin American countries that have returned to democracy this decade after bitter experiences under military regimes, Brazil's "New Republic" came to power with wide public support. The 1985 transfer of power from the military to the politicians went smoothly. The political and labor climate was relatively calm. The productive base of the economy was solid and business sectors wanted to give democracy a chance. Brazil had a foreign debt of over $100 billion, but huge trade surpluses made foreign creditors willing to refinance the debt. Under these circumstances the transition did not have to go badly. But it has.

As a result, the dominant political emotion as Brazil's 80 million voters prepare to elect a new president on November 15 is a desire to protest. A groundswell of public disillusionment with Brazil's political leadership and an explosive mood of social discontent have replaced the high hopes of 1985 when millions of Brazilians celebrated the restoration of democratic government after two decades of military rule.

The main target of this rejection is President José Sarney, who has become a politically discredited symbol of Brazil's failures. The main beneficiary has been Fernando Collor de Mello, a 39-year-old political upstart, leading the presidential candidates in all the polls with an anti-Sarney campaign based almost entirely on one theme-punishment of corruption in high places. The public mood and the lack of clear-cut and tested political alternatives make Brazil's future direction highly uncertain.

The first government of the New Republic, as the restored democracy was named, has proved unable to cope with the complex problems of Brazil's economy and has produced a crisis that has deepened long-standing contradictions in Brazil's society. "When the New Republic came to power, everyone expected that the return of democracy would place the country on the high road to development, that the foreign debt burden would be removed, that inflation would be halted, that corruption would be punished," said Edmar Bacha, a Yale-educated economist and former director of the National Institute of Statistics and Geography. "None of this has happened, so there is disillusionment and unhappiness."

During the Sarney government Brazil has lived almost constantly on the brink of hyperinflation. Sarney came in with inflation at 200 percent a year and will leave the annual inflation level at 1,000 percent or more. Four finance ministers in four years applied different stabilization formulas, but none brought lasting results because government spending was not drastically curtailed. Since 1986 prices have risen at dizzying rates of up to 30 percent a month; monthly interest rates have gone as high as 60 percent. Wage earners, pensioners and borrowers, including small farmers and homeowners, have been the main victims of this monetary disorder.

Equally disturbing has been a serious slump in Brazil's economic growth as investment levels fell. In 1988 gross national product remained flat while population increased two percent. Despite the fact that 1989 has been a good year for agricultural production, GNP is contracting. Industrial wages were down 25 percent from 1986 levels. The Brazilian "bolsas," or stock market, has suffered a decline far greater than Wall Street's October 1987 crash. The market value of the 500 shares most heavily traded on the São Paulo exchange fell from $75 billion in mid-1986 to $25 billion.

With such shocks, Brazil's habitual national optimism has given way to a sense of frustration. Faith in the nation's future has been so shaken that talented people and capital have been leaving at unprecedented rates. These days, "chaos" and "anarchy" are commonplace terms employed by Brazilians when discussing national prospects. "Incompetence," "irresponsibility," and "corruption" are frequent descriptions of the political leadership's conduct.

Summing it up, Mario Henrique Simonsen, a former minister of planning and widely respected economist, described Brazil as a country "going the wrong way on the road to history." Is Brazil headed for a dramatic upheaval? The country does not have a tradition of political upheaval, but a failure to arrest the economic decline and social resentments that have been corroding Brazil's national life could provide sufficient causes for just that.

Brazil's democracy has yet to reach the solid ground where political leaders and republican institutions inspire general public confidence. Just the opposite. There are clear signs that Brazil's workers and middle class, with declining income and opportunities, are going to vote for a drastic political change. New leadership in Brasília could restore public faith, at least temporarily, in popular self-government, but another failure to confront the basic causes of Brazil's decline could lead to an even deeper crisis. This article will examine the key problems left unresolved by the first government of the New Republic and suggest what a new government will have to do to restore confidence in democracy.

More than in any other Latin American country, the success or failure of the democratic experience in Brazil has global importance. This continent-sized land, embracing the ecologically sensitive Amazon basin, contains huge resources in minerals, forests, energy and agriculture. Its industrial complex is the only one in Latin America sufficient to make it a major global trader. But realizing this potential requires political stability and rational management.

With a projected internal market of 180 million people in the year 2000, Brazil can be the cornerstone for an era of regional achievement in South America-or a millstone that can sink not only Brazil but much of the region into economic stagnation and political violence. In either case, the world cannot afford indifference. Latin America is not on another planet. Historically, culturally and economically, it is part of the West.

II

In its return to democracy, Brazil confronted political challenges similar to those in Argentina, Peru, Uruguay, Bolivia and Ecuador, where civilian democracies have replaced military regimes in this decade with results varying from progressive stability and growth in Uruguay and Bolivia to disastrous declines in living standards and personal security in Argentina and Peru. Chile, with the most successful economic experience in Latin America in recent years, will face similar challenges in December when the voters will elect President Augusto Pinochet's successor. Mexico is also testing the democratic waters after 60 years of one-party dominance.

The recent experience with democratic government in Argentina, a country with which Brazil has strong historical ties, is particularly relevant for this stage of Brazil's transition. The virtual collapse of the Argentine economy during the first half of 1989, under the effects of runaway inflation, and the electoral triumph of the opposition Peronists led by Carlos Saúl Menem were seen by Brazilians as harbingers of a similar evolution in their own country. The melancholy end of the Radical government of President Raúl Alfonsín, whose inability to control the Argentine crisis led him to cut short his constitutional term by five months, was a lesson not lost on Brazil's current political leadership.

The most important effects of Argentina's change of government are still to come, however, because it will take months to see whether Menem, who has adopted a "pragmatic" approach instead of the old Peronist dogmas of populist economics and nationalism, will succeed in managing the recovery of Argentina's economy that eluded Alfonsín. Argentina has applied emergency measures, including price and wage controls and a proposed "social pact" between employers and workers, to meet the immediate goals of stabilizing prices, reactivating production and maintaining employment. Similar formulas have been applied before in Brazil, so this represents no novelty.

The more fundamental reforms announced by Menem after taking office in July go much further toward facing problems that are basic for both Argentina and Brazil. These include a comprehensive negotiation of the foreign debt based not only on reduction of the debt principal and softer interest terms, as Alfonsín demanded, but also on internal reforms to increase domestic savings and attract foreign investment. These involve abandonment of long-standing practices of government intervention in the market economy through state enterprises and trading agencies that have contributed strongly to Argentina's economic and fiscal distress. The effective dismantling of this inefficient state economic structure, transferring what is saleable to private hands, would be a revolution in Argentina (as well as Brazil). If Argentina were able to combine this privatization with a successful refinancing of its $55-billion foreign debt, Brazil would almost certainly attempt to follow suit regarding its own state enterprises, which are a major source of deficits.

The democratic governments in Argentina and Brazil produced an important regional initiative for economic union that has brought these two countries, once regarded as rivals for South American dominance, into close economic and political relations. This cooperation, which involves joint business ventures, trade clearing arrangements and scientific research, aims at an "economic union" in the Paraná-Paraguay watershed, or River Plate area. Uruguay is part of this venture, as is Paraguay since the overthrow of the aged dictator Alfredo Stroessner and the election of General Andrés Rodríguez as president. Paraguay's large hydroelectric power sources make it a strong partner. Bolivia is also being drawn into the River Plate orbit as a large potential natural gas supplier with important agricultural areas of eastern Bolivia awaiting development.

Without stretching the imagination, this grouping of countries, led by the two most industrialized nations of South America, could be the basis for a South American free trade area. The economic advantages and the political importance of such a union for the consolidation of democratic government in the region are readily acknowledged. But little can be accomplished as long as the two main sponsors of the regional project are in constant economic crisis. The inability of Argentina or Brazil to pay commercial debts has directly hurt Bolivia and Paraguay, for example, which depend very heavily on the markets of their larger neighbors.

Because of this interdependence, the examples of successful economic management to be found in the region are studied closely as possible models. Bolivia is a notable case. When Víctor Paz Estenssoro was elected president of Bolivia in 1984, inflation was out of control, at an annual level of 12,000 percent, and the Bolivian economy operated on black market dollars supplied by cocaine smugglers. Through rigorous monetary discipline, a tax collection drive, a balanced budget and elimination of money-losing state enterprises, Bolivia's inflation has been reduced to less than ten percent a year, and economic growth is coming back. Bolivia's success in controlling inflation under Paz Estenssoro has achieved a "textbook" status and influenced Venezuela's adoption of a strong anti-inflationary program after President Carlos Andrés Pérez took office in December 1988.

Fighting inflation in the extreme cases that exist in South America is like restoring life to a severely polluted river. As Menem said when he took office in Argentina, "the country is dying." The cleanup requires not so much an economic prescription to deal with the effects of inflation as a political leadership that can mobilize a national community for the necessary reforms. That has happened in Chile, where inflation has been controlled by the authoritarian regime of President Pinochet, and it has happened in Mexico under the political domination of the Institutional Revolutionary Party. The examples of Bolivia, which had the worst inflation in the world in 1984, and more recently of Venezuela, show that the problem can also be solved in democracies. It is the hour for Argentina and Brazil to make their choice.

III

In 1984 Brazilians turned out by the millions across the country for rallies supporting direct elections for president. Never in Brazil's republican history had there been such a massive demonstration of civic enthusiasm for democracy. The opposition to the military government, led by the Brazilian Democratic Movement Party (PMDB), had won control in 1982 of a majority in the federal Chamber of Deputies and of key governorships in industrial states, like São Paulo, Minas Gerais and Rio de Janeiro. The opposition campaign failed to obtain the two-thirds majority in Congress needed to call a direct election, but the public demonstrations convinced the military, which had governed for 21 years, to give up plans to nominate yet another general for president. The opposition took advantage of a split in the pro-government parties in the electoral college and elected Tancredo Neves, former governor of Minas Gerais and minister of justice in the last civilian government, as president. His running mate was Senator José Sarney, one of the government dissidents. The coalition between the PMDB and the dissidents, organized in a new party, the Liberal Front, was to provide the Neves government with a solid majority in Congress and among state governors.

Neves never took office. On the eve of his inauguration, he fell critically ill and died two months later. The task of leading the New Republic fell unexpectedly to Sarney, a former governor of Maranhão who was little known outside his home state in the poor northeast region.

It is clear, in retrospect, that the untimely death of Neves produced a fatal crack in the coalition that would progressively weaken the democratic government. Two figures with differing political ambitions, personalities, loyalties and sources of power emerged to fill the vacuum of leadership left by Neves' death. One was Sarney, an ally of the military for most of his political career and, as such, on the opposite side of the fence from the PMDB until the election of Neves. The other was Ulisses Guimarães, who, as the president of the Chamber of Deputies, was the symbol of PMDB's opposition to the military.

Neves had picked Sarney to play a pawn's role in a political gambit that split the pro-military party and made the opposition victory possible. With the death of Neves, the pawn became the king in a coalition that only Neves could have held together. Once installed, Sarney became a stubborn defender of his executive powers, in which he was supported by the commanders of the armed forces. He used his powers of appointment and patronage to develop the backing of conservative political and business interests.

But Sarney had no commitment to a national reform program; he lacked both a blueprint and the political muscle. Sarney's personal priorities favored his northeast region, where he maintained huge tax favors for investors against all efforts to impose fiscal austerity. He also built, as a personal monument, a railroad in Maranhão that benefited large landowners, including his personal cronies.

Guimarães, a São Paulo law professor, had built the PMDB into Brazil's largest political party during the years of military rule. After Neves, he was the leading figure in the opposition. Guimarães initially gave Sarney tactical support in exchange for influencing the choice of ministers. But the conflict between Sarney and the PMDB, which controlled the Congress, could not be contained when the left wing of the PMDB tried to cut short Sarney's term to four years, in hopes of forcing an early election.

A constitutional assembly was elected in November 1986 to reform the constitution adopted under the military regime, which provided a six-year term for president. Neves, as a candidate, had said he wanted only a four-year term for the transition. Sarney held out for five years and finally won the extension in June 1988, after a 15-month battle that cost the country dearly. To win support, he agreed to postpone necessary but unpopular spending cuts and distributed federal favors to every governor, senator and deputy who would vote for a five-year term for him. In the process, the PMDB lost its unity, Sarney lost control over Congress and Brazil lost a chance to put its economic affairs in order.

After the vote on the presidential term, Sarney and Guimarães went increasingly in different directions. Guimarães, who presided over the Constituent Assembly, wanted a "progressive" constitution as the platform for his own presidential candidacy. Sarney opposed the reforms; the higher welfare and labor benefits and the increased shares of tax revenues assigned to states and municipalities embodied in the new constitution made federal finances "unmanageable." Guimarães' preferences prevailed, but at the cost of making Brazil's economic management more difficult.

Would the New Republic have fared differently under Neves? Could he have done better than Sarney? There are reasons to believe that Neves could have maintained much stronger presidential control over the coalition. He had his own base of popular support, mainly in the large influential state of Minas Gerais, but also in São Paulo and in the northeast region. His relations with the military were good. In financial policy, Neves' intention to run this critical area personally was shown by his appointment of Francisco Dornelles as finance minister, a technocrat (and also his nephew). Dornelles had been director of taxation in the last military government and held to orthodox principles on internal stabilization and foreign debt negotiations. Under pressure from the PMDB, Sarney fired Dornelles shortly after Neves died and appointed the PMDB's Dílson Funaro, who led Brazil into the foreign debt moratorium of 1987.

In sum, the death of Neves probably made a difference, although the problem of Brazil's government goes much deeper than political personalities. The conflict between Sarney and Guimarães illustrates the New Republic's lack of a stable political base with well-defined policies during its first phase.

IV

Since the Brazilian republic was established in 1891 as a presidential system, Brazil's national political party structure has been inherently weak and unstable. Presidents were initially chosen by alliances of political magnates in the key states, which retained considerable autonomy. Political parties, as such, had small followings and little power.

After the revolution of 1930, Getúlio Vargas created a modern central government, introducing the corporatist concepts of Italian fascism into Brazil's traditional patriarchal politics. This led to the establishment of two large parties, a conservative one for landowners and businessmen and a "labor" party based on union leaders dependent on government favors and the ample patronage of a new social security system.

The opposition to this two-party system took shape around "liberal" parties, based on a combination of urban elites and local political clans in the rural states, and a communist party, the largest in Latin America. Since the "liberal" opposition could never muster enough votes to win the presidency, it conspired constantly with military sectors to overthrow the government-and succeeded in this goal in 1964.

The PMDB, which developed in opposition to the military, pulled together pieces of the old Vargas political machine and incorporated sectors of the new technical-professional class that emerged with Brazil's industrialization. In 1986, the PMDB won 22 of Brazil's 23 governorships and control of Congress, but this power was dissipated by the lack of party unity and solid programs in the PMDB. The party is a catch-all coalition that extends from conservative local political bosses, catering to rural landlords in some states, to Marxist labor lawyers who depend on "progressive" urban voters for support. The PMDB shone in opposition; it was organized to get protest votes, not to rule.

The Liberal Front Party (PFL) contains some of the elements of the old liberal opposition. It is a natural rival to the PMDB, but it lacks the strength of its forerunner, the National Democratic Union, which opposed Vargas.

The weakness of Brazil's party system is apparent in the leading contenders for the presidential election on November 15; they are all personalities whose charismatic appeal to voters eclipses their small, improvised parties.

The surprising leader in the polls since early summer is Collor de Mello, a young, wealthy former governor of the backward state of Alagoas, who achieved national fame by reducing the fat salaries of a select group of public officials in his state, known as "maharajas." He is backed by the tiny National Renovation Party, which did not exist a year ago, but his candidacy has grown rapidly thanks to a modern political marketing campaign in the media. He has cast himself as "just the opposite of Sarney," without too many specifics in the early stages, filling his sails instead with the winds of protest. While he is on record as favoring privatization of state-owned companies, his general statements give little indication of whether and how he would actually try to accomplish it.

The next most popular favorite, but far behind Collor, is Leonel Brizola, former governor of Rio de Janeiro, who claims to be the political heir of Vargas populism, just as Menem appears as the disciple of Juan Perón. Brizola, 67 years old, has a national party, the Democratic Labor Party, which he likens to the Australian Labour Party, but it is a personal vehicle with little strength outside of Rio de Janeiro and his home state, Rio Grande do Sul.

Guimarâes, the PMDB's nominee, has trailed these two candidates, indicating that the party's impressive collection of governors and congressmen has less organizational clout than had been expected. The PFL's candidate, Aureliano Chaves, a former vice president under the military, has done even worse. Other personalities who have joined the race, appealing to the right, include Paulo Maluf, who lost the presidency to Neves in 1985, and Ronaldo Caiado, who mobilized a national rural landowners movement that kept the constituent assembly from adopting strong agrarian reform.

In the swollen field, only two candidates seem to have the makings of solid party support. They are Luís Inácio ("Lula") da Silva, a former autoworker union leader, running for the Workers' Party, which won the mayoralties of São Paulo and Pôrto Alegre last year, and Mario Covas, former mayor of São Paulo, who formed the Social Democracy Party out of the PMDB's dissident left wing.

If no candidate receives 50 percent of the vote in the first round in November, the decision will go to a second round in December, when the voters will choose between the two candidates with the highest pluralities. Currently, 27 candidates are running, with at least a dozen expected to last until November. Thus, with this number of candidates, the November vote could produce two front-runners with relatively small pluralities. While Collor claims to be able to win in a first round-polls now show 40 percent of voters favoring him-the final outcome is uncertain. In a runoff the candidates will face the difficult challenge of courting support among the highly divided and personalized parties.

The Brazilian military leadership can be expected to provide the same support to the next democratic administration that it gave Sarney. Recent military pronouncements have conveyed the message that the armed forces are guardians of order and will resist any revolutionary violence against Brazil's democratic system, but there is no hint that the military has the desire to reimpose an authoritarian system. The military would have the most objection to the election of Luís Inácio da Silva, supported by a leftist front, but this outcome is unlikely. His inflammatory rhetoric scares off moderate voters, and the divided left would find it difficult to unite behind him.

General Leonidas Pires Gonçalves, the powerful army minister, expressed personal sympathy for the candidacy of Collor de Mello, but the military has said there are no "vetos." This has been interpreted to mean that if Brizola were to win he would be allowed to take office. Brizola had been on the military blacklist after the 1964 overthrow of President João Goulart; it was Brizola, his fiery brother-in-law, who usually stimulated his more radical postures. After 16 years in exile Brizola returned and was elected governor of Rio de Janeiro in 1983. Since then Brizola has gone out of his way to cultivate the military, as well as businessmen, with some success. A Brizola government would in all likelihood be pragmatic in financial management, but his abrasive personalistic style and long-standing enmities would make his government confrontational, not consensual.

The next president will at least have the mandate of being elected by popular vote, for the first time since 1960, and thus will have greater political authority than Sarney has had. But the party structure will be as weak as ever, and the new president will probably face an opposition Congress for at least the first two years of his term.

V

The despairing mood that has invaded Brazil seems strangely at odds with the country's accomplishments and proven potential for growth. But the profound and rapid changes that have modernized the country's social relations, political habits and productive capacity since World War II have themselves created the political and economic strains that now plague Brazil.

Brazil occupies over 40 percent of the South American continent, covering vastly different terrains and climates. The Brazilian people, a fusion of three major races, have forged an impressive national unity and unique cultural identity. It is the largest domestic market in Latin America, despite chasms of social inequality that remain a challenge to national stability.

Thanks to the sheer size and technical development of its industrialized economy, Brazil is internationally competitive. The productive structure has been generating foreign trade surpluses which may reach $17 billion this year from a wide variety of commodities and manufactured products, including $2.4 billion in automobile and truck exports. This surplus in world trade is topped only by West Germany and Japan.

Oil production, after years of disappointing exploration efforts, has leaped forward with large new offshore and Amazon Basin discoveries that have raised domestic crude output to 640,000 barrels a day. Agricultural production has expanded significantly, reaching 70 million tons of grains and oilseeds in 1987. In the last ten years, Brazil has become the world's largest exporter of frozen orange juice, moved into second place behind the United States in soybean exports, and become a $1 billion-a-year shoe exporter.

During the "economic miracle" of the 1970s Brazil's gross national product grew annually at 11 percent with low rates of inflation. Two international oil shocks plus the debt crisis have slowed this growth since 1982, but it has become nonetheless the free world's eighth-largest economy. Population growth has declined sharply to levels now below two percent a year, compared with over three percent in the 1950s. Many of Brazil's vast natural resources, particularly in minerals and forest products, have yet to be exploited.

Brazil's potential is undisputed, yet the economic "miracles" performed under the military masked the country's weaknesses, including the extreme poverty of the majority of its 145 million people. Even though the size of the economy trebled in real terms over the past 20 years, more than half of Brazil's population lives in households where income is less than $120 a month. Infant mortality rates in the northeastern region reach 130 deaths for every 1,000 registered live births. One-fifth of the 35 million children legally entitled to public education have never set foot inside a school. Under the military, demands for change were met with political repression.

The universal assumption was that democratic government would remedy these social and economic ills. Once in power, however, the first civilian government since 1964 did not come forward with any significant reform. The official slogan of the Sarney government was "everything for the social" but the lack of resources for education, health, housing and community programs has crippled progress.

This lack of resources is often attributed to Brazil's $120-billion foreign debt, the largest in the Third World. But the foreign debt, like inflation, is only a symptom of a more basic problem in mobilization of savings, taxes and investment in Brazil. Massive borrowing simply compounded the inability of Brazil's government to turn domestic and foreign resources to productive uses. Gargantuan projects, inefficiently run, ate up capital and provided decreasing returns on the investment-and no direct returns at all to the impoverished majority.

In the 1970s Brazil began borrowing from foreign private banks at floating interest rates, at a pace far exceeding the country's export earnings. This strategy of incurring debt was justified by the theory that borrowing for investment in energy substitution and export products would permit Brazil to grow while also servicing the debt. In 1965, the year after the military seized power, Brazil's foreign debt was $3.5 billion, or ten percent of gross domestic product. When the military stepped down in 1985, the foreign debt exceeded $100 billion, 35 percent of GDP. The country's indebtedness was vastly compounded by the two oil price increases of 1974 and 1979; Brazil, as a major oil importer, was one of the most battered customers.

The loans were poured into huge projects, like the Itaipú and Tucuruí hydroelectric dams, iron mines and steel mills, oil exploration and refining, and agricultural credit for soybeans, oranges and other export crops, and for sugarcane alcohol to replace gasoline. The result was a huge expansion of state-owned enterprises and of private production based on subsidized public credit.

In this state capitalist scheme, however, Brazil's huge public sector, as a whole, did not generate profits that would pay the government a return on the enormous investments. The state-owned productive sector includes such strategic areas as petroleum, electric power, primary steel, railroads, ports, telecommunications and a variety of industrial and service companies. These unprofitable enterprises consume rather than generate government revenues, contributing the lion's share to the public deficit. Antoninho Marmo Trevisan, a São Paulo management consultant, concluded that at the end of 1987 the empire of 228 state-owned companies had an accumulated debt of $70 billion for net assets of $50 billion and generated only one-third of their investment needs from net revenues.

The major problem is that the prices charged for goods and services by these strategic companies are manipulated politically, either to favor some privileged private sector activity, such as petrochemicals and fuel alcohol, or in attempts to disguise inflation. Because the rates charged are fixed far below inflation, Eletrobras, the state electric power holding company, is unable to generate from earnings the money to carry out a $5 billion-a-year investment program without which Brazilian industry faces almost certain power shortages in the coming decade. Telebras has a waiting line of nine million applicants for phone lines and can finance only four million new lines by 1991. Petrobras says oil self-sufficiency could be achieved at 900,000 barrels-a-day in 1995 if it could invest $5 billion a year, but it is spending only $2 billion because fuel prices are controlled, including subsidized alcohol fuel that now powers most new cars in Brazil. The annual deficit generated by the alcohol fuel program, according to a World Bank study, is $2.7 billion.

The theory of growth through foreign borrowing collapsed in 1982; international bankers cut off new lending to Third World borrowers, including Brazil, when Mexico was unable to service its debt. In that year of crisis, Brazil's economic growth stopped dead and a record current account deficit of $14.8 billion virtually wiped out reserves.

Disaster was postponed by two developments. First, the investments in exportable products began to pay off. By 1984 the trade surplus hit $12 billion and the balance of payments was $600 million in the black. Second, the government's inability to raise money abroad was offset by mobilization of internal savings at high interest, but payable in domestic currency. Domestic borrowing to finance public deficits kept the economic pump primed, but at a cost of rapidly rising inflation.

When the democratic government took office in March 1985, debt service drained $10 billion a year from Brazil's exchange earnings with no new money coming in from the banks. Moreover, in 1986, capital withdrawals by foreign investors exceeded new investments by $110 million and remittances of profits and dividends abroad rose to a record $1.2 billion.

For one fleeting moment during Sarney's presidency there seemed to be a chance that the New Republic was going to succeed in reversing the slide toward financial disaster. This was during the critical months in 1986 when Sarney launched the Cruzado Plan, a "heterodox" or shock treatment to halt inflation. It combined price and wage controls with the replacement of Brazil's depreciated cruzeiro by a new currency, the cruzado. This scheme was devised in secret by a group of young economists who had studied similar shock treatments in Israel and Argentina. It was accepted by then Finance Minister Dílson Funaro, a PMDB protégé, and sold to Sarney as a way to control inflation without political costs. The International Monetary Fund and Brazil's creditors were asking for budget cuts, fiscal reforms and reduction of state economic intervention as conditions for refinancing the debt. Funaro and the PMDB rejected any formal agreement containing these conditions and put up the Cruzado Plan as the alternative.

At first, the Cruzado Plan worked wonders. For several months prices stood still and consumers went on a buying spree. The stock market boomed and the dollar was cheap. Sarney's approval ratings in opinion polls soared and the PMDB had a winning platform for gubernatorial and congressional elections. In the November 1986 elections the PMDB won 22 of 23 governorships and a wide majority in Congress.

The catch was that Brazil's international reserves dropped below the critical level of $4 billion as foreign investors took the opportunity to get as much money as possible out of Brazil. Price controls began to produce empty shelves and black-market prices soared. The Sarney government's confrontational stance toward the International Monetary Fund (IMF) and the creditor banks proved to be a serious strategic error. In February 1987, with monetary reserves running out, Sarney declared a unilateral moratorium on debt payments to foreign banks. This only aggravated the crisis of confidence and inflation returned with a vengeance.

As a result, internal borrowing became the only way to finance public deficits. The government placed short-term treasury notes at high real interest rates to cover mounting imbalances, and internal debt in the hands of the public snowballed to over $40 billion. By the end of 1987 fiscal revenues were covering only half the government's spending. Each new borrowing forced the central bank to issue new currency to cover repurchase of retired debt.

When the Cruzado Plan was abandoned in May 1987, prices rose 25 percent in one month. Another plan was instituted the next month, but it met with the same fate as the first. The enthusiasm with which Brazilians had reacted at the beginning turned to embitterment and Sarney's public approval ratings plunged. They never rose above 15 percent thereafter and the PMDB, despite its later distancing from Sarney, has borne the onus among the public for the betrayed hopes of the Cruzado Plan.

During the first four years of democratic government neither Sarney nor the PMDB leadership adopted effective measures to reduce the public deficit, contain the internal debt, reform the state enterprises or normalize foreign financial relations. Despite public pronouncements freezing government hiring, congressional critics uncovered records showing 140,000 new employees had been hired.

In 1988 Sarney named as his finance minister, Maílson Ferreira da Nóbrega, a respected technocrat and career civil servant. Brazil ended the moratorium on foreign debt payments and tried to restore access to foreign credit. A refinancing of $64 billion owed to private banks was obtained in June, but disbursement of "new money" was made conditional on Brazil's reaching a stabilization agreement with the IMF. This agreement failed to materialize after the new Brazilian constitution and a new minimum wage law adopted by Congress over Sarney's veto overwhelmed the government with new obligations without providing new revenue sources.

As the election approached, Sarney's lame-duck government was in international financial quarantine. With government reserves at $6 billion in July 1989, Brazil notified its creditors that it would reduce debt service payments unless the banks released new money. Domestic debt continued to mount, along with the interest rates needed to finance it. Yet another effort to control inflation, the Summer Plan, was launched in early 1989, but the fundamental task of reducing the public sector remained untouched.

VI

The diagnosis of Brazil's crisis as a failure of the public sector and of the political class is now increasingly accepted in Brazil. Even Sarney, in a lucid moment of political analysis, if not self-criticism, acknowledged that major changes had to be made. In June 1988 he told the graduating class of the Superior War College, a famous forum for policy debates between military and civilian students of national strategies:

We are reaching the point of exhaustion of a model that in the industrial area aimed at import substitution with foreign resources. . . . We are coming to the end of a political model that was unable to consolidate strong parties, which are the basis for stable democracy. . . . We are also experiencing the crisis of the national state, the great protector state that solves everything. . . . The Brazilian state lacks the resources to satisfy the minimum needs that the public expects from the state in health, education and other public services. . . . The great challenge that faces us is the organization of political forces capable of managing civil power in Brazil and of rethinking our political and economic models.

The crisis and the challenge are clear. What happens after Sarney is not so clear.

The winner of this year's presidential election may be burdened with many political debts incurred in the horse-trading necessary to secure sufficient votes from other parties in the runoff. Thereafter, the new president's ability to go over the head of the political parties and appeal directly to the people will be limited by an incumbent Congress that has proved to be opportunistic, and by the powerful state governors.

The financial crisis is so serious, however, that the adoption of strong austerity measures and a reform program cannot be postponed. There are fears among Brazilian businessmen that the Sarney government could end in the same hyperinflation that overtook the demoralized Alfonsín government in Argentina. These fears have led to measures to prevent such a crisis, including tight control over international reserves and an edict from the ministry of finance that the government will spend on wages and operational costs only as much as the revenues it takes in. This still leaves open the window of internal and foreign borrowing, however.

The steps Brazil needs to take to deal with its crisis are obvious. Whether these reforms and sacrifices will be broadly accepted by the nation is unclear, or even if the president will have the will to seek the changes. It requires attacking major vested interests, such as eliminating a host of tax breaks for politically privileged business sectors. These breaks sap 25 percent of potential tax revenues.

Political compromises will have to be struck on the reform and privatization of the public sector enterprises. These enormous economic units, including Petrobras, Eletrobras, the Bank of Brazil and Siderbras, the state steel holding company, are political fiefdoms that must be made accountable, efficient and profitable. This in turn means trimming the economic advantages that the private sector receives through the public sector, such as subsidized rates for electric, gas and phone services. Only a very determined national political leadership can do this.

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  • JUAN DE ONÍS has been a correspondent in South America for the Los Angeles Times and The New York Times, and is co-author of The Alliance That Lost Its Way.
  • More By Juan de Onís