Brazilian scandals strain the bonds between business and government

Brazilian scandals strain the bonds between business and government

Brazil’s expansive corruption and bribery scandal is nearing the end of its first act.  With any tangible resolution months if not years away, it is difficult to assess the net impact this painful process will have on Brazilian politics and society.  However, the immediate consequences signal a profound shift in the relationship between the government and business.

Corruption is not a Brazilian problem, but rather a problem in Brazil where inward focused industrial policy measures have fostered overly cozy dealings between companies and government officials, while failing to foster innovation and sustained economic growth.  The country faces an historic opportunity to lay bare the true extent of past missteps and set a new path to growth and institutional strengthening.

Previously, the Mensalão scandal (where the administration used public funds to buy congressional support and pay off election campaign debts) dogged then President Lula, but his political acumen and a cooperative economy enabled him to weather the storm relatively unscathed. However, he left his presidential successor and protégé, Dilma Rousseff a legacy of industrial planning focused on national content and the institutionalized practice of diverting a portion of public spending contracts to the coffers the governing coalition.

Brazil’s anemic growth over the last four years has lagged most of its Latin American neighbors. This underperformance poses a serious challenge to the government’s “Bigger Brazil Plan” (known simply as Brasil Maior), the harmonized public policies backed by state funding mechanisms promoting domestic production, innovation and exports.  Brasil Maior ties a disproportionate number of attractive business opportunities to government purchases and margin preference schemes, including those under the Buy Brazil Act, allowing the state to grant incentives to local companies and chose winners. The program is the defining structural platform of President Rousseff’s government. Under the plan, state agencies, namely state owned banks, such as BNDES (the federal development bank), have rapidly expanded financing activities, effectively crowding out private investors while delaying the development of more mature financial markets. By every measure, the plan’s execution has been a failure. The country’s industrial output and worker productivity have fallen and the trade surplus has evaporated.

If Brazil is to trace a path of sustainable growth independent of global commodity cycles, the government must redefine its relationship with the productive sector.  Recent revelations of widespread corruption and bribery allegations serve to highlight the urgency of this shift.

Operation Lava Jato (Or “car wash” based on one participant’s preferred money laundering vehicle) testimonies reveal that the pay to play and kickback schemes were well known among executives in Brazil, so much in fact that some politicians were known to require more than the going rate for certain projects.  Most of the beneficiaries were Brazilian construction and engineering firms that have long dominated the Brazilian market shielded from foreign competition. Nevertheless, while the Mensalão was an all Brazil affair, the Lava Jato scandal is more cosmopolitan. Several foreign multinational contractors specialized in the oil business have also been implicated.

These investigations are ongoing, but based on cooperating witness testimonies from contractors the companies had to pay kickbacks or vindictive politicians would blacklist them from tendering processes, while arrested public officials complain that powerful corporations unduly tempted them with illicit gains. Irrespective of the final judgment, it is clear that both sides accepted greater risk by failing to account for the growing independence and increased tenacity of Brazilian investigative agencies.

Former shareholders are suing Petrobras in the U.S. where its ADRs are listed.  Similar litigation is likely in England and Germany.  Fraud within Petrobras falls under the jurisdiction of the Foreign Corrupt Practices Act, as do several of the acts of alleged tax evasion.  The internationalization of this scandal will take the investigation beyond the political control of implicated parties witihin the Brazilian government, amplifying the potential for reform.

The corruption scandals do not end with Petrobras. At least two other instances of alleged widespread wrongdoing are currently under investigation. Several multinational transportation infrastructure companies stand accused forming a cartel with local firms to overcharge the state of São Paulo on subway construction contracts and benefit the state’s governing party.  Additionally, the Federal Police have recently unsealed a case accusing prominent local companies and foreign multinationals of bribing members of the federal tax appeals board to evade R$19 billion in taxes.

Successful companies in Brazil evolved in an environment where virtually every activity is subject to state involvement or intervention.  Whether serving as regulator, financer, levier of taxes, promoter, client or competitor, the state is an omnipresent force.  This has led to relationships between the private sector and government that are out of step with the international legal framework for preventing and combating corruption.

Domestic and multinational companies alike need to shine a light on how they conduct business dealings involving the state.  Corruption of this magnitude requires many conspirators.  When one player sees another gaining advantage, it is tempting to join the game rather than complain about the rules.  Current events illustrate what many market participants have quietly observed over recent years.  Local content and procurement preference rules when applied through a political decision making process tend to drive up costs and reduce efficiency.  However, whether out of fear of political reprisals, missing the Brazilian boom or out of acceptance of the status quo, many companies opted to participate in the schemes.  Such opportunities are difficult to turn down, but taking advantage of them can cause future problems.  As William Faulkner famously observed, “The past is never dead. It’s not even past.”

Many are getting the message.  Increasingly, companies operating in Brazil are creating dedicated Government Affairs departments, effectively formalizing the relationship and points of contact for regulators and public agencies.  In a rejection of the very practices on display in the current scandals, companies are beginning to eschew shadowy networks of assorted lobbyists in favor of compliant public affairs practices capable of managing their complex interactions with the government.   Professional organizations such as Abrig and Irelgov have followed, offering legitimate fora to discuss and improve corporate advocacy best practices.

Today’s lessons are challenging the respective roles government and business play as underwriters and guarantors of domestic growth.  The government’s reaction remains uncertain, but it falls to companies to seize the opportunity to change the way they approach the market and defend their interests while developing and expanding in Brazil.

Concordia Pas

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