Brazil’s Runoff Election Is a Close Race Between Lula and Bolsonaro

This transcript was generated using AI and may contain errors.

PATTERSON:
While the November U.S. midterm election certainly presents some significant risks, as we discussed last week on The Spillover, it’s certainly not the only big election this fall worth watching for spillovers. Brazil’s presidential runoff is just days away. On October 25th, voters are going to choose between the incumbent, here we go, Luiz Inácio Lula da Silva, who is nearly 81 years old and running for his fourth, an unprecedented number term, and Senator Flavio Bolsonaro, the son of the jailed ex-president.

Flavio Bolsonaro finished first in the October 4th first round vote with an unexpectedly large two-point lead. Prediction markets still favor him by a wide margin, but polls are saying it’s effectively tied. What makes this election stand out is Brazil’s precarious fiscal situation.

Investors are applauding Bolsonaro’s campaign pledges to cut spending and stabilize the country’s debt dynamics, but there’s a big question whether or not they’ll be disappointed. And certainly we’re seeing in other countries around the world, France really stands out right now, that talking about fiscal austerity on the campaign trail is very different than implementing it in office. Bigger picture, are we reaching a point where investors are gonna actually reward fiscal prudence, even if it means potentially slower growth for a while?

I’m Rebecca Patterson, welcome to The Spillover. I’m so excited to have Shannon O’Neil as my guest today. Shannon’s the Senior Vice President of Studies and Maurice R.

Greenberg Chair here at the Council. Importantly for our conversation about Brazil, she is a leading authority on Latin America, including Mexico and Brazil, as well as a leading authority on global trade. Welcome to The Spillover, Shannon.

O’NEIL:
It’s great to be here. I’m loving your office today.

PATTERSON:
Thank you, it’s great.

O’NEIL:
It’s very nice.

PATTERSON:
Now listen, I’m a big believer in the idea that we have to do a lot of good things I understand that you literally just landed late yesterday after a quick trip to Lima, Peru. I know we spent a lot of quality time on airplanes, our glamorous lives.

Before we get into Brazil, what were you doing in Lima? And I hope there was some good food involved.

O’NEIL:
I was in Lima giving a talk at a banking conference there. Sadly, I barely left the hotel, but I will say the hotel restaurant had a pretty good ceviche. So I got a little bit of good food.

PATTERSON:
Okay, all right. It’s not allowed to travel to good food countries and not eat something good. So I’m happy about that.

And maybe we can talk more about Peru in the future. But today I want to help our listeners benefit from your wisdom around some other Latin American countries, not just because they’re an important part of the global economy, but I think we can also look for lessons for some of the developed markets dealing with similar issues today. Again, I mentioned France, but I feel like I’m a broken record now about my fragile four, France, the US, UK, and Japan.

All of them continue to be in the spotlight for their debt dynamics. But let’s start with Brazil and its upcoming vote. It is, I don’t know who to believe.

I mean, the polls suggest it’s effectively tied. Kalshi, as of this morning, suggested more than 80% odds for Bolsonaro to win. What I think is more interesting though, Shannon, is this disconnect between what Brazilian voters want and what the markets want and are applauding.

You know, when you look at the polls, Brazilians are saying they want a tough leader. They want someone who’s going to be strong on crime and especially the drug trade, and someone who’s going to address cost of living issues, which sounds like a lot of places today. But that’s very different from what investors are looking at.

If you look at how markets have been trading, what’s so interesting to me is that Wall Street sees Bolsonaro as more likely to attack the fiscal problems in Brazil. You know, I think about Milei in Argentina wielding his chainsaw to cut spending and corruption and whatever else. Bolsonaro, maybe you know the word for it, talks about large scissors.

It’s not exactly a chainsaw. It’s kind of, rah, rah, rah, but whatever. He’s still talking about cutting spending.

In any case, he’s pledged to make the country’s debt-to-GDP ratio on a more sustainable track, and the spending cuts would include things like reducing the number of government ministries materially, increasing privatization. So I want you to kick us off walking through some of the basic economic issues here, the cost of living issue, the crime issue, and the fiscal issue, so what voters care about and what the markets seem to care about.

O’NEIL:
Yeah, as you say, it looks like right now it’s sort of a dead heat. I will say in Brazilian history, the person who wins the first runoff has gone on to win the final vote almost all of the time. So I would say it’s in Flavio Bolsonaro’s favor at this moment, his to lose, but it’s very close.

And it’s very close for a number of reasons, I would say. You know, one is that, you know, while the Brazilian economy has been growing, while unemployment is quite low, given Brazil’s standards, over 100 million Brazilians have jobs and have that aspect, we have seen challenges of inflation in Brazil, which hits, you know, back to the affordability issue, what do things cost, you know, what’s happening in terms of energy prices and the like, and electricity in particular has hit Brazil and hit, you know, basic consumers and voters. So that has been a challenge.

The other big challenge for Brazil is not just government debt, which is what markets are looking at and care about, but personal debt. And, you know, almost half of Brazilians have debt and they are feeling like they’re being swamped. And in fact, Lula, one of his proposals in the campaign has been, can you help households renegotiate that debt?

Because he sees that. And so as the Bolsonaro campaign. So I think here, you know, we see, like we see in so many places around the world, sort of an anti-incumbent leaning, right?

You’re not happy with the way your current situation is. You know, you want growth to be faster. You want affordability.

You’re worried about crime, which is a big issue in Brazil, both sort of street level crime, as well as worries about organized crime. You know, we talk about it here in the United States, a lot of, you know, Mexican cartels and the like, but Brazil has really strong organized crime groups that, you know, many years ago kind of came out of the prisons and the like, but very influential in the economy and people want that to end. So there’s, those are the campaign issues for the regular voters.

And what’s sort of juxtaposed to that, I don’t think the regular voters are thinking about debt to GDP ratios. Nor are they here in the US.

PATTERSON:
No, they’re thinking about their own debt issues, right?

O’NEIL:
And what you would need to resolve individual debt issues, like renegotiating, having the government help people come out under that debt is almost the exact opposite of what you need a country to come out of their debt, right, or to lower their debt. So that is the big challenge, right? Now, Lula has, to be fair, in this first term that he’s had or his, it’s his third term, but second time around first term, he has done some tax reform.

He has done some things that have incrementally made things easier in terms of fiscal consolidation or better, but they’ve been very small. And so Bolsonaro is coming in, Flavio Bolsonaro is coming in and saying, I’m going to do, I’m gonna fix this problem. But he’s so, I mean, the details are almost absent, right?

He’s talked about tax cuts, which does not help you with your fiscal consolidation. And he’s talked about he will do some things to cut spending, but the challenges he faces are a few. One is so many of the spending parts of the federal government are written into the constitution.

And so unlike the US constitution, Brazil’s constitution is hundreds of pages long and all kinds of stuff is in there. Like wages are indexed, that’s in the constitution. And so are lots of other social spending and other kinds of spending.

So unless you have a super majority, it’s very hard to limit that spending. So, so much of it is so much baked in, it’s really hard to do. So that’s one side.

The other side is that, you know, people don’t want their social, you know, social programs to be cut. Right. And in fact, Flavio Bolsonaro’s campaign manager came out and talked a little bit about cutting one of the big programs is called Bolsa Familia, sort of the family basket.

And then he had to walk that back. So are we gonna see fiscal consolidation? Are really he’s gonna make markets happy?

We’ll see. But I think the challenges for either, whoever becomes the next president is so much of the spending is baked in that it’s really hard to appease markets, especially if you’re also trying to appeal to citizens and voters.

PATTERSON:
Which again, I know it’s written in their constitution. The US is different in that sense. But when you think about some of the fiscal conversations we have and we hear about on the Hill here in the United States, a lot of it is we need to cut spending more.

We need to cut spending more. Fine, where? Because most of our spending is so-called mandatory.

It’s not constitutional, but it is effectively something we can’t avoid. So it’s, it is interesting that that analogy. So look, I think I’ve just been in this business so long. I’ve become a little jaded.

So I wanna acknowledge my bias here, but I am kind of amazed that investors are taking the Bolsonaro pledges at face value. And maybe they’re just in it for a very short-term trade. Bolsonaro wins, the markets surge, and then they take profit.

Maybe they do no better. And this is all very short-term, but just for our listeners, this is what we’ve been seeing, especially since early October, late September, as you’ve seen the polls shift day-to-day when they move relatively in favor of Bolsonaro. So fiscal austerity, relatively speaking, it’s been a consistent, strong relationship.

You get a stronger Brazilian currency, the real. You get tighter spreads on credit default swap. So a measure of the risk around government default.

You get stronger equities and lower bond yields. In other words, markets are saying Bolsonaro is good for Brazil. Now, people are making good money on this trade so far, but let’s say Bolsonaro wins.

How quickly? Now, I know you raised some concerns already. We have the constitutionally mandated spending, et cetera, but how quickly could he execute on these pledges?

I know one gentleman who might be finance minister has already acknowledged, like, there’s a tight window here, we have to move. What could happen quickly, if anything?

O’NEIL:
So let’s bring in Brazil as a democracy.

And so let’s bring in one of the other big players on tax reform and the like, and that would be the Congress. Brazil’s Congress has become increasingly important and muscular on these issues over the last decade. So they really take a leading role.

So what we did see in the first round election, we see a runoff at the presidential level, but Congress was elected. Many of the House and the Senate and the like. And so what we saw there on the good side for those wanting fiscal consolidation, wanting sort of a change, is we saw the rightist parties, both Flavio Bolsonaro’s parties, but others who are affiliated on the right, we saw them win a good number of seats.

So there is a stronger right that presumably would want to pass tax reforms or others to reduce the debt levels of Brazil. So I think that’s the good side. The other side, though, is they did not win a majority.

And Brazil has always, or often for many years, had sort of this whole set of centrist parties. And they don’t really have an ideology, but what they do is they are used to being in power and being power brokers. And so the way they usually work with presidents, whether it’s Lula, whether it’s Flavio Bolsonaro, the way they work is they will help pass legislative agendas in return for cabinet positions and in return for earmarked spending.

So the challenge here is you’re trying to reduce spending, but you may need parties that they will come along with you because they get to spend. And so I think there are just challenges there. There’s sort of checks and balances, which you wanted in democracy with Congress and the executive, but it will make it harder to get more than incremental reform.

I will say in almost any administration, whether it’s Brazil, whether it’s France, whether it’s the United States, like that first honeymoon period, right? When you come in, if you feel like you have a mandate, you have a new Congress to work with, that’s when you can try to get things done. That’s the time to go big and bold.

I would imagine if we’re gonna see a fiscal consolidation, if we’re gonna see this ambitious attempt by say a Bolsonaro government, assuming Flavio Bolsonaro wins, it would be at the beginning there. Afterward, you get kind of into the morass of politics. Everybody starts looking even to the midterm elections and it’s very hard.

PATTERSON:
So talk to me for a minute about Flavio’s dad. So my understanding is that he also came into office saying fiscal austerity, yay. And then that didn’t exactly happen.

Now, I appreciate like father doesn’t mean like son, but I think it’s interesting just to be aware that people can change their stripes. Can you give us a couple sentences on that?

O’NEIL:
So I will say, you don’t wanna say like father, like son, though this whole campaign, the son has been tying himself very, very closely to his father. So like father, like son, at least that’s been the campaign that he has put forward. Two, as you say, right, Jair Bolsonaro was not a fiscal hawk.

He actually increased spending, especially in the latter part of his term. So this isn’t sort of, in fact, many of the rightist parties were frustrated with Jair Bolsonaro because he did expand spending rather than cut it. So I think that’s an issue.

And then the last thing I will say is if you get a small window to do big reforms, everything the campaign has told us is it’s not going to be fiscal reforms. It is going to being trying to get his father out of jail. He wants an amnesty for his father.

He wants an amnesty for, here in the United States, we have our January 6th. In Brazil, they had their January 8th, which is a similar sort of going after the government and people storming the Capitol who were unhappy with the previous election.

PATTERSON:
I remember that vividly.

O’NEIL:
So that is the bigger issue. I think we will probably see Bolsonaro focus on his father. And also another issue that’s come up in the campaign is the Supreme Court and the politicization, the corruption.

PATTERSON:
Right, the corruption.

O’NEIL:
It is unbelievable. And that politicization of the Supreme Court. And in Brazil, just different than the United States, in Brazil, people know all the names of the justices on the Supreme Court.

They’re kind of celebrities. They’re kind of like politicians that are out there. I know here in the US, you and I know lots of the names of them.

We follow them, but it’s not sort of the front headlines of the papers. It is in Brazil.

PATTERSON:
Oh, that’s fascinating. So, you know, when I think about, all right, so he’s got his first 100 days, whatever period, we want to get amnesty for dad. We want to maybe address the Supreme Court.

And then fiscal, perhaps, those are three of our top priorities that we want to get done the first year while you have that window. And it’s interesting. It hasn’t been true necessarily over the last few US presidential cycles, but historically in the US, if I go back the last 60 or 70 years, that was also true in the US.

That if you look at our four-year presidential cycle, the first year after a president is elected, that’s when they do the politically unpopular stuff because you have a mandate. If you’re going to cause any pain that makes voters grumpy, get it out of the way while you have the mandate and your opinion poll ratings are relatively higher. And so you’ve seen cyclically adjusted fiscal austerity in that period.

And then you tend to see more stimulus going into the next election, which it makes sense from a political perspective. The one reason, I hear you on your skepticism, which I think I share. One reason I think maybe he pushes really hard to do it this time is because he’s at a point where he doesn’t have a choice.

Like literally we are at that point now. I think increasingly in a lot of countries, I think France is at that point. I think the US is getting close to that point.

I think Japan is close to that point. We could go on. The cost of not getting Brazil’s fiscal house in order would be very, very steep.

You said earlier, debt is household and government. Debt is a percent of GDP. Looking at that government, it’s almost 90% now.

That’s more than double Mexico’s debt to GDP ratio. We’re near a record high or at a record high, I believe. And I go back to my economics 101 RNG, right?

Your interest rate and your growth rate. And if you want to stabilize your country’s debt, you need to get growth above the interest rate, right? You can grow your way out of it or you can bring down the cost of the debt.

I think in most countries these days, they just want to grow their way out of it. In Brazil’s case, they’re hoping to do a little bit of both, I think. But the high interest rates make this so hard for Brazil because it’s making the cost of servicing that debt go up so rapidly right now.

You know, the policy interest rate in Brazil today, the Selic rate is around almost 14%. And GDP growth, real GDP growth is right around 2%. So that math isn’t awesome.

My understanding, and correct me if I’m wrong, Shannon, is that under Lula, fiscal consolidation is probably off the table completely. Would you agree with that?

O’NEIL:
No, I think you might see some incremental changes for precisely the reason that you say, which is they have to do it, right? And there are some rules that are within the system about sort of managing spending vis-a-vis sort of growth. So there are things that he could fall back on if he so chose.

I do think we’d see a Flavio Bolsonaro being more aggressive on the sort of fiscal consolidation, on some of the austerity, right? He’s not from a leftist side. He doesn’t, you know, his voters aren’t the ones who would benefit from some of these programs or at least the vast majority of his voters are not.

I do think you might see a Bolsonaro presidency focusing on the agricultural sector, which is, you know, a strong base for them, on how do we increase exports, which are already booming just given what’s going on in the world in terms of agricultural, in terms of oil, in terms of other energies and the like. So I think it would be, for either president, we would see sort of a focus on pro-growth. How do we kind of amp up the exports and how do we amp up some of the other parts?

And we’ve seen a lot of foreign direct investment coming in and sort of amping that up as well. And then some, you know, kind of austerity side, more on the Bolsonaro side, but Lula may be forced, if he becomes president, be forced to do some of the things on that side.

PATTERSON:
And the risk, just to put a fine point on it, if we don’t get sufficient fiscal consolidation in the first, call it 12 months, the risk is that we get Brazil government debt getting downgraded by a credit rating agency or downgrade watch, at least. That pushes borrowing costs even higher, which could weigh on growth, makes local investments less attractive, less capital coming into the country means you could have a weaker currency. You have a weaker Brazilian real, that can push up inflation.

And that means the central bank might not be able to cut interest rates as much as it might otherwise. So it’s a pretty nasty feedback loop. Shannon, let’s pivot and talk about a few other regional economies while I’ve got you here.

I want to take advantage of all your expertise. Argentina elected, is it Javier or Javier? Javier.

I hate when I mispronounce names and Sebastian and I do that quite a bit. Anyway, Javier Milei is president in November 2023. He has his next election in next year, about this time, October 27, at a time when confidence in his economic policies has started to fade.

O’NEIL:
I’d say at least a little bit, right?

PATTERSON:
Yes, yeah. So I’m inclined to put him in the same broad category as Flavio Bolsonaro.

He’s a right-wing populist. Is that fair?

O’NEIL:
I think Javier-

PATTERSON:
Or more libertarian. How would you describe him?

O’NEIL:
I would say he’s more libertarian. He’s actually more ideological on the fiscal economic side.

I think the Bolsonaros are, you know, they’re power brokers. They, you know-

PATTERSON:
Opportunist right-wing.

O’NEIL:
Opportunist right-wing.

You know, they do believe on conservative values, I would say, but I think they’re less fiscally conservative. Javier Milei is the real deal. He’s been an economist.

You know, that’s his training. And he has long held these views of a more libertarian about opening markets, about reducing the size of the state. And he spent the last three years doing so in Argentina.

PATTERSON:
All right, so inflation’s come down. As you said, he’s gotten some things right, but household debt in Argentina is still extremely high. My understanding is it’s still rising in part because you’re seeing costs go up on things like electricity and power.

So, you know, what else would you say about how the economy is doing there?

O’NEIL:
So I would say in Argentina, in fact, last year I was in Argentina three times. I was there when they first devalued and then I was there maybe four or five months later, and then I was there at the end of the year. And what you saw is while you had a devaluation and things in dollars, you know, became quite cheap the first time around, they really held the pace.

So there was a moving, but it was moving very slowly compared to inflation. And so by the end of the year, things were really expensive. Going out to dinner in Buenos Aires was like going out to dinner in New York City.

And so if you think about a population that’s earning in pesos, not in dollars, you know, the challenges for the local economy in terms of just your day-to-day expenses were really high. And then also if you’re trying to hire workers, if you’re thinking about boosting the economy, you see a real challenge on sort of the inflationary side. So the, you know, overvalued peso, which makes it very hard for local businesses to compete, you know, imports are coming in, so compete with imports, but also for them to think about export markets and growth that way.

So that’s one of the challenges. The other thing is part of his austerity measures was to cut back the size of the state. And so he cut back workers.

So, you know, people lost some of their jobs, but he also cut back on public spending. So, you know, construction went down, you know, by double digits in terms of a part of the economy, which meant consumption went down. So, you know, many of these things were what was needed to be done in Argentina, right?

You had to break the inflationary cycle. You sort of had to break the sort of economic challenges and crisis Argentina had been in, but you haven’t yet seen growth. And, you know, this movie has happened in Argentina before, where you have a populist government that spends lots of money, gets them into a financial crisis.

You have a government that follows them, that, you know, does the right austerity measures, cleans things up. But after three or four years, the population’s tired of austerity. They’re tired of recession.

And so they vote back in the populist who promised to spend like they did before and now have the room because you had a government that did the cleanup. So hopefully Milei will, you know, for the markets and for the sort of fiscal consolidation that we’re talking about here today, hopefully Milei will be reelected because he will continue on this path. If you see an opposition president, you know, a year plus from now, I think we could see a return to that spending.

We’re back to the Argentine cycle that we’ve seen for decades.

PATTERSON:
Which again, I can’t help, but think about the analogies with some of the developed markets today, right? You elect in a new government, you’re hoping for change, you don’t get the change. So then you swing the pendulum the other way, but it means that the economy doesn’t get out of some of these structural issues that it needs to address.

It’s fascinating to me.

O’NEIL:
Yeah.

PATTERSON:
Fascinating to me. I am a complete macro nerd. So maybe, hopefully it’s fascinating to our listeners too.

All right, I also wanna touch on Venezuela while we’re down South. This is another country that’s gotten a friendly nod from the Trump administration, and it’s also gotten a new leader after the US seized Maduro in January and left Delcy Rodríguez in power as acting president.

You know, I’ll admit as an investor, as a researcher, I have not spent a lot of time focusing on Venezuela in recent years, partly because for me, it’s very hard to research a country where there’s not even good public available data. And I think for people who don’t spend time focusing on this part of the world, it’s hard to even appreciate that, that the government and central bank for many years just didn’t publish data. And I think it was just this April that the central bank published a few economic numbers.

It was the first time since 2019 that happened. I mean, it’s kind of incredible. And then fiscal data, the fiscal data in Venezuela are out of date by like 15 years.

So you have to use private sector data, you have to triangulate, but that’s the state of the country. You know, it seems like when we go back to R and G, right, we need to get interest rates down, we need to get growth up to stabilize our fiscal dynamics. Venezuela seems very focused on the G, right?

And that’s all about the oil and gas sector, but they have some huge challenges. As I know you know better than I do, one of the really important but basic ones is power, electricity. You know, their grid is so poor, they can barely keep the lights on, so to speak, for the oil and gas sector now, much less, let’s say the US investment, other investment comes in, that sector starts to get resuscitated, they’re gonna need even more power.

Where is that coming from? Voters aren’t gonna be super happy about constant blackout. So are you more optimistic than me on Venezuela?

And look, I appreciate what the Trump administration’s done in terms of trying to help them reinvigorate this part of their economy. I mean, that would be good for them, it would be good for the world if it happens, but can it happen fast enough to turn the economy around, to lift the G? And how much investment do you get when you don’t know how long the current government’s in power, right?

If this government is there, thanks in part to President Trump and the current administration, and that administration could change in two years, then what? So I know that’s a lot to unpack, but your thoughts on Venezuela, please.

O’NEIL:
Well, for a macro nerd, the good thing is the IMF and World Bank and others have gone back into Venezuela, so there should be good numbers coming out again. They’re gonna start giving numbers again. And we also see the Venezuelan government working to sort of renegotiate the debt take.

There’s a lot of debt outstanding that has been not paid for many years, so trying to come up with some sort of solution. Because one of the challenges with your RNG is it’s really hard to tell what the interest rate is because they’ve been a sanctioned country, and so you actually can’t raise debt, right, outside of the country. So one issue for the country is just coming back to domestic and international markets.

And so they’re taking the steps there, which I think is a good sign. I mean, I think it’s worth just reflecting, Venezuela, as you say, the numbers aren’t good, but the economy over the last decade plus has probably shrunk 70, 75%. It’s incredible, right.

This doesn’t happen outside of major wars where you just see such a decline. So you’re coming from such a difficult place. And as you say, just the basic infrastructure, the electricity grid and the like, during these really difficult years, people pulled out the copper wire because it was the only thing they could sell, so you don’t actually have connections.

And so you have all of this, just very difficult situation, and now a government that is in control, but is an interim government that was not elected by any ways or means. So has de facto control, but de jure is a little bit unclear, but is supported and backed up by the Trump administration, as you say. And so what we’re seeing now is deals around energy.

Most of them are in production and transport and sending the oil that was pretty easy to get out into the global markets and particularly to the United States. And we’ve long seen a tie between the Southern United States and Venezuela oil, because Venezuela has a particular kind of oil that’s pretty heavy and it can be processed fairly easily by refineries that are in the Southern United States, not as many other places. So there’s a good synergy there that the Trump administration is helping open back up.

The challenges for Venezuela are sort of the ones you point to, is to really blossom, you need investors, international investors or Venezuelans who have money from the outside to come back in into infrastructure, you need to electricity, you need to do sewer systems, you need it into ports, you need it into roads, you need the things. And that stuff is sunk costs. You have to really believe in the government that you’re gonna get a return down the road and someone’s not gonna confiscate the money that you’ve put in or the sort of the infrastructure that you put in and it’s gonna pay you a fair wage for utilities and the like.

And I don’t think investors right now have that certainty. And the other side is, the Trump administration has been making some deals in terms of bringing out oil, but it’s really unclear what those deals entail. And in fact, there’s a great piece that just came out yesterday from ProPublica looking at this big oil deal.

And you read at least they have seen the version that was classified, sensitive and it just brings up more questions and answers in terms of who the partners are, where the money’s going, what the kind of cuts would be. And so most of the big major oil companies or others with lots of expertise who have worked all around the world, they call it above ground risk. The below ground is like, is there actually oil there to explore and to produce?

This is the above ground risk, like will you make any money off of it in the politics? And so, as I look forward, we have an opposition leader, Maria Corina Machado. She’s sitting in Panama right now.

Polls still say that if there was an election held today in Venezuela, she would win by far. But the Trump administration has pretty much turned their back on her because they are working with this government because they feel like they’ve gotten a deal. So I think the, right now we’re seeing growth in Venezuela to some extent, we are seeing some oil come out.

Last estimates I saw is maybe 14, $15 billion worth of oil has been sort of exported without sanctions. So it’s kind of a big bump, but it’s very hard to tell where that money has gone.

PATTERSON:
And okay, let’s assume for a minute that the US midterm election, the Democrats take the House, we’ll leave the Senate out of it for now, but we have relatively more balance in Congress and we probably get lots of investigations that follow. Does that affect how you’re thinking about how the current administration, how the Trump government is dealing with Venezuela? Would the Dems having more power affect your thinking at all?

Or do we need a whole new government? In which case it’s a 2028 issue if it happens.

O’NEIL:
So it does affect the thinking in the sense that I think we’ll see a lot of hearings and investigations into deals. And I think Venezuela will be top of the list, right? There’s just too much going on there and it’s too opaque.

The fact that members of Congress have not really seen yet what the terms of the deal are. There’s questions about the deal because the Department of War is going to buy these warrants and have sort of a stake. There’s questions about whether they actually have the legal authority to do so.

So I think there’s just a lot of issues there. And what I think that means for development in Venezuela, if you see those who have gone in under investigation, being subpoenaed to testify in front of Congress, I think it will make some of the major companies, those who are publicly held companies with shareholders and the like, I think it would make them hesitant to make a big bet on Venezuela until this part gets sorted out.

PATTERSON:
Okay, I’m keeping an eye on time. There are so many countries and they have so many interesting nuances and stories, but I wanna keep moving and hit one more quickly at least, which is Mexico. So this is our left-leaning government.

So they haven’t moved right. It’s the second largest economy in the region after Brazil. Claudia Sheinbaum came to power in 2024 as the successor to President Andrés Manuel López Obrador, or AMLO, it’s easier to say AMLO.

And they’re from the left-wing Morena party. And I think if there’s one thing we can all agree on at the outset is it doesn’t really matter these days if you’re left or right. Everyone’s struggling with affordability, everyone’s struggling to a degree with crime, et cetera.

In Sheinbaum’s case, as it is in Brazil, crime is a big headwind for the economy. I was so struck. There was a poll that came out from the main business lobby just a few weeks ago.

It said crime, uncertainty around judicial reform and tax enforcement are the biggest drags on investment in Mexico. Not the tariffs, right? In the US, we’re all talking about tariffs and the negotiations around USMCA.

But if you go to Mexico, that doesn’t even make the top three, which I find fascinating. So Sheinbaum has a lot on her plate, institutional credibility, affordability, tariffs and supply shocks with the wars. I’m curious how you’re thinking about the negotiations and about how Sheinbaum is doing vis-a-vis all the things she has to address.

O’NEIL:
Well, I was in Mexico last week, so I got to ask some of the folks.

PATTERSON:
Again, as one does, the glamorous lives. Yes, go ahead.

O’NEIL:
It doesn’t feel glamorous on hour five on a plane. But-

PATTERSON:
No, or going through TSA, yes.

O’NEIL:
Exactly.

But that rings true, the sense of what are the biggest challenges for Mexico? And many are homegrown, right? They are reforms to the justice system in Mexico that happened a couple of years ago that makes companies worried about politicization of judges.

They now elect all of their judges. So it’s unclear whether they really are the best candidates and impartial. That’s sort of a question that people have.

So that’s one of the challenges. Crime and sort of just the cost of keeping your workers safe, your products safe, the transit, especially if you’re exporting to the border, those trucks or rails that take it up there, are they gonna be attacked or sort of goods stolen from that? That’s also a worry.

Extortion is a challenge for many of these folks. The other thing I’d add to that, that’s been an issue in recent years is access to affordable energy and maybe even clean affordable energy. Mexico has not, because they have put in pretty stringent rules about public investment in energy rather than private investment in energy, it means that you’re not sure if you have a plant, an aluminum plant or a car plant or electronics plant, will you really have clean, affordable energy and able to make the goods that you wanna make?

So all of those things are sort of challenges there. That doesn’t mean that tariffs don’t matter. And on the good side for Claudia Sheinbaum, and they are negotiating, though it’s been slower than many would hope, I think, on that side, the good side is that while the headline tariff is high for all countries, including Mexico, USMCA, which is the trade agreement between Mexico, the United States and Canada, there’s an exemption for goods that are quote-unquote compliant with USMCA.

And 85, 90% of goods are compliant. And so that means most goods are coming in tariff-free. So while Mexico is going through negotiations and working hard with the US and being very accommodating, I would say, on the dozens of issues the US has put on the table, they sort of are, they’re in a better place than almost any other country in the world in terms of they have zero tariffs on lots of the stuff that they export.

PATTERSON:
The one exception there is the auto industry. Right, which auto, auto exports, I was just checking this, for Mexico, it’s about 4% of GDP exports just in those two categories. I mean, it’s an incredibly big number.

O’NEIL:
It’s an incredibly big number, and it’s also a big employer. So there’s a lot of jobs tied to the auto industry. And, you know, just for comparison, over the summer, electronic exports from Mexico to the United States actually surpassed autos and auto parts for a couple months there.

And that’s because lots of the big companies, Foxconn, NVIDIA, others are setting up shop there. They’re shipping servers. It’s the AI boom has a big pull.

Those also have zero tariffs, part because of USMCA, but really because, you know, when we talk about these headline numbers, lots of those electronics have zero tariffs coming into the United States, right? The Trump administration has exempted them. But autos really matter because it’s a huge industry.

It has a long history, and it is a big job creator. And so there you actually see higher tariffs because, you know, not to get trade wonky on you, but there are these 232 tariffs, which are sectoral tariffs, right? It’s not the economy-wide, it’s just on a sector.

And the sectors of steel, aluminum, and then cars, they’re paying a higher tariff than countries that have negotiated and finished their negotiations with the US. That includes the European Union, that includes Japan, South Korea. So cars coming in from Japan or South Korea or the European Union or UK, they’re paying a lower tariff today than cars that are being built or assembled in Mexico.

PATTERSON:
Wow.

O’NEIL:
Which means you’ve seen a decline in exports, but you’ve also seen a decline in US company exports to Mexico. And those are often the engines, they’re big parts that are going in to be assembled down there.

So the whole North American car industry is getting hit by these sort of, these changes of tariff where it’s cheaper in many cases to build a car in South Korea or Japan and send it to the United States than to build it in Mexico that would have, say, a US engine or other parts in it.

PATTERSON:
Right. I just have one last question for you. First of all, I love the tour de force, tour around Latin America, South America today.

It’s so helpful, especially as we head into this election in Brazil and think about next year and what could come. I can’t help but think about the analogies between there and a lot of these developed markets as well. And in a lot of ways, we could spend a lot more time on it.

I guess the one thing I’m trying to grapple with, is there a candidate? Is there a political party platform today that combines what voters care about, the affordability, the quality of life, crime, et cetera, and is fiscally responsible? Is it possible even to deliver both in a way that will make markets happy and voters happy?

I don’t know if there’s an example in Latin America that comes to mind, maybe a country we haven’t talked about, or am I just wishing on rainbows here?

O’NEIL:
Well, that’s the utopia.

That’s what we’re all looking for, right? That candidate that’s gonna solve all those problems. You know, as we go forward, I do think maybe we’ll begin to have real conversations about these things.

And I know in the past spillovers, you have talked with really smart people about AI and maybe that the money that’s gonna be earned from AI could be shared more broadly across society. I do think there’s a conversation, frankly, to be had, whether it’s in an advanced economy or an emerging economy. As we see productivity increases, which hopefully we are seeing and from AI, how do you share that between capital and workers, right?

And I think that is part of it is, you know, people want to invest. People want the stock market to get ahead. People want markets to be strong.

And they also wanna feel like their wages are going up and that their jobs are real. And so I don’t know what the platform is. And I frankly, I don’t know if I’ve heard it.

I hope you’ve heard it, but I haven’t heard it from anyone yet. But I do think there’s something about if there is, are there gains to be had? Can we share them more equally so that people, regular people, their households and the like, feel like they’re gaining along with, you know, the capital that’s investing behind all of these big forces that are transforming the world economy.

PATTERSON:
Right. You’ve got to get the population happy first before you can get your fiscal house in order is kind of what I’m hearing. We don’t have much time to get that done.

I don’t think given what’s going on with bond markets around the world. Look, you are amazing. Let me just say that.

The fact that you just flew to South America twice in the last two weeks, and you still have more energy than I do on my best day. I’m like, well done you. I wish I were you.

O’NEIL:
The beauties of caffeine.

PATTERSON:
No kidding. I actually went crazy today.

I got a pumpkin spice latte to get me going. Thank you for doing this, Shannon. This was amazingly helpful.

And I’m very excited to see what happens with Bolsonaro. So, or Lula, I’m not a betting person. I’m an investor, not a gambler, full stop.

If I were a betting person, I would easily bet you a very nice pair of Havaianas that we do not get fiscal austerity from Bolsonaro. Would you take that bet?

O’NEIL:
Wouldn’t take the other side of that one.

You know, I already have some Havaianas, so I’m good.

PATTERSON:
All right, me too. I love my Havaianas.

Well, we’ll circle back in a few months and see how things are going there. Maybe we can wear our Havaianas. Thanks again for joining The Spillover today, Shannon.

O’NEIL:
Oh, it was so fun to join you. Thanks.

PATTERSON:
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