FROM $30 CHEESE pizzas in São Paulo to $250-a-night windowless, smelly hotel rooms in Rio, the lasting memory from a visit to Brazil in recent years has been shock at how expensive it is. When Lula came to office in 2003 a dollar bought 3.5 reais; by mid-2011 it bought just 1.53 reais, barely a third of the 2003 figure in real terms, because inflation in Brazil during the period was much higher than in the United States. Since then the exchange rate has fallen to 2.3 reais to the dollar, but that has undone little more than half the past decade’s gains. In any case, the causes of Brazil’s competitiveness problem go far deeper than the exchange rate. The strong real actually helped keep prices down by making imports cheaper. It did, however, give foreign visitors a chance to experience something the locals know so well that they have a name for it: the custo Brasil (Brazil cost).

Compared with other middle-income countries, Brazil is astonishingly poor value for money. Large domestic appliances and cars cost at least 50% more than in most other countries. For everyday items such as toothbrushes and children’s toys the difference is often a lot more. Among the 48 countries tracked by the Big Mac index, The Economist’s lighthearted currency-comparison tool, a burger in Brazil costs more than in only a handful that are much richer (Norway, Sweden, Switzerland) and one that is dysfunctional (Venezuela). Burgers should be cheaper in poorer places because wages are lower: in Brazil, less than a quarter of European or North American levels. Allowing for that, a Brazilian Big Mac costs an indigestible 72% more than it should do, and the real remains one of the world’s more overvalued currencies.

The IMF’s broader cost-of-living figures show that Brazil’s high prices are no mere quirk of burgernomics. In most less well-off countries people find their money goes further than market rates would suggest because non-tradable goods are cheaper. Averaged across all goods and services, a Mexican’s spending power, for example, is 45% higher at home than if he bought dollars and shopped across the border. But a Brazilian can buy little more at home than he can in the United States.

The causes of Brazil’s cost problem are legion. Start with taxes. At 36% of GDP, the total tax burden is far heavier than in other developing countries. Payroll taxes, at 58% of salary, are higher than in any other big economy. Consumption, too, is heavily taxed, which explains why a Brazilian-made car costs up to 45% less in Mexico than it does in Brazil itself. High tariffs push up the price of imports even more. A smartphone costs about 50% more than in the United States. Most cars imported from outside the Mercosur trade block and Mexico attract not only a 35% tariff but an extra 30% on top of the normal sales tax.

The complexity of the tax code also raises compliance costs. A mid-sized Brazilian firm takes 2,600 hours to prepare its annual tax return, almost ten times the global average. Rigid labour laws make it hard to deploy workers efficiently and lead to costly court cases, 3.2m last year alone. Many businesses prefer to hide in the informal sector. A 2006 McKinsey report estimated that by remaining in the shadows a retailer could more than triple its profit margin, but at the cost of forgoing investment and economies of scale. A simplified regime for small firms introduced since then has persuaded many to register, but the resulting efficiency gains are limited by a new problem: too many “Peter Pan” firms unwilling to grow up and lose their privileges. A plethora of other costs help drive up prices. Poor roads and a limited rail network make for high freight charges. High crime rates have bred a private army of 650,000 security guards. Prime office rents in big cities are vertiginous; Rio’s are the highest in the Americas, north or south. A low savings rate, high bank-reserve requirements and the government’s considerable funding needs (it runs a budget deficit each year, despite that 36% tax burden) make credit expensive. FIESP, São Paulo’s association of industrialists, says firms’ financing costs make up 5% of the end price of manufactured goods. Retailers manage to keep selling by accepting payment in instalments. The hyperinflationary years taught Brazilian consumers not to worry about the total cost, just whether they can afford the monthly payments. But the effect is to push up the sticker price, since the cost of waiting for full payment and the risk of default has to be built in. Corners are also being cut on quality. In Mexico the bottom-of-the-range VW Gol, made in Brazil, is a 1.6-litre, four-door affair with air-conditioning. In Brazil it has a 1-litre engine and two doors, with air-conditioning extra.

Shopping around

Brazilians respond to whopping price differences by going on foreign shopping sprees. Brazilian tourists spent $22.2 billion abroad last year, a record, and seem set to go even higher this year. Direct Luxury Group, a consultancy, estimates that four-fifths of Brazilians’ spending on upmarket goods takes place abroad. Miami has been getting so many Brazilian shoppers in recent years that many stores there have hired Portuguese-speaking staff. TAM, a Brazilian airline, says it takes on extra fuel on the return leg of that route to allow for excess baggage.

The story of the custo Brasil is decades old. Now soaring pay is adding a new chapter to it. Since 2003 the country’s unit labour costs have doubled, compared with inflation at 67%. In dollar terms they have trebled, thanks to currency appreciation. One reason is the scarcity of well-educated workers. Manpower Group, an employment agency, says Brazil is the world’s second-hardest place for firms to find the skills they need, behind only ageing Japan. At the top end, headhunters say multinationals often have to pay their Brazilian executives more than their bosses in London or New York earn. But the main reason is a decade of big increases in the minimum wage, which sets a trend for all pay negotiations. At the start of 2003 it was 200 reais a month; now it is 678 reais, almost twice as much in real terms (see chart 2). The government is committed to above-inflation increases until 2015. Raising the minimum wage had its merits at first, says Gray Newman of Morgan Stanley. In the years before Lula took office its value had eroded, creating room to shift profits from capital to labour. High interest rates kept inflation in check, and the weak currency ensured that exports remained competitive even if prices did rise a bit. Higher incomes, helped by somewhat more accessible consumer credit, boosted consumption, creating more jobs in a virtuous cycle.

Large domestic appliances and cars cost at least 50% more than in most other countries

But the policy has now pushed costs beyond what either the foreign or the domestic market is willing to bear. Household consumption, one of the economy’s few bright spots in the past two years, has levelled off. Consumers are overstretched, with 21.5% of household income going to service debts. Despite some of the world’s highest tariffs, imports are taking a bigger share of the manufactured products Brazilians buy. Exports of manufactured goods are slipping. After several years of price rises close to 10%, demand for services is losing steam. “After a long boom driven by credit and consumption, Brazil has ended up looking in some ways like southern Europe,” says Tony Volpon of Nomura Securities, a broker. Only the rising value of its commodity exports saved it from ballooning current-account deficits.

In the short term a weaker currency will help, as long as tight fiscal and monetary policy prevent it from fuelling inflation. The real is now 11% lower than at the start of this year, having touched 20% in August, though after taking inflation into account it is still well above its long-run average. A cheaper real will make Brazilians poorer by lowering their wages in foreign-currency terms and do nothing to get to the roots of the custo Brasil. But it will protect jobs by making exports cheaper and imports pricier, and by reducing the price of services compared with tradable goods.

In the longer term Brazil needs to boost its productivity. A recent study by the Boston Consulting Group estimated that three-quarters of Brazil’s growth in the past decade has come from adding more workers and only a quarter from productivity gains. Since there is little room for the workforce to grow further, that needs to change. Other developing countries, and plenty of rich ones too, are doing far better. Regis Bonelli and Julia Fontes of the Fundação Getulio Vargas, a university, calculate that in 2000 Brazil achieved 19% of United States productivity levels, but by 2012 this had dropped to 18%. Over the same period the Chinese figure leapt from 6% of that in the United States to 17%.