Will Argentina waste a historic opportunity?

Rarely do you see a country where the mood among business people tells such a different story than the statistics.  Now, in Argentina there are statistics are then there are damn lies--inflation figures are made up--but the broad contours of the economic performance of the last few years are not in dispute.  Argentina has been growing at Asian rates, its investment rate has risen to levels not seen in decades, national saving is at record levels, and TFP growth has been stellar.  By their own admission, Argentine businessmen are making more money now than they ever have in recent memory.

Yet business people are somber, bitter, and angry at the government. The general sense, even among those that supported Nestor Kirchner's policies, is that the government is frittering away a golden opportunity.  Worse, the government has authoritarian--some would say thuggish--tendencies that portend ill for the future of Argentina's democracy.

What is going on?

First, the good news.  Recent economic growth, unlike that of the 1990s, is of the good kind and it not just the result of high commodity prices.  The investment boom of the last few years is supported by high saving, not by external borrowing as in the 1990s:

The difference is that recent growth has been fueled by a competitive currency, which increased the relative profitability and output of a wide range of tradables: agro-industries, manufacturing, and a wide range of services (from tourism to call centers). Unemployment and poverty rates have come down. Manufacturing employment has been growing after a long period of decline.  The weak currency has stimulated the right kind of structural change--from lower productivity activities to higher-productivity tradables--which is the source of the economy-wide increases in TFP we have seen. This is a textbook illustration of the magic of sustained currency undervaluation.

To get a sense of the magnitude of Argentina's accomplishment, compare its recent record to that of Brazil, a distinctly worse performer:

So next time someone says Brazil is the tortoise that will eventually overtake the Argentinean hare, ask how this will be possible with saving and investment rates that are well below 20% and a productivity growth rate that is decidedly lower.  (All data here come from the Economist Intelligence Unit, but I have cross-checked them against other sources where possible.) 

Now the bad news.  In a growing economy, the tendency for the real exchange rate is to appreciate--unless the economy can generate growing surpluses of saving over investment (as in China until recently).  The result can be seen in Argentina's prices. While the peso is stable against the dollar in nominal terms, the overheated economy has generated inflationary pressures (over 20% annually at present) which are being grossly mismanaged.  The answer to high inflation is a big fiscal surplus--much larger than what the government is managing at the present despite the huge windfall in commodity prices. Instead, the government has been resorting to ad hoc and temporary measures: price controls, export taxes, and intervention in currency markets.  It has no coherent plan to deal with inflation and no strategy for sustaining competitiveness in the face of the real appreciation that will take place even in the best of circumstances.      

Even worse is the growing disconnect between the government and the business community.  In its approach to the private sector, the government is developing a reputation for being abusive, threatening, and intimidating.  The Kirchners' strategy seems to be to play to their main political power base while assuming that growth will continue.  But in the current environment it is difficult to imagine that the private sector will continue to invest as strongly as it has.

In the early 1990s, after years of mismanagement and hyperinflation, the binding constraint on Argentinean growth was lack of confidence in macroeconomic policies. The Convertibility Law was an ingenious short-cut for overcoming this constraint.  But as circumstances changed and the binding constraint became lack of competitiveness instead, the Convertibility Law turned into a liability. It allowed no way to respond to the new constraint within the existing rules of the game.  The post-2002 policies were in turn successful because they removed the competitiveness constraint. But the growing gulf between the private and public sectors has put lack of confidence and credibility once again front and center--now as the binding constraint on sustaining Argentina's growth. 

And that is a pity, because there is a lot that is going right with the Argentine economy today. The underlying model is much more sound than anything in memory. There is nothing wrong with it that a larger fiscal surplus and a bit of dialog between the public and private sectors would not cure.

Comments

[Justin Rietz]

I'm a bit confused: if the government carries a big fiscal surplus, won't this drive up the value of the peso?

[Ana C.]

Merveilleux. You should visit Argentina twice a year.

[Escriba]

Dani:
The thing with dialogue with the private sector in Argentina is that most businessmen want the public sector to guarantee them profit in excange for nothing. They do not want to be competitive but instead to maintain a statu quo, even in social terms (they are not really worried for poverty or unemployment).
For me, it rings a bell for what Vivek Chibber tells us in "Locked in Place" for the Indian case.
In other terms: most of the private sector doesn't want dialogue but domination of the public sector. They want a weak state in order to obtain a lot, but giving very little.
My question is: ¿will poverty go down faster with less government spending? (There is a joke here in Argentina which says: "Government says distribution of income has already been accomplished, but that there wasnt't enough for all").

http://press.princeton.edu/titles/7685.html

[Kramladen]

Justin, it's the other way around: expansionary fiscal policy leads to an appreciation because it tends to increase interest rates (at least in theory). So restrictive fiscal policy is just doing the opposite.

[Andres]

i must say to you, that is a political decision from de government to mantain a depreciation of the peso... so this is not a causality from a fiscal policy, but instead, is product of a monetary policy of the central bank... to acts in the exchange market, for Keeping by this way the peso in his actual value.. (1 peso = u$s 3.15 aprox.).. By this..the country has a competitive currency and in this way, that acts as some kind of Protectionist barrier for the national industry...having as a result the development of it and the gaining of national and international markets.. it is a mechanism very interesting how the central bank injects money in the market when the dollar is falling to the peso, and then Sterilizes thoses emisions with bonds form the central bank (LEBACS and NOBACS).. trying to control by this the inflation rate...
In summary.. in argentina we have this exchange rate by the action of a monetary policy and not for the result of a fiscal one...

[Andres]

i must say that the value of u$s 1 = 3,15 pesos... sorry for that.. see you

[Andres]

SORRY FOR ThaT.. but a u$s 1 = 3.15 pesos...

[opa]

and because public spending mainly falls back on the non-tradable sector of the economy, pushing up prices and appreciating the exchange rate.
It could also be argued that a fiscal tightening reduces the risk premium, pulling in more money and it ends up appreciating the exchange rate.

[Iván]

Dani,
I agree with all your points except for the following sentence: "The weak currency has stimulated the right kind of structural change--from lower productivity activities to higher-productivity tradables--which is the source of the economy-wide increases in TFP we have seen".

First of all, I don't really see that the rise in TFP is due to a "structural change" in the economy. In fact, as your graph shows, only in the case of 2007 we can speak about a genuine rise in TFP respect to the '90s. I think that the overall rise of TFP ows more to the full-use of installed capacity (particularly for 2003, 2004 and 2005) than to a change in the economic structure. There has been, indeed, an expansion of dynamic high-productivty sectors (agroindustries and services, as you mentioned) but a big part of the expansion in manufacturing has taken place in sectors really behind the "technological frontier" (for instance, shoe, toy and some mechanical industries as well). The growth of this labor-intensive sectors has contributed enormously to the reduction of unemployment (although many of the jobs created aren't well paid and are very irregular in terms of social security coverage, for instance), but it hasn't really generated a structural change in the economy as they are extremely dependant on the real exchange rate being depreciated and on a great subsidy on energy prices. What is worse, the government doesn't seem interested in fostering the generation of a more genuine competitivity for this sectors apart from keeping the real exchange rate depreciated.

What I see is that the RER depreciation has boosted the output of many sectors in the economy, some of them quite dynamic and others not so much. Most of them (dynamic and not-so-much ones) had been completely erased during the RER-appreciated '90s. For this I give a credit to the depreciation of a RER that has taken place post-2002. But I think that now, with the economy back at full power, the challenge is to generate a real structural change - that is, to make the dynamic sectors be the core of the economic growth and not just one of its "participants". The lack of a development plan (or any kind of mid-term plan) expresses doubts, from my point of view, about the real conviction of the government in not wasting, as you say, this historic opportunity.

[Dani Rodrik]

Ivan --
I would just make this point: when a worker moves from informal employment to the manufacturing sector--even one that is behind the global technology frontier--this increases TFP in the economy and is the "right" kind of structural change.

[Mark Manger]

I wholeheartedly agree with your views on the role of exchange rate policy, and
yes, a lot is going right at the moment. But to achieve real structural change, Argentina would also need a major investment in its human capital to allow sustained productivity gains. Another unfortunate legacy of the Menem years was the destruction of an excellent education system, especially its outstanding vocational schools, because the market would supposedly supply education somehow. It rarely does so, if ever.

I have spoken to several executives who see a huge "generational skill gap." The country still has a few internationally competitive industries (energy-related engineering, for example), but they're living off their own substance.

Unfortunately, I do not see any such investment being made by the Kirchner government.

[Elemaco]

Dani: The employment informality has not decreased enough to be able to explain the TFP growth.

In fact, the informality and it's structural consolidation is one of the biggest flaws in the "Kirchner's Model"

In addition, Wages gaps between formal and informal sector has substantially increasy, contrary to whay one would expenct after 5 Years of growth.

We've reach a point where work is not enough to break the poverty line, (7% unemployment, +20% poverty) and the competitive real exchange alone doesn't seem to be doing a good work in changing this fact

[Elemaco]

Dani: The employment informality has not decreased enough to be able to explain the TFP growth.

In fact, the informality and it's structural consolidation is one of the biggest flaws in the "Kirchner's Model"

In addition, Wages gaps between formal and informal sector has substantially increasy, contrary to whay one would expenct after 5 Years of growth.

We've reach a point where work is not enough to break the poverty line, (7% unemployment, +20% poverty) and the competitive real exchange alone doesn't seem to be doing a good work in changing this fact

[Iván]

Dani,
thanks for the reply. I now understand better the point at which you were aiming. I should nevertheless say that informal employment still represents 40% of Argentina's total employment - even many jobs in the manufacturing sector share more than what they differ in with "informal" activities. So, although I agree that is better to have people working in the manufacturing sector and not selling hot dogs in a train station, my impression is that this change -at least in Argentina's case- doesn't have the enough "strength" to last for several years. The manufacturing sector is terribly dependent on the subsidies schemes implemented by the government. I would like to see the manfuacturing sector well fitted to survive the RER appreciation you say it's almost imminent even in the best of the circumstances.

Maybe my difference with what you say is more semantic - the adjective "structural" makes me think about something that is deeply rooted in the economy and it's destined to last for a long time. My impression is that it's now, in these days, when it will be decided whether this change in the economy is here to stay or not.

Thanks for having the possibility to share my humble views with you. It's always a great pleasure to read your blog! It would have been very interesting to have you as a speaker in the University of Buenos Aires :(

[Nicolás]

Dani: I'm an argentinian economy journalist. You've just explained the actual situation in my country really accurately. Now, how do we do to prevent the government to spoil an incredible opportunity?
Thanks

[Justin Rietz]

Kramladen-

In a free market with no intervening central bank (a rarity), a decrease in government debt would push downwards on interest rates, as you state. However, this push may be partially offset by the private demand for savings and investments.

Once the government is running a budget surplus, other factors come into play. If the government sits on its surplus, it has effectively reduced the money supply, thus raising the value of the currency. If the government uses its surplus to buy back existing debt (assuming such debt exists) this will push downwards on interest rates. Once there is no more debt to buy back, it becomes more constrained and the reduction in the money supply becomes a greater factor. In addition, such an economy would be viewed as incredibly stable, so we would expect an inflow of foreign capital from businesses seeing good growth opportunity - not all FDI is purely related to interest rates. The government could use some of its savings to offset this inflow, but now it would be getting into more complex policy territory. The stability of such "prudent" fiscal policies may also prompt local businesses to borrow more - especially if they need to buy more expensive foreign capital goods - again pushing upwards on interest rates.

[ft]

Escriba: You think, wrongly, that Argentine businessmen are different than in any other place. Already in 1776, Adam Smith thought that "Businessmen seldom gather together except to conspire against the public interest". Differences in behaviour and characteristics of the Argentine business "class" surely are due to the incentive structure they have faced for decades. Even today, under the Kirchners, businessmen who are "friends" with government are doing especially well.

[ft]

I'd like to correct my previous quote which, lazy me, I got by googling. It should really be: "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices."

[Ana C.]

Strong assumptions, Justin Rietz. The argentinian government will have more than sufficient debt to buy back during the next few generations.

[Justin Rietz]

Dani -

At what point (if ever) does a government discontinue or phase-out its "currency undervaluation" policy, and how does it know when it has reached this point?

[Frank]

OK, Argentina is a nice country, very rich in natural resources and good soccer teams, but Peru is the new economic phenomena, higgh growth rates, high save rates, surplus in current account, surplus in fiscal budget and an exchange rate market with interventions every day. Recently, the central Bank increased the marginal reserve requierments for capital inflows!. I hope you can post something about Peru. Best wishes to argentineans, you have an economy very close to Peru, but more educated

[MS]

I think Argentina has already lost its opportunity. 2004, 05 where the years to make the economic reforms Argentina needed to become a more serious country. Remember I said more serious, talking about a big change.
For example: a needed tax reform (with surplus it was a great opportunity), from the coparticipation law, to a minor IVA (Value Added Tax). I can continued with a lot more of thing that this administration could have done, but now with inflation in levels around 20%, no credibility and a government base on confrontation, no on progress... all this makes impossible to take the opportunity.

I recall again; Argentina lost this opportunity, maybe somethings can be done yet. But if you think about the current problems in Argentina, you would arrive to the conclusion that they were all created during the period 2003 - 2007, knowing in advanced that will happen.

If you analyzed the economy of ARG, you have to analyzed politics and politicians. I haven´s seen any politician willing to accept the cost of becoming a more develop country. (Two years before such costs were to resign 5 point of growth, growing at a rate of 4,5%, not at 9%; and reducing a little public spending).

Regards, MS

[Rodrigo]

If nobody believes the oficial inflation figures in Argentina, why should we believe the oficial GDP deflator? I ask myself how much of the current real growth is just plain inflation...

[Justin Rietz]

Rodrigo -

We could look at money supply growth to get a better idea of "real" inflation. I don't have these numbers on hand, but I am sure they are available on the internet.

[Escriba]

FT:
In order to change that incentive structure you will need a stronger state, which businessmen here wouldn't like at all.