Wednesday, October 31, 2007

Lessons from Argentina

The title link goes to the PDF file of the report from CEPR entitled Lessons from Argentina: New Paper Looks at Economic Policy in Argentina's High-Growth Recovery. While I appreciate the Center for Economic and Policy Research work at bringing economic issues from Lower Income Countries (LICs), I see their literature as promoting isolationism and autocracy for all countries even if to the detriment to other regional countries. Import substitution policies have not done a good job even if the goals are well intentioned. I also think that Dean Baker is a Dweeb and also P2. Although Dean's latest report on the health of the USA was pretty balanced at Exports and Structures Drive Third Quarter GDP Growth.
Argentina’s current economic expansion is now more than five and a half years old, and has far exceeded the expectations of most economists and the business media. Despite a record sovereign debt default of $100 billion in December 2001 and a financial collapse, the economy began growing just three months after the default and has enjoyed uninterrupted growth since then. The country's GDP during this period has grown by more than 50 percent, making Argentina the fastest growing economy in the western hemisphere during this time. In the process, more than 11 million people, in a country of 39 million have been pulled back onto the positive side of the poverty line. Furthermore, this recovery was accomplished without any help from the international financial institutions that had (led by the International Monetary Fund) provided tens of billions of dollars in
loans prior to the collapse; and with the use of unorthodox macroeconomic policies.
Yes, the numbers look simply spectacular as the graphs and data in the paper show. But let us look further at the analysis...
It was one of the worst economic crises in the history of Argentina, and was not resolvable under the economic policies to which the government at that time was committed.2 Most importantly, the "convertibility system" under which the Argentine peso was fixed at a one-to-one exchange rate with the dollar, had long been an unbearable burden for the economy, a strait-jacket with regard to monetary policy, and had become unsustainable. Both the exchange rate and the economy were being maintained through increasing international borrowing, which piled up an unsustainable public debt burden.
I can not imagine that the IMF would be promoting such policies. Most of the reports I read says the IMF would like to see floating exchange rates or at least a peg that is tied to a basket of currencies. And especially not a hard peg at one to one conversions with another currency.
However, relatively little of Argentina's growth over the last five years is a result of exports or of the favorable prices of Argentina's exports on world markets. This must be emphasized because the contrary is widely believed, and this mistaken assumption has often been used to dismiss the success or importance of the recovery, or to cast it as an unsustainable "commodity export boom." Table 1 shows the relative contributions of the various components of GDP to economic growth, for three phases of the recovery.5 It can be seen that exports played a major role only for the first six months of the recovery (the first phase), when the economy grew at just a 1.3 percent annual rate.
Yes as the paper tries to point out that growth was actually more in other segments over the 5 years, but I would say the most important aspect is what sector of the economy is going to lead. Without this massive and substantial increase in Net Exports as percentage change in contributions to the GDP of 239% for the first time period used then the recovery would not have gotten off the ground. Simple as that.

I would doubt that people would dismiss the recovery because of exports and I think export booms can be sustainable even if a lot of it is in commodities.
During this period exports grew at a 6.6 percent annual rate and accounted for 71.3 percent of GDP growth. Imports dropped by more than 30 percent and therefore accounted for 167.8 percent of GDP growth during this period. Thus net exports (exports minus imports) accounted for 239.1 percent of GDP growth during the first six months of the recovery. This was countered mainly by declining consumption, with private consumption falling at a 5.1 percent annual rate.
Much of what I already mentioned but notice the significant drop in consumption. In most Structural Adjustment Programs (SAP) this is one of the key policies the IMF is trying to incorporate, i.e. reducing the Absorption of the economy and thus reduce inflationary pressures. And of course these policies get the most controversy.
However, in this phase exports did contribute more than in the previous period, accounting for about 16.2 percent of growth; although imports grew faster, resulting in a negative contribution for net exports. Over the entire recovery through the first half of this year, exports accounted for about 13.6 percent of economic growth, and net exports (exports minus imports) contributed a negative 10.9 percent.
Still a respectable and important part of the overall growth of the economy and allowed needed inputs for capital accumulation also. Nothing here voids the idea that the engine starter for the recovery was export growth. Without at least one sector being the first, I can not imagine that any recovery would have been possible.
The economy reached its pre-recession level of real GDP in the first quarter of 2005. As of the second quarter this year, GDP was 20.8 percent higher than this previous peak. Since the beginning of the recovery, real (inflation-adjusted) GDP has grown by 50.9 percent, averaging 9.7 percent annually. All this is worth noting partly because Argentina’s rapid expansion is still sometimes dismissed as little more than a rebound from a deep recession.
Again I would never dismiss a recovery just because of countervailing factors, just that after a severe depression, you would expect that at least some strong rebound effect would kick in eventually. Since the factors of production have not gone to rot in the short term, we would expect some recovery in industrial capacity at least.
A number of government policies seem to have contributed to Argentina's rapid and robust recovery. This is often overlooked, possibly because some of these policy choices are considered controversial. Perhaps the most important of these policies was the government's exchange rate policy. This was important from the second quarter of 2002, when the government strengthened
foreign exchange controls and intervened in the foreign exchange market in order to stabilize the currency. At first, the problem was that the peso was too low, as a result of significant exchange rate "overshooting" (see Figure 2) that brought the nominal rate to 3.6 pesos/US dollar in May of 2002. The devaluation had caused a sharp spike in inflation, which was then running at a more than 28 percent annual rate. It was important for the government to stabilize the nominal exchange rate –
not only to help stabilize inflation but also the financial system. This was done primarily through interventions in the foreign exchange markets (selling dollars), and also by restricting the outflow of pesos from the banking system. The government also required that dollars from export revenues exceeding $1 million had to be turned over to the central bank, thus increasing the supply of dollars that the central bank could use at this time to stabilize the peso.8 These exchange controls were therefore also an important part of the process of stabilizing the exchange rate, and therefore of the economic recovery.
Sorry for so much text here, but wanted to give the context for the ideas. I think it is funny to say there is controversy and then go into exchange rate regimes that I see very little controversy in what was done. Argentina went off the pegged exchange rates and went to a managed float or a managed band, which most economists consider a good policy overall-including IMF staff. The foreign exchange controls that were strengthened is controversial but so is no restrictions. So this is an issue that is mostly empirical than strictly theoretical, that is the degree of freedoms of capital is more of a numerical consideration.
The Argentine government's policy of pursuing a stable and competitive exchange rate was and remains unorthodox and controversial. The conventional wisdom among central bankers today is that the central bank should not target the exchange rate, and most central banks would not do it. Most Central banks may target inflation itself, or intermediate variables such as short-term interest rates and monetary aggregates, but not the exchange rate. It is generally believed to be incompatible
with controlling interest rates in the domestic economy, in an economy with open capital markets. However, this is not true if there is an excess supply of foreign exchange at the central bank's target exchange rate. The Argentine government has also been able to sterilize its interventions in the foreign exchange market by issuing bonds in the domestic market, and it turns out that this policy is also sustainable.10 Also, the prevailing orthodoxy is that central banks should be independent of the government.
I have seen some support such monetary targets, but I fear if the world economy becomes in a crisis or even regionally to its partners it could have spill-over effects. But everything I have read seems to not correspond that sterilization will work over the long term. Either the central bank will run out of reserves or reserves will explode and then cause inflation. Again with a managed float then maybe such concerns can be negated. Lastly, yes independence for the central bank is of the utmost importance I see. Politicians like Hugo will see the central bank as a source of free funds to promote socialism and ultimately hyper-inflation is the result.
Did you also note from the graph above that the currency was actually more unstable after the stabilization as before the default period. And this does draw into question the hard pegging that was before the crisis.
Another important policy concerns the default and renegotiation of the government's external debt.
As noted above, the expectation that Argentina would pay a large and continuing cost for its default did not materialize. On the contrary, the default appears to have been necessary for the country to change its macroeconomic policies so as to restore economic growth. Before the default, the government was focused on tightening its fiscal and monetary policies in a futile – and, probably impossible – attempt to restore credibility among its creditors, an effort that included maintaining the convertibility system. The default enabled the government to pursue a new set of ultimately successful macroeconomic policies.
Good that they suffered no cost for the defaults and this subsidized time did allow them to get their house in order. So being the pragmatist, I will applaud any effort to get back on track, but to imply that the IMF and others did not help out is false even if the actions were beyond their control. By Argentina not paying its debts it was allowed to transfer monies to productive uses in the economy. This is one reason that the IMF has implemented HIPC funding, with realization that overburdening debt for developing countries can prevent growth and development.
The Argentine government was subject to considerable pressure from the IMF in the years following the debt default to offer better terms to the defaulted foreign creditors (see below). But in
the end, a debt swap in 2005 was arranged that took 67.3 billion of foreign external debt off the books. This was a record 65.6 percent "haircut" and was very important to Argentina's recovery. This can be seen by the reduction of the overall public debt, which the swap combined with the rapid economic growth reduced the public debt from 127.3 percent of GDP in 2004 to 62 percent today (see Table 2).
So this haircut was not considered a subsidy? Sounds like the international community including the IMF did a lot to help Argentina to recover.
Two unorthodox taxes levied by the government were also important to the recovery. One was an new export tax which allowed the government to get some of the windfall profits that exporters received as a result of the devaluation. The other tax was already in existence: a tax on financial transactions. As Frenkel and Rapetti (2007) have noted,12 the two taxes together pulled in about 2.7 percent of GDP, and were responsible for almost the whole national primary budget surplus in 2004. It is also worth noting, as can be seen in Table 2, that real short-term interest rates have been negative throughout most of the recovery (since 2003).
Well golly gee wiz! Maybe exports would have done a better job without a drag on that sector. And this opens the possibility that they actually were driving the economy since they had nice growth with a disincentive tacked on. I prefer no export taxes but it is something that should be looked at more closely especially when concerning commodity exports. Thus most of the fiscal balancing of the budget was accomplished on the backs of the export sector. And we do remember that balancing the Fiscal Budget is important in SAPs and considered an important aspect of all those economic theories like Neoliberalism.

As far as the financial tax scheme the writer does not give us any indication of how it is implemented. But as far as negative real interest rates we have covered that quite extensively here with regard to 'financial repression' and Ronald McKinnon. But the actual numbers as I read them are 2003:5.1%, 2004:2.3%, 2005:-3.2, 2006:-2%, and 200:-0.2|
Another policy that contributed to the recovery was a program that provided a monthly stipend (150 pesos) to heads of households who were unemployed with children of up to 18 years-old (or disabled of any age), and to those where the head of the household was ill. At its height (2003), the program reached 20 percent of all households, with 97.6 percent of beneficiaries under the poverty line. 13
The writer here goes to great length to explain how well the social safety net worked, and I applaud that. But how does this program help the recovery? Now it may have made structural adjustments more feasible for the general public but increasing consumption at a time when absorption needs to be reduced does not seem to help the economy out of the depression.
While recognizing that steps must
be taken to bring inflationary expectations under control, and avoid a wage-price spiral, the government is willing to live with double-digit inflation for some time as a tradeoff for the rapid real growth of the economy and its enormous positive impact on poverty, employment, and income distribution.
Yes some cultures/economies live more freely with higher levels of inflation without causing much problems. India is an exception to this from much of South America, where nearly segment of the economy wants a low and stable inflation rate. So I am not as hard on Hugo Chavez on his inflation rates as others are but since he has destroyed the independence of the central bank, this is a portent for hyperinflation.
As more countries become more independent of the IMF and allied IFI's and governments, the "policy space" for different and potentially more successful macroeconomic and other economic policies will expand. In Argentina's case, as we have seen, the IMF was opposed to most of the major economic policies that contributed to the country's rapid economic recovery. Argentina's break with the Fund was therefore one of its most important decisions, and one that may prove to have lessons for other developing countries as well.
The last portions of the paper talk about the IMF mostly. And yes some of the criticisms are legitimate, but I see them not so much as problems but just signs that maybe the IMF has lost it meaning in the present international economic environment. But I still see that many of the tools the IMF have developed over the years should be of use to the general welfare of the world economy. Such as the monitoring and technical assistance they provide to member countries. How the IMF finances such ventures is anyones guess.



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