NS4053 Winter Term 2015

Argentina: Reverse Convergence

Overview

Miguel Kiquel, Argentina: A Case of Reverse Convergence, Brookings, November 2014

Main Points•Argentina’s growth performance over last century unique•Country has •moved from being a prosperous developed country at beginning of 20the century to•Joining the group of emerging countries 100 years later•Possibly a case of reverse convergence

Main lesson, •Convergence does not occur naturally, but •Requires supporting policies to take advantage of opportunities opened up by openness and capital inflows.

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Argentine Economic History I

• Argentina’s successful period largely between 1880s and the 1920s

• Country was integrated into the world economy

• One of the major suppliers of food and raw materials to the world

• Magnet for foreign direct investment for poor workers leaving Europe and searching for opportunities in the new world

• Depression in 1930s marked a turning point

• Drop in commodity prices

• Trade barriers were imposed on Argentina exports

• Sudden drop of capital flows from advanced countries

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Argentine Economic History II

• Conditions resulted in a change in the development paradigm

• World economic order in 1930s was that of protectionism in Europe and the U.S.

• First -- policy response in Argentina – shift towards industrialization and import substitution

• Prebish thesis – terms of trade go against primary producers therefore need to industrialize

• New policy shift created tensions between

• traditional export sectors (mainly agricultural/beef sectors) that were efficient and main suppliers of foreign exchange and

• Infant industrial sector that needed foreign exchange to import intermediate and capital goods

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Argentine Economic History III

• Second change in the economic paradigm was a relaxation of fiscal and monetary discipline

• A trend that became more pronounced since the mid-forties during Peron administration

• Beginning of the era of inflation and the stop and go macroeconomic cycles

• Typically an expansionary phase stimulated by fiscal and monetary policies

• Always ended in balance of payments crisis due to lack of reserves and an overvalued exchange rate

• Cycles became more intense over the years

• Inflation hit triple figures in 1970s

• Devaluations in these cycles resulted in unsound banking system and led to debt restructuring or outright defaults.

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Argentine Economic History IV

• Since mid-1970s Argentina suffeed a large crisis approximately every seven years

• Widespread bank failures and sovereign debt defaults

• In 1989 country experienced hyperinflation.

• These were distributive episodes in which thee were sharp redistributions of income and wealth.

• Between 1975 and 1991, GDP per capita dropped 22 percent

• Worst period in Argentina’s economic history

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Argentine Economic History V• Hyperinflation marked a new turning point

• Triggered a new change in economic polices and

• Put the economy back on a growth path

• Between 1992 and 2013 economy grew at an average rate of around 4 percent

• Faster than that of most Latin American countries

• However there was a deep crisis in 2001

• Since then there has been some sifting of policies and a return to inflation

• Some concerns about the near-term outlook as the country is again in default with large fiscal deficits and balance of payments problems

• Still the post-hyperinflation period suggests Argentina may be on a new secular cycle that is simply on a pause due to macroeconomic problems.

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Lessons from History ILessons from Argentina’s growth patterns•First – Argentina grew faster in periods in which

• It was more open and more integrated with the world economy

• When it followed an export oriented strategy as opposed to those in which it adopted import substations.

•Second – The abuse of stimulus policies – fiscal deficits primarily financed by printing money in an environment of fixed exchange rates

• Started a new era characterized by high inflation and business cycles closely tied to an abundance or scarcity of reserves

• Typical stop go cycle – expansion driven by macroeconomic policies leading to higher imports and inflation

• Currency strengthened, balance of payments deficit often caused massive devaluation and further inflation

• Produced significant volatility and reduced the trend rate of growth

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Lessons from History II

• Third – exchange rate policy matters

• Most crisis occurred following a period in wich currency became overvalued

• When devaluation occurred it was recessionary because it affected domestic income

• Negative balance sheet effect that affected the ability of government and banks to service foreign currency debt

• Created a link between devaluations and financial crises

• Fourth macroeconomic financial crisis were very disruptive to growth

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Reasons for Optimism I

Some cause for optimism at the present time•First, although country is in default – this time clearly related to legal and political issues as opposed to the ability to pay

• Once new government takes office at the end of 2015 and debt resolved, country risk should drop

• Would open up way foreign capital inflows that should help reignite growth

•Second – Argentina has a sound banking system that this time is not the source of vulnerability – few foreign currency liabilities•Third key macroeconomic imbalances:

• The fiscal deficit

• Overvaluation of currency

•Have increased but not reached unmanageable levels as in previous crisis

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Reasons for Optimism II

• Solving macroeconomic imbalances will be critical if country wants to take full advantage of growth opportunities

• During Kirchner years a shift towards interventionist policies

• New trade restrictions – import substitution

• Directed credit lines

• Subsidized interest rates

• Numerous controls to access foreign exchange and

• A near freeze on utility rates

• Brought to a halt investment in energy generation transmission and distribution

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Assessment

• Country needs large investments in infrastructure and many sectors – mining, oil and gas, and agriculture

• If new administration does not address the incentives to invest in infrastructure and in key sectors, the macroeconomic improvements will

• Provide short-term relief but

• Not foster long-term growth

• Big question is whether

• The next government will be willing and able to attract investment and external financing to develop major projects or

• The country will again get trapped in domestic politics

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