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The mysterious case of the optimism about the relation between depreciation and growth

By Fabián Amico and Alejandro Fiorito* (Guest Bloggers)

The current debate about economic growth in Argentina, has accepted as dogma that the fast rate of economic growth between 2003 and 2011 had as its primary cause the devaluation in 2002, and the maintenance of a Sustainable and Stable Competitive Real Exchange Rate (SSCRER). Several economists attribute the current deceleration of economic activity to the real exchange rate appreciation.

The most analyzed economic variable is the real wage in dollars: between 2009 and 2011 the official exchange rate was devalued in 12.6%, while nominal wages in the private sector increased by 68%. In other words, the dollar value of wages increased almost 50%. In 2012 this was partially reversed.

How would a more competitive (devalued) real exchange rate stimulate growth? First and foremost it would lead to higher exports and lower imports, and then it would stimulate investment, and would generate more output and employment. The implicit assumption is that all the other components of demand would not change with the devaluation. But that is highly unlikely.

For at least 60 years it has well known that in Argentina devaluation have been contractionary. All available empirical evidence suggests that the sensibility of external trade (exports and imports alike) to variations of the exchange rate is extremely low. Yet, the inflationary and regressive on income distribution (associated to lower real wages) is considerably stronger, and, as a result, the global effect of a depreciation is contractionary. Worse even when devaluation is accompanied by fiscal austerity. The reduction of the level of economic activity has a depressing effect on investment compounding the negative effect.

Some economists suggest that the way in which devaluation generates an increasing demand for labor domestically – for a given level of activity – is related to the reduction in the relative price of the labor ‘factor’ with respect to capital. In other words, if a persistent reduction in the relative price of wages to capital goods (in dollars) were to take place, then the level of employment would increase irrespective of the rate of growth of the economy.

The devaluation of the exchange rate is, in this case, analogous to the neoclassical logic according to which a downwardly flexible real wage would eliminate the unemployment (and why wouldn’t one continue to devalue until full employment is reached?). But, in general, there is more rigid (technically) relation between capital and labor; ergo, even if relative prices change, the employment to output relation may not change significantly.

Surely, a SSCRER might have a positive role – together with other policies – in the maintenance of the external sustainability of the long term growth strategy to the extent that it contributes to export diversification and facilitates import substitution. Yet, this is a different proposition than suggesting a simple positive relation between real devaluation and growth: it really implies an exchange rate policy that is nuanced enough to maintain competitiveness, while not reducing real wages, which are the real locomotive pushing Argentinean economic growth. In sum, a ‘horizontal’ devaluation (without any type of differentiation in types of exchange rates or compensations for losers) produces an improvement in the profitability of exporters, a small effect on the volume of exports, and a contraction in the level of economic activity.

It is fairly clear that Argentina has a structural tendency to external disequilibrium between imports and exports, associated to the over dependency on primary exports, the low diversification of exports, and the composition of imports (which are entirely determined by domestic investment, and not by the real exchange rate). Domestic growth leads to increasing investment and this requires higher demand for imports of capital and intermediary goods, while exports grow at a lower pace. In other words, the propensity to import of the economy is incompatible with the countries’ export platform.

The counterpart to these arguments is that, contrary to what many defend, real exchange appreciation is expansionary, since is the other side of the coin associated with higher real wages. Note that in 2008 several economists already argued that the real appreciation was a matter of concern and that growth would stall immediately. Several argued that the time of ‘Chinese’ growth rates was over. Yet, after the 2009 crisis, in a context in which the real exchange rate had already achieved the late 1990s levels, the economy grew at record levels (9.2% in 2010, and 8.9% in 2011), while the industrial output grew even more (9.8% in 2010, and 11% in 2011). Something similar happened in Brazil and the result was, in both countries, the result of expansionary fiscal policy.

Clearly, other than the increase in real wages, it was the increasingly expansionary fiscal policy that explains the Argentinean recovery since 2003. This was for the most part unacknowledged since the government had a significant fiscal surplus since 2003, suggesting incorrectly that fiscal policy was contractionary. However, the most important component in the fiscal surplus was the increase in the tax revenues levied on exports. The government was able to use the revenues of the taxes on exports to pay the obligations on the external debt re-structured in 2005, increasing significantly its fiscal space. At the same time, the main categories of primary spending (public investment, social transfers, and wages) grew at a fast pace.

Nonetheless, there are deeper reasons for looking down on the role of fiscal policy. There is an almost complete consensus that expansionary policies in the context of an economy with an external restriction are by definition unsustainable. Instead of this ‘populist’ policies, the argument goes, it is suggested that a SCRER would be a more ‘serious’ alternative. However, the Argentinean economy, even if the main restriction to growth is given by its capacity to import, grows – as it did in the past, and as most medium and large countries do – pushed by the expansion of domestic demand. It is a structural feature, and not a policy option.

Another aspect – more circumstantial – that led to the misplaced optimism on the effectiveness of a nominal devaluation to become a real one, was the very low wage resistance exhibited by the working class back in 2002 (in the context high unemployment and labor flexibility). In the past, nobody would have accepted that proposition, since a maxi-devaluation would easily translate into a virulent wage-exchange rate spiral, with unpredictable results. And in this respect, it is possible that now, with lower unemployment, Argentina is back to its traditional situation.

The last aspect that favored the optimist views about the relation between the SSCRER and growth is the uncritical acceptance that the import substitution strategies, in general, and the processes of industrialization led by the State, in particular, were exhausted and disreputable. In this context, exchange rate policy looked like a suitable alternative in a world in which the State should have limited intervention in the economy and the process of development. Put simply, exchange rate policy (horizontal) is market friendly. Sadly, the effects of exchange rate policy are not the ones suggested by this optimistic new macroeconomic developmental consensus.

In sum, the feasible development strategies for Argentina (and for Latin America) do not simply change with the whims of fashion. The attempt to promote development by getting the prices right (the exchange rate in this case), is a vain utopia, that might have undesired consequences. The more it takes to return to the old wisdom and realism of the old Structuralists, the longer it will take to begin the practical reconstruction of a viable development strategy. This would necessarily require the intervention of the State in the difficult tasks of inducing selective import substitution, diversification of exports, modernization of infrastructure, and policies that promote technological change, within the context of high and sustained growth levels. It is not possible to leave all of these tasks to be performed by the change of one single variable.

* Researcher at CEFID-AR and Professor at UNLU, respectively.

PS: Originally published in Spanish in El Economista here, and also here. A similar view was discussed here before.


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